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Odey's cautionary comeback

Those whom the gods would destroy they first make hedge fund managers.

Those whom the gods would destroy they first make hedge fund managers.

Crispin Odey was schooled at Harrow and accepted into one of Oxford University's premier colleges, Christ Church, at 16. Coming down from Oxford, he trained as a barrister, then in 1983 joined a small British equity house, Framlington Group. Odey soon left for Baring Asset Management, where within two years, at the age of 26, he was put in charge of Baring European Growth Trust, at the time one of a handful of mutual funds that invested in Europe.

By 1990 Odey was recognized as a rising star. Peter Jeffreys, founder of Standard & Poor's subsidiary Fund Research, recalls: "His performance was right at the top of his peer group. He had a track record and a fundamental, stock picking investment approach that was really top drawer." Says Odey, "I seemed to have the knack of finding companies that would do well despite the recession." Indeed, he grew so confident of his stock picking skills that he decided to strike out on his own, establishing Odey Asset Management in 1992 to buy European stocks.

Plenty of talent spotters were eager to bestow money on Odey, but there was a catch: They would only back a long-short hedge fund manager. "People like George Soros and Gilbert de Botton [the founder of Global Asset Management] were very bearish at the time. They were keen to back European managers, but they didn't want money run on a long-only basis," says Odey, who at the time knew next to nothing about hedge funds. "Well, like an idiot, I said, 'If you want me to run it as a hedge fund, I will.'"

Certainly, his ignorance of hedge funds didn't appear to make any difference in his investing performance. In its first year his fund, Odey European, produced a 28 percent return, even as the MSCI Europe index slid 8 percent. The following year, 1993, the index rose 26 percent - and Odey's fund soared 42.9 percent. He rewarded himself with a £19 million ($31 million) payday. The spectacular returns did not come about because he shared his patrons' bearishness: He continued to invest predominantly long in European equities.

But by the end of 1993, Odey's market view was changing. He became obsessed with the specter of global deflation. Japan was three years into its economic contraction, and the world economy was still struggling to recover from the early 1990s' recession. The disappearance of German property developer Jurgen Schneider, who owed $4 billion, seemed to Odey to portend a European real estate and banking crisis similar to that in the U.S. in the late 1980s.

Odey loaded up on European government bonds, expecting yields to collapse and prices to skyrocket. For a time his strategy paid off. Then in the spring of 1994, the U.S. Federal Reserve Board, detecting signs of inflation, began raising rates, prompting other central banks to follow suit.

The interest rate cycle was now turning sharply against Odey, but he stubbornly stuck to his fixed-income strategy (as did many another money manager in that annus horribilis for bonds). Odey's exasperated investors watched their gains disappear as a once-dazzling stock picker seemed determined to become a bond manager at the worst possible moment. The MSCI Europe index had a lackluster year in '94, rising 0.2 percent, but Odey's fund tumbled 34.8 percent.

Investors rushed headlong for the exit. From a high of more than $950 million in 1993, funds under Odey Asset Management's control sank to $230 million in 1995. The flagship hedge fund saw its assets plunge from $770 million to $40 million. As surely as nemesis follows hubris in Greek tragedy, the none-too-modest Odey had been shaken and humbled. In an industry where two out of five new funds don't survive even five years, he could easily have packed up Odey Asset Management and settled for a quiet and comfortable oblivion in the English countryside, which he adores. His remote farm in west Gloucestershire, on the Welsh border near the Forest of Dean, is ideal for shooting, fishing and golf, all passions of Odey's.

His family would undoubtedly have been understanding of his transition from City gent to country squire. Four years earlier Odey had married Nichola Pease, then the only female director at London broker Smith New Court Securities and today chief executive of JO Hambro Capital Management. They have three children. Pease, Odey's second wife, is the daughter of former Barclays Bank vice chairman Sir Richard Thorn (Jock) Pease and the great-great-great granddaughter of a Gurney, one of the bank's founding families.

Another hedge fund manager who famously flamed out in the mid-1990s, David Jongh de Weil, wound up wandering the ashrams of India. But rather than skulk away, Odey went back to the drawing board to discover what it took to run a hedge fund properly. His first insight was that he would be crazy to attempt to continue to run the business as a one-man show. So in June 1995 he hired David Fletcher, who had been chief executive of a small U.K. merchant bank, to be chairman and co-CEO of Odey Asset Management.

With Odey watching the market and Fletcher watching the books, the firm has prospered. Odey Asset Management today has $650 million in assets. Its rise and fall and rise serves as both a comeback story and a cautionary tale for other hedge fund managers.

Odey attributes his decision to carry on to sheer bloody-mindedness, intellectual curiosity and the encouragement of two friends: brother-in-law John Varley, now finance director of Barclays, and Brian Marber, a well-known technical analyst and former fund manager who now works with Odey two days a week.

Like a therapy patient, Odey first confronted his mistakes in an unsparing manner. What Odey Asset Management required, he concluded, was not to be reinvented but to be refined. For one thing, the firm needed to invest in risk management systems.

"There was a complete failure to exercise any risk controls," he admits. In 1994 "I was ranting about deflation. You only had to look at one of my quarterly reports - they weren't reports, they were diatribes. When I read them now, if I had been a client, I would have sold out after a page."

Thanks to new IT systems, Odey now knows minute to minute what the maximum risk to his overall portfolio is from any position. He can also monitor other elements of risk, such as unexpected correlations among securities. This technological wizardry simply wasn't available a decade ago.

Still, Odey stresses that he hasn't delegated risk management to some black box. "I don't look at value at risk or anything like that, though I could tell you our beta at any point," he says. "What we do is work very hard not to lose money. We don't live with hope in the portfolio; we live with fear. Our view of the market now is: Take care of the downside, and let the upside take care of itself."

Once Odey had put his risk systems in place, he began adding more people, including a marketing and sales chief, David Helm, so that he could concentrate on managing money. "I'm building this business because I want it to be bigger than any individual," Odey says. "I like being surrounded by intelligent people." Odey Asset Management now has 23 employees, 11 of whom are investment professionals.

His unflinching examination of the firm also persuaded him that it needed a counterweight to his fundamental, value-driven investment style. So now Odey Asset Management relies on technical-investing techniques, from the rudimentary - stop-loss orders - to the sophisticated, to do active trading on top of old-fashioned stock picking. When stocks hit the top of their trading range, a disciplined Odey sells them. "Most long-only fund managers are in denial about a large part of their portfolios," he contends. "Once a stock has been bought, that's it, you love it and you hold on to it because you think the market will eventually learn to love it, too. But that's not good enough if you're running a hedge fund. In the 18 months it might take for your genius to be proved right, your clients have all gone." As Odey sees it, this painfully learned lesson applies in particular to hedge fund managers who, like him, come from long-only backgrounds.

But fundamental investing still dominates his style. He believes that the market can be relied upon to overlook opportunities. For example, early this year Odey was extremely bullish on British Sky Broadcasting Group, the London-listed satellite broadcaster, which happens to be owned by his former father-in-law, Rupert Murdoch. (The fund manager was married to Murdoch's eldest daughter, Prudence, between 1985 and 1986.)

Although most of BSkyB's 5.5 million British subscribers are sports fanatics, Odey contends that when the broadcaster goes fully digital in the near future and can offer 1,000 channels instead of 40, it should make huge inroads into the rest of the U.K. market, which comprises 25 million households. Within five years, he predicts, BSkyB will have doubled its market penetration and increased in value two- or even threefold. In short, a classic hold.

Still, Odey actively trades his BSkyB positions. He made a gain of more than 50 percent on the stock when it rallied last fall. In December he was selling BSkyB at £8.80 and buying it back at £8.00. He describes the current environment as "a trading market, which is really a euphemism for a bear market."

Gone is the imperious fund manager who thought he could defy the market. "Contrary to popular belief, being a hedge fund manager is not about being a master of the universe," muses Odey. "We believe the market is the master." Indeed, he characterizes the market as "a capricious king": "If the king wants prawn cocktails, there is no point in offering chocolate gäteau."

Odey swears that he no longer has any inclination to "fight the Fed," as he did in 1994. In any case, the issue is moot for the time being: He feels the Federal Reserve and other central banks are taking appropriate action to promote recovery. Nevertheless, his outlook as of mid-January was fairly bearish, in large part because he believes stocks remain greatly overpriced. Odey reckons that instead of a price-earnings ratio of about 19, the average European stock ought to be selling for no more than 10 to 12 times earnings. "If I were a long-only manager, I wouldn't know where to hide," he mutters.

Not surprisingly, Odey European is only about 15 percent net long at the moment. "This will be a great year for the short side of the portfolio," the fund manager says. "The returns will be made from understanding valuation dynamics rather than from the short-term trading decisions that characterized our portfolios in 2001."

For instance, he's bearish on pharmaceuticals. Britain's Shire Pharmaceuticals Group is a "great short," Odey says, because the patent on its top-selling Adderall, a drug for the treatment of attention deficit disorder, has run out. Similarly, AstraZeneca's patent on ulcer treatment Priolosec is expected to expire this year, he notes. As for longs, Odey characterizes the portfolio as a "little shop full of curios." One segment he sees as promising is U.K.-listed property companies.

Longer term, Odey fears a revival of inflation and, most of all, the prospect of European states' butting their noses further into the private sector. Odey cites Sweden's recent decision to nationalize its lumber industry. But he regards the British government's impending renationalization of Railtrack, the national rail system, as the most glaring case in point. He describes himself as "very exercised" by the actions of "Herr Majesty's" government. Indeed, he has been a ringleader in trying to rally other institutional shareholders to sue the government for compensation.

Today Odey Asset Management offers five funds and is still growing. In October 2000 it launched Odey Japan & General, a long-short Japanese equity fund run by former Henderson Global Investors fund manager Alex Griffiths. Another long-short fund, Odey Latham Global, was inaugurated at the end of May. Baring Asset Management alumnus Mark Latham is the manager. The long-only CF Odey European Trust, introduced in April 1997 and run by Hugh Hendry, who had previously worked at Scottish fund manager Baillie Gifford & Co., has been the top-performing unit trust in its class over one and three years. "Hugh could now run a hedge fund standing on his head," says Odey. "The risk disciplines and trading methodology we have developed here offer a lot to someone coming from a long-only background."

High performance remains the firm's drawing card. The flagship hedge fund, Odey European, has produced compound annual returns of 26 percent since 1995, trouncing the MSCI index's 13 percent. But - and this is what's new and noteworthy - Odey achieved these dramatic results with a volatility that was one quarter of the market's and a beta of just 0.26. Last year Odey European was up 7.3 percent in dollar terms, compared with a 21.6 percent drop for the MSCI Europe index.

"We have shown we can make money in bad markets, as last year has proved," boasts Odey. "I would say that we are like a money market fund that has an optionlike payoff in good markets. All of my contacts with private investors and increasingly with institutions tell me that this is very attractive."

Odey assuredly has fans. Richard Timberlake, founder and CEO of Investment Manager Selection, a London fund-of-funds with $3.5 billion in assets, states flatly, "Any portfolio of European managers should have some Odey in it." Adds another London fund-of-funds manager, "Odey does now have a credible set of risk controls and a very good track record."

Yet some wonder why, given that track record, Crispin Odey hasn't managed an even more impressive comeback. Timberlake suspects that the mud thrown at Odey in 1994 by rivals still sticks to him.

Moreover, though the erudite and entertaining Odey may be the "best dinner company in London," as one fund-of-funds promoter describes him, his charm comes with an edge that may put off prospects accustomed to blander fare. As Timberlake explains: "Odey is very bright and doesn't suffer fools, so one can imagine conversations and social situations where he simply leaves some people behind. That can lead to bad-mouthing."

Even fund-of-funds managers who readily acknowledge Odey's remarkable renaissance have been slow to include him on their buy lists. Fund Research's Jeffreys thinks the investment community should let bygones be bygones. "In all my long experience, the one golden rule is that with an outstanding fund manager like Crispin, you should almost be down on your knees begging he has a bad year, because it gives you an opportunity to buy," he says. "But that is not the way the City views fund managers. They see a great fund manager have a bad year and they are out of the door and often never come back, which is ridiculous. He did a great job up to 1994, and the way he has bounced back is even more impressive. He deserves more credit."

Still, Odey, who once backed a cigarette named Death (see story below), has shown little concern for the opinions of the men in gray. He staunchly defends his right to trade bonds and currencies as well as stocks, though this unnerves fund-of-funds managers who prefer one style per manager, please, and control one out of every four dollars invested in hedge funds. "Odey should be a viable investment, but the unwillingness to stick to one investment category is the problem," says one fund-of-funds manager. "It leaves the suspicion that even though the process may have changed, perhaps the person hasn't."

Odey accepts that his eclecticism creates controversy. "Fund-of-funds managers like to pigeonhole managers," he says, "and I suppose I refuse to be pigeonholed, not least because my money and that of my friends is at stake in the fund." Nevertheless, he sees enormous opportunities for Odey Asset Management, provided they're pursued on his terms. He compares fund-of-funds managers to medieval priests who purported to be the critical intermediaries between laymen and God: "My view is that the laity understand very well the philosophy of absolute-return investment, and if I need to build this business by talking directly to them, I will."

Odey's brush with Death

Death cigarettes were one of the more macabre marketing stunts of the past decade. Launched in 1992, they came in tar-black packages adorned with such slogans as "The grim reaper don't come cheaper" and "Light your pyre."

Not so surprisingly to those who know him, Crispin Odey was one of the backers of Death. Then 35, he had already made a name for himself as the manager of Baring European Growth Trust. But his voracious intellectual curiosity, classical liberal (that is, conservative) political proclivities and disdain for political correctness made him an obvious sponsor for this ghoulish but serious attempt to break into the British cigarette market. (Odey invested only his own money, not the fund's, in the project.)

He was determined to demonstrate just how profoundly the Single European Act challenged the powers of European national governments. Passed five years earlier by the European Community member states, the act removed - starting in 1992 - some 300 barriers to the free movement of goods, services and people within Europe.

Selling Death cigarettes across Europe's borders was to be Odey's smoking evidence of the act's sweeping impact on trade. If he could make a shilling being a merchant of Death in the bargain, so much the better.

Odey and the handful of other private investors who backed Death (including the son of a Danish fashion tycoon) established the Enlightened Tobacco Co. in low-tax Luxembourg. The eventual business model called for marketing Death as well as conventional brands to British smokers by mail order, bypassing U.K. customs and excise charges and cutting 40 percent off the price.

This was too much for British tax authorities, who hauled the company into court within four months of Death's launch. The British High Court, mindful of the threat posed to £8 billion ($12 billion) in annual U.K. tobacco taxes, blocked the scheme. In 1995 the verdict was upheld by the European Court of Justice.

Odey lost his small investment but made his larger political point by forcing the issue into the courts (and the newspapers). "We did help show just how radical a piece of legislation the Single European Act was," he says. "I do think it is possible to have fun, make money and make a serious political point. We achieved two of our three goals." - A.C.