The princely family of Liechtenstein didn’t get to be Europe’s richest royals, with a fortune estimated at $4.5 billion, by not taking care of their money. Along the way they’ve developed quite a penchant for managing other people’s riches as well.
Their ventures did not always win the family praise, but Prince Hans Adam II von und zu Liechtenstein, the ruler of the tiny principality located between Austria and Switzerland, and his younger brother, Philipp, have displayed a regal knack for snatching victory from the jaws of seeming defeat.
Consider the saga of LGT Chancellor. After spending a decade building a global asset management business, the princes unloaded this once-premier firm to Amvescap in 1998 for $1.1 billion. To the world they looked like forced sellers. LGT Chancellor was disintegrating, beset by poor returns and bitter infighting. Yet for all the bad publicity they earned, the canny princes managed to make a killing -- parlaying an investment of $318 million into a nearly $800 million profit. Moreover, they exited from traditional fund management at what turned out to be close to the high-water mark of what buyers were prepared to pay for asset businesses.
The family’s initial foray into hedge funds was also a chastening one. The princes were founding investors in ill-fated Long-Term Capital Management. When LTCM melted down in 1998, LGT Group, the holding company for the princes’ money management operations, took a $30 million hit. Nonetheless, LGT still made a double-digit return on its initial investment. How? Wary of the increasing opaqueness of the hedge fund’s accounts, the princes had sold a majority of their stake that year.
The early success of the LTCM investment whetted the princes’ appetite. In 1996 they created what is now known as LGT Capital Partners to manage their alternative assets and to solicit third-party co-investors. The proceeds from the 1998 sale of the LGT Chancellor mutual fund operation helped ignite the business, even as it led to a restructuring of LGT Group. The royals, who own vineyards, large tracts of forest and a private art collection that includes a dozen paintings by Rubens, narrowed their focus principally to their private bank, LGT Bank in Liechtenstein, and to building a business in alternative assets -- creating funds of funds for hedge funds as well as for private equity investments in venture capital and leveraged buyouts.
Marketing chiefly to institutions and to very-high-net-worth customers, the princes have built a thriving operation. Based in the tax haven of Pfäffikon, Switzerland, halfway between the private banks of Zurich and the princely castle in Vaduz, Liechtenstein’s capital, LGT Capital Partners now manages $3.7 billion -- $2.4 billion in private equity and $1.3 billion in hedge funds. With institutional money management businesses desperate for expertise in high-margin alternatives, fund-of-funds businesses are changing hands at 10 percent of assets, or five times the valuations of mainstream firms. In seven years LGT Capital has blossomed from little more than the princes’ family office into a business that could be worth $400 million.
Not that the family has any reason to sell. LGT Capital contributed mightily to LGT Group’s reported 2002 profits of Sfr115.9 million ($89.2 million). And it manages a healthy chunk of the family fortune, about 40 percent of the princes’ estimated $1.3 billion in liquid assets. Altogether about one seventh of LGT Capital’s assets is the royal family’s own money, evenly divided between hedge funds and private equity.
This commingling of funds is a big selling point for LGT Capital, which has embarked on an aggressive buildup of its private banking business. With the lure of offshore banking diminished by tough new anti-money-laundering rules in the wake of the September 11 terrorist attacks on the U.S., LGT has shifted its focus onshore, opening six private banking offices in Germany this year. Unabashedly embracing its heritage, it is advertising its services with the slogan “Investing like the prince.”
“We believe this is an important point of differentiation,” says LGT Capital Partners CEO Roberto Paganoni. “As well as the money from the princely family, most of the partners’ investable assets are in the funds. We think it is the best way to align the interests of clients, the firm and its owners.”
The approach is old-school Europe -- emphasizing capital preservation and a low risk tolerance. “We are in this business because we are passionately convinced that alternative investments, hedge funds and private equity -- are an important asset class that can protect and build wealth,” says LGT Capital partner Thomas Weber, a 14-year veteran.
LGT’s move into hedge funds was largely orchestrated by the 42-year-old, German-born Weber, who has a Ph.D. in mathematics from St. Gallen University, the finishing school for Switzerland’s financial elite. From there, in 1989, he was appointed a special assistant to former LGT Group chairman Christian Norgren. Prince Philipp replaced Norgren that year, following an investigation into Norgren’s role in an insider trading scandal involving the takeover of U.S.-based Combustion Engineering by ABB Brown Boveri, of which he was a director.
Weber then worked as an equity portfolio manager and later headed a small department that developed quantitative models. His interest in hedge funds was piqued by the royal returns the princes’ investment in LTCM was yielding. In ten months of 1994, LTCM was up 20 percent; in 1995, 43 percent; and in 1996, 41 percent. By the end of 1997, when the original investors were allowed to sell for the first time, $10 invested in LTCM was worth more than $28.
In 1996, LGT Group began to look at other hedge funds. Though LTCM’s returns were exceptional, Weber found they were far from unique. So he persuaded LGT Group to found an investment firm, then called LGT Non Traditional Advisers, and to establish an innovative fund-of-hedge-funds vehicle, Castle Alternative Invest. To encourage institutional investors Castle Alternative Invest was listed as a closed-end investment fund on the Zurich Stock Exchange in September 1996, only the second fund-of-funds vehicle to list in Europe.
“The more I looked at hedge funds, the more convinced I was that institutions should have access to the asset class,” says Weber, adding that the exchange listing was critical to soliciting funds. “It was the only onshore structure that worked in Switzerland at that time, and for reputational reasons institutions preferred to invest onshore rather than in the available offshore vehicles.”
Pfäffikon neighbor RMF Investment Group, set up by Ranier-Marc Frey in 1992 as one of the first fund-of-hedge-funds businesses in Europe, took a 20 percent stake in LGT Non Traditional Advisers and helped with investment advice. (In 2000, Swiss Life Group replaced RMF as an investor.)
The fund raised $120 million and now has $440 million. Then in early 1997, LGT Non Traditional Advisers established a private equity division and appointed Paganoni, a former McKinsey & Co. partner, as chief executive and Ivan Vercoutère as head of private equity investments. Vercoutère had worked at Pacific Corporate Group in La Jolla, California, managing money for the likes of California Public Employees’ Retirement System and the World Bank. The executive team also includes Maximilian Brönner, the leader of the private equity investment team; Tycho Sneyers, in charge of business development; and Kassandra Wipf, responsible for legal and compliance issues.
Castle Private Equity, launched in June 1997, was the first exchange-listed private equity fund of funds in continental Europe. It now has committed equity of $800 million and total assets of $1.2 billion.
All went well, initially. In 1997, Castle Alternative Invest returned 12.95 percent net of fees. Then came 1998. Castle lost 2.12 percent for the year, having sold down its LTCM stake as the fund grew less and less transparent and began losing money. Investors fled. From June through October, Castle’s portfolio suffered a cumulative drawdown of 10.15 percent.
But LGT did not walk away from hedge funds. Instead, after it sold LGT Chancellor in early 1998 and suddenly had more than $1 billion in liquid assets, it hiked its commitment to the asset class.
The princes asked Weber and his team at LGT Non Traditional Advisers to design an asset allocation strategy for the windfall. Weber in turn asked the biggest and best investment banks and fund managers, including Goldman, Sachs & Co., Morgan Stanley and UBS Warburg, for advice on model portfolios. Meanwhile, he and his team fed return and volatility assumptions into a portfolio optimizer and ran thousands of simulations.
Weber recommended that the princes put 20 percent of their assets into hedge funds and 20 percent into private equity. The balance of the portfolio was to be split almost evenly between traditional long-only bonds and equities, with the majority of the long-only money invested in passive or quasipassive index-tracking mandates. Such a barbell asset allocation has lately become fashionable in academic journals but was decidedly avant-garde then.
“We did a lot of quant work on strategic asset allocation, but ultimately, the allocation was based on our judgment,” says Weber. “We decided that there is a greater possibility of generating alpha from the skill of hedge funds and private equity managers. We are happy to pay for that skill. There is no skill to generating beta, so we want to pay relatively little for that.”
For LGT, which traces its history back to 1920, it was a short step from managing the royals’ money to soliciting outsiders’ investments. Paganoni says that LGT is pursuing a conservative growth strategy that aligns the interests of the firm’s partners with those of its investors. “Some firms are looking to grow because their principals want to exit, others because they are driven by a distribution machine,” he says. “We are invested in our funds and are driven by risk-controlled performance.” To that end LGT has no ambition to pile on assets. Instead, it wants to continue to serve a small but sophisticated institutional client base.
“We learned a lot from LTCM,” says Weber. “We analyzed what went wrong, changed our approach to risk management and built up our team and resources.” From three full-time employees in 1996, LGT Capital Partners now has 50; more than half research and do due diligence on hedge and private equity funds.
Paganoni adds: “We don’t want to be the biggest alternative investment house in Europe. We want to be the best in terms of performance and client service. Successful investing in alternative assets is about controlling growth and managing capacity, not maximizing assets under management. We want a select group of relationships with committed, long-term investors who understand the asset class.”
The support of a royal family that has been around since 1719 probably helps nurture this long-term perspective. It is an approach that has worked well for LGT. The closed-end fund structure of Castle Alternative, the backing of the princely family and the long-term contracts that come with segregated mandates from institutions mean that its assets are relatively stable and that it can afford to think strategically.
Throughout the 1998 hedge fund crisis, for example, LGT added to its positions with hedge funds that were suffering redemptions from other investors. For hedge fund managers this sets LGT apart.
“It is a generalization, but many funds of funds have a bit of a reputation for jumping from one hot fund to another. That is certainly not LGT’s style,” says Colin McLean, a founder of SVM Asset Management, which manages the Highlander Fund, a $1 billion long-short European equity fund that has been one of LGT’s top ten holdings. “It is good at building relationships. It is more methodical, disciplined and analytical than other fund-of-funds managers we have dealt with. It has an aura of maturity and experience.”
The firm’s character, he says, reflects that of hedge fund chief Weber. “I regard him as one of the most astute hedge fund investors in Europe,” says McLean.
Weber says that the typical LGT hedge fund portfolio turns over about 20 percent a year. It is LGT’s longevity and stability that give it access to funds such as Raptor Global Funds, run by Tudor Investment Corp., and Kensington Global Strategies, run by Citadel Investment Group, which have been largely closed for many years.
LGT Capital has two main hedge fund vehicles, Castle Alternative and the princes’ portfolio, which is known internally as the Global Investable Markets fund and is externally marketed as LGT Alternative Invest. Castle has about $400 million in assets, while GIM has $1.7 billion, which includes some private equity investments.
Both are managed with the same conservatism, described as typically Swiss by ABN Amro fund analyst Mark James. Neither fund’s performance has been harmed by that approach.
Despite its dalliance with LTCM, Castle Alternative boasts an 8.91 percent compound annual return since its inception, with 4.94 percent volatility (the MSCI world index has an annualized return of 5.22 percent, with 14.74 percent volatility for the same period). Since 1998 the worst losing months for Castle Alternative were 0.76 percent in November 2001 and 0.97 percent in March 2003. With these exceptions, the graph of its returns has been the smooth, upward-sloping curve that fund-of-funds managers like to boast they can deliver. Although the performance of Castle Alternative is bested by the 10.17 percent return of Hedge Fund Research’s fund-of-funds index, Castle has lower volatility than HFR’s 5.83 percent. It has also demonstrated better performance than other Swiss closed-end funds, such as Julius Baer Group’s CreInvest, RMF’s Swiss Life Absolute Return Strategies and Bank Leu’s Leu Prima Global Fund.
“From the risk-return perspective it is one of the very best funds available,” says ABN Amro’s James. “It rarely trades at a discount because it is such a high-quality portfolio. For many investors it is the only way to get access to funds like Raptor, Highbridge Capital Corp. and Kensington.”
The performance of the GIM portfolio has been similarly impressive. It has returned 9.9 percent annualized since its inception, versus a decline in the MSCI world index of 2 percent.
This track record has been noticed by some prominent institutions. LGT’s external clients include Axa Private Equity, Benelux insurer Fortis and AP3 and AP7, part of the Swedish national pensions system. Today 75 percent of LGT Capital’s $3.7 billion under management comes from external institutional investors, with the balance from the princely family and the firm’s partners.
Weber describes his investment process as bottom-up, driven by the imperative of getting access to the world’s most talented managers. “In the traditional long-only world, finance theory tells you that more than 90 percent of the variance of returns comes from asset allocation and less than 5 percent from stock selection,” says Weber. “In my view and experience, in the hedge fund world more than 50 percent of the variance of returns comes from manager selection.”
Weber heads a 16 person-strong hedge fund investment team. His chief aides include Bruno Hidber, who leads a manager selection committee that meets once a month, and Stefan Muehlemann, who directs the strategy allocation committee that meets quarterly. Weber thinks strategy allocation is gaining in importance but is still secondary to fund selection.
“Fund-of-funds investing is not just sitting around and picking some great managers,” Weber says. “There are times when it is right to be in merger arbitrage and times when it right to have a smaller allocation. But the reality is that most funds have limited liquidity, so it is hard to aggressively shift allocations around. There are also funds that you may want to stay invested in even if the strategy isn’t optimal, because once you sell it might be difficult to get back in.”
Weber describes his approach to manager selection as a variation on the core-satellite asset allocation model. Ten managers typically make up 50 percent of the overall portfolio, although at the end of July, it was closer to 60 percent. These are generally well-known names such as Caxton Global Investments (the world’s largest hedge fund), Raptor and Highbridge Capital. The remaining 50 percent satellite portfolio might be made up of as many as 20 other managers.
Weber says that buying into smaller, lesser-known funds allows LGT to grow familiar with the managers and their strategies and more flexibly manage its own growth. Satellite positions can become core if the manager does well. For example, McLean’s Highlander Fund, which is only three years old and relatively low-profile, was a top-five holding for LGT until this spring.
The private equity portfolios follow broadly the same core-satellite philosophy. There are big allocations to the largest buyout funds, such as Permira in Europe and Clayton, Dubilier & Rice in the U.S. But half of the portfolio is committed to smaller venture capital funds.
There is also an emphasis on secondary investments. “There are many financial institutions pulling out of private equity, often because they are distressed, and we see that as a great opportunity to acquire some good assets cheaply,” says CEO Paganoni. Last year LGT hired Marco Bizzozero, a leveraged finance specialist at UBS Capital, to lead its secondary investments team.
The Castle Private Equity portfolio has an annualized internal rate of return of 6.4 percent since 1997. Top-quartile performance for European private equity funds of funds is 2.8 percent over the same period, according to Thomson Venture Economics.
Having been for most of its life something of an exclusive (and secretive) Swiss club, LGT Capital Partners is now telling its story to Europe’s broader investment community. For years it scarcely bothered to market itself, but in 2001 it hired Sneyers, a Goldman, Sachs & Co. veteran who had most recently run AltGate, a London-based hedge fund research business, to head a business development effort. However, Sneyers is under no pressure to add billions in assets. “We can grow, of course we can, but growth is driven by investment capacity.”
Firms like Pfäffikon neighbor RMF, which was acquired by Man Group for $833 million in 2002, have far outstripped the growth of LGT. That doesn’t bother Paganoni. The firm has a partnership structure, and senior employees are incentivized with both equity and profit sharing.
“We feel comfortable growing our asset base by between 20 and 25 percent each year,” says Paganoni. “We want to generate the very best risk-adjusted performance, not to engage in an asset grab.”
That’s a very royal we, by the way.
