Gartmore’s company men

Who says you can’t run a successful hedge fund franchise within a traditional money management organization? Gartmore is doing just fine, thanks.

“There’s a long line of people telling me I’m crazy,” says Roger Guy

All around the world, from London to New York to Singapore, portfolio managers, bankers and research analysts are fleeing financial behemoths to join or set up their own hedge funds, lured by the freedom and -- these are not charities, after all -- the prospect of enormous wealth.

Then there is Mr. Guy, one of the world’s best stock pickers, who diligently plies his trade for Gartmore Investment Management. Inside the $73 billion London-based asset management group, a subsidiary of Columbus, Ohio’s Nationwide Mutual Insurance Co., Guy co-manages Gartmore’s top-performing flagship hedge fund, the $1.7 billion, long-short AlphaGen Capella Fund. Though he sacrifices the independence and some of the compensation that would come with running his own show, that’s fine with him. “I just love fund management,” says Guy, 37. “But I don’t want to be bothered with administration. Gartmore has always given me the freedom to do what I want.”

Empowering Guy, and others like him, is one of many shrewd moves made by Gartmore CEO Glyn Jones, and it’s a key reason the firm stands out: Only a few traditional big money managers -- Barclays Global Investors, Goldman Sachs Asset Management and Edinburgh-based Martin Currie among them -- have made a go of running hedge funds. Better known are the failures. In 2001, Boston-based MFS Investment Management abandoned its attempt to run hedge funds after star portfolio manager Brian Stack jumped ship. Lazard Asset Management’s hedge fund operation famously imploded in early 2003 when marquee manager William von Mueffling bolted to start his own shop and 75 percent of Lazard’s hedge fund assets followed him.

In less than five years, Gartmore has amassed $6 billion in hedge fund assets, attracted and retained a top-notch crew of managers and delivered impressive performance. Guy’s AlphaGen Capella, which invests in European equities, is up an average annual 21.4 percent on a net basis since its 1999 launch (see table), compared with a 17 percent average annual decline for the MSCI Europe index. Though last year was a chastening setback -- the fund gained just 6 percent, versus a 33.8 percent jump for MSCI Europe -- CEO Jones remains upbeat.

“I just don’t think there is a problem running a hedge fund business in the context of a traditional fund management company,” he says. “I say to fund managers here that there is an equality of opportunity. If they want to run a hedge fund and they are good enough to do it, Gartmore is a tremendous place to do it.”

Gartmore’s hedge fund bonanza is part of a bigger turnaround story at the firm. Largely an institutional equity shop -- the ratios of institutional-to-retail investors and stock-to-bond trading are both roughly 80-20 -- Gartmore was sent reeling in the late 1990s when poor performance in its core pension business, coupled with a shift to specialist managers among U.K. pension funds, caused clients to flee and assets to tumble. From 1998 through 2001, Gartmore’s assets plunged 35 percent, to £41 billion ($65.6 billion).

But in the past two and a half years, performance and fund inflows have greatly improved. Since its inception in October 2002, Gartmore’s £1.04 billion-in-assets high-alpha, long-only U.K. equity strategy has returned 50 percent, versus a 16 percent rise in the FTSE all-share index. In the past 12 months, its £37 million-in-assets high-alpha, long-only European equity strategy posted a 44.79 percent return, versus 25.3 percent for the MSCI Europe index. Meanwhile, net institutional inflows in long-only portfolios hit $2.5 billion in 2003. On the retail front 70 percent of Gartmore’s mutual funds won double-A or triple-A ratings from Standard & Poor’s; net retail flows totaled $3 billion last year.

Gartmore is betting that hedge funds will kick in an increasing share of its assets and profits -- a strategy that many second-guessed when the foray into alternative assets began in 1999.

“If you had asked me five years ago if Gartmore could succeed in running hedge funds, I would have said no,” says Paul Dunning, CEO of $10 billion-in-assets HSBC Republic Investments, one of Europe’s biggest funds of hedge funds and a Gartmore hedge fund client since 2001. “But I have been proved wrong.”

How did it happen? Most critically, Gartmore appears to have solved the knottiest problem facing all traditional money managers with hedge fund operations: how to navigate the wide gap between the compensation levels of independent hedge fund managers, who typically share performance fees of 20 percent of fund returns, and traditional portfolio managers, who earn a salary and a bonus. Gartmore keeps the details of its compensation program secret, but it must be doing something right: Just one of its more than 20 hedge fund managers has departed in the past three years.

Most long-only firms that have diversified into hedge funds have maintained two separate pay scales. It’s a less-than-ideal arrangement. Mainstream portfolio managers often resent their better-paid brethren, whereas hedge fund managers feel that they are subsidizing their colleagues. “The potential for tension is inevitable,” says David Smith, head of investment at Global Asset Management, a $34 billion-in-assets money manager owned by UBS that has $15 billion in funds of hedge funds. “It’s human nature to gripe when someone is doing disproportionately well.”

Gartmore, which launched the first of its 12 single-manager hedge funds, AlphaGen Capella, in November 1999, takes a different approach: It maintains one bonus pool for its analysts, traders and portfolio managers.

In addition, 18 of Gartmore’s 22 hedge fund managers also co-manage at least one long-only fund. That structure will become illegal in the U.S. if Congress passes the Mutual Fund Transparency and Integrity Act, sponsored by Representative Richard Baker, a Louisiana Republican. At Gartmore the double duty helps eliminate the us-against-them mentality that infects so many other money management firms with hedge fund divisions. It also encourages the longs and the shorts to share their investment ideas. “I think there is general understanding that hedge funds have contributed to the business,” says AlphaGen Capella’s Guy. “There’s no sniping, no envy.”

Adds Jones: “Our bonus pool is bigger because of the revenues hedge funds generate. This means that we can retain the talent we have and also attract talent to Gartmore that may have perhaps been beyond our reach before we had hedge funds.”

Several big names have already joined the team. Though Roger Guy is by far the best known of Gartmore’s managers, his A-list colleagues include Capella co-manager Guillaume Rambourg and Simon King and Ashley Willing, who run the top-performing AlphaGen Avior Fund, a $546 million long-short U.K. equity fund, and the long-only Gartmore UK Focus Fund, a $462 million mutual fund. Since inception in November 2001, AlphaGen Avior has returned an average annual 9.3 percent, versus an 8 percent decline for the FTSE. AlphaGen Volantis Fund, a $179 million long-short U.K. small-cap equity fund steered by Gervais Williams and Rob Giles, has returned an average annual 28 percent since inception in May 2002. The duo also run three retail funds: Gartmore Growth Opportunities Fund, Gartmore Irish Growth Trust and Gartmore U.K. and Irish Smaller Companies Fund.

“The fact that Roger Guy, one of the best managers in Europe, and very good managers like Gervais Williams and Rob Giles also manage long-only money is probably an inspiration to other Gartmore managers,” says Global Asset Management’s Smith.

Certainly, Guy and his colleagues are making a handsome living. Sources suggest that Guy could have made comfortably more than $20 million running the hedge fund while also earning his salary and bonuses for the long funds he runs. Out on his own he could have earned considerably more, pocketing a larger portion of the performance-based fee in addition to the management fee, while building a firm valued at roughly $320 million, or 20 percent of Capella’s $1.6 billion in assets.

For Gartmore, Guy’s compensation is money well spent, as hedge funds are becoming an increasingly visible and important part of the firm’s franchise. Gartmore is the sixth-largest European manager of hedge funds, after Man Group, UBS, Vega Asset Management, GLG Partners and Barclays Global Investors. The firm’s $6 billion in hedge fund assets includes $4.5 billion in 12 single-manager strategies; along with existing long-short equity, currency, emerging-markets and credit funds, a new long-short financial sector equities fund debuted on July 1. The remaining $1.5 billion is in a U.S. fund of hedge funds, Gartmore Riverview, which Gartmore acquired in June 2002 for an undisclosed price. Although hedge fund assets account for less than 10 percent of Gartmore’s total, they contributed 35 percent of the firm’s 2003 revenues. CEO Jones wants hedge funds to kick in 50 percent of revenues by the end of 2006, when he expects hedge fund assets to hit $10 billion.

“We have identified a range of strategies we will seek to incubate,” says Jones. “I am extremely confident that we can grow this business at a rapid rate.” He plans to launch new hedge funds that are closely related to the current lineup. So, for example, he has seeded a quantitative long-short pan-European equity fund.

If Jones succeeds, he will hear nothing but cheers from Gartmore’s parent. In May 2000, when asset management businesses were fetching record sums, Nationwide paid £1 billion, or 1.9 percent of assets, to buy Gartmore from National Westminster Bank. Today, even amid a hedge fund boom and resurgent equity markets, Gartmore would probably sell for no more than £775 million.

THE 35-YEAR-OLD FIRM HAS LED A NOMADIC corporate life. It started as the fund management arm of British & Commonwealth Holdings, the family company of the Cayzers, a Scottish clan that made its fortune in shipping and finance. (Gartmore takes its name from a village on the family’s former estate in the Scottish Highlands.) In the early 1970s, Gartmore began to manage retail money in investment trusts; by the end of the decade, it reported £700 million under management.

Paul Myners, an NM Rothschild & Sons banker who joined Gartmore in 1985 as CEO, pushed the firm into the pension fund business. Gartmore made a name for itself two years later by anticipating the market crash: Well before Black Monday the firm had moved its balanced funds into cash and bonds.

In 1990, B&C sold Gartmore to Banque Indosuez, a French investment bank. That relationship never flourished, and in 1993 the bank floated a 25 percent stake in Gartmore on the London Stock Exchange to raise capital and give the asset manager some measure of independence.

A few months later Guy joined Gartmore as a European stock portfolio manager. A 1988 economics graduate of the University of Sussex, he had worked as an analyst and European stock mutual fund manager at Eagle Star, a U.K. insurer now owned by Zurich Financial Services. After beating his benchmarks for several years at Gartmore, Guy was given the reins of the firm’s high-profile European Selected Opportunities Fund, a large-cap equity mutual fund with a growth bias whose assets now total $3.2 billion. He turned in a tour de force performance. For the ten years ended in April, the fund returned an average annual 21 percent, more than double the return of the average European stock fund.

In January 1996, British retail bank NatWest, now part of Royal Bank of Scotland Group, acquired Gartmore for £472 million. NatWest thought it could create a wealth management powerhouse, leveraging Gartmore’s investing expertise with NatWest’s distribution strength.

It didn’t happen, largely because by the mid-1990s the performance of Gartmore’s institutional portfolios had begun to deteriorate, even as the retail funds run by Guy and his colleagues continued to beat their benchmarks. By the end of 1999, Gartmore’s core U.K. balanced pension fund portfolios ranked in the bottom quartile of their peers, according to CAPS, the U.K. performance measurement service. Gartmore suffered $30 billion in net institutional outflows between 1998 and 2002.

In the midst of these troubles, Madhav Misra, then head of Citibank Alternative Investment Strategies Group, appeared on the scene, looking for long-short European equity managers for Citibank’s high-net-worth clients. Misra, now chief investment officer of Allianz Hedge Fund Partners in San Francisco, had admired Guy’s performance running the European Selected Opportunities Fund and thought he would flourish as a hedge fund manager. “I put the idea to Roger and Gartmore CEO Myners,” Misra recalls, “and we set up a small separate account for Citibank in February 1999.” It was Gartmore’s, and Guy’s, first foray into hedge funds.

Guy continued to manage European Select while running his new long-short separate account for Citibank. After six months the separate account was up 80 percent -- and Gartmore’s marketers were eager to exploit Guy’s newfound talents. In November 1999, Myners green-lighted the launch of the AlphaGen Capella long-short hedge fund. The name is meant to suggest “alpha generator"; Capella is a cluster of stars. (Many of Gartmore’s funds, including Avior, Cepheus and Volantis, are named after stars.)

AlphaGen debuted with $77 million in assets, $70 million of which came from Global Asset Management. From his days as a pension fund consultant, Global Asset Mangement investment director Smith had been impressed by Guy.

“There’s a misconception that you can build a hedge fund around a great stock picker, but very few are successful,” Smith says. “Stock pickers fall in love with companies, and volatility can destroy them when they are running hedge funds. Hedge fund managers need a trading mentality, and Guy has one.”

Guy never hesitates to -- as William Faulkner famously advised aspiring writers -- kill his darlings. He notes: “I have always been a believer that the market can stay irrational for a lot longer than any investor can stay solvent, as Keynes said. I don’t fight the market. I never take the view that I am right and the market is wrong. I don’t even like short-term performance volatility.”

Managing AlphaGen Capella has only heightened this sensitivity. “Running the hedge fund has helped keep Roger at the top of his game,” says Robert Burdett, who runs $4 billion in multimanager portfolios at Credit Suisse Asset Management.

Guy usually splits both his long-only and hedge fund portfolios into two components. One half is made up of long-term fundamental stock picks, usually large caps, which he may own for two or three years. The balance is composed of short-term ideas: trades that may last between one and six months and are driven by particular events, market trends or catalysts other than valuation. For the most part, the long-term stock bets appear in both the hedge fund and the retail mutual funds. Guy reports that about eight of the top ten positions are identical for both European Selected and AlphaGen Capella.

For his long-term picks, Guy often chooses growth stocks with earnings momentum that is outstripping analysts’ forecasts -- companies like Sogecable, Spain’s fast-growing cable TV operator, which Guy holds in both European Selected and AlphaGen Capella. “Sogecable is a great company and a well-known growth story,” he says, “but my view is that the market is still underestimating its potential.” Guy also favors companies with high free cash flow, such as Total and Telecom Italia.

A longtime advocate of hedge funds, Gartmore CEO Jones has a special respect for Guy’s unique talent as a portfolio manager playing both long and short: “This business is all about talent and skill. If you have managers of the caliber of Roger Guy and Guillaume Rambourg or Simon King and Ashley Willing, your job as CEO is to nurture it.”

The former chief executive of London-based private bank Coutts Group -- which he had pushed into alternative investments -- Jones arrived at Gartmore in December 2000, replacing the retiring Myners as CEO. He immediately focused the firm’s energies on producing more alpha across all its portfolios and asset classes.

“We are in the business of alpha generation,” Jones says. “I think of Gartmore as a series of boutiques focused on producing alpha.” To that end, he sold off Gartmore’s £18 billion passive management business to State Street Global Advisors for an undisclosed price soon after becoming CEO.

“I immediately determined to press the accelerator on hedge funds,” Jones says. Gartmore subsequently launched ten of its 12 single-manager funds and bought U.S. fund of hedge funds Riverview International.

The acquisition of Riverview gives Gartmore an outpost in the U.S. as well as a presence in the fund-of-hedge-funds market. Jones believes institutional investors will eventually become savvy enough to buy single-strategy hedge funds on their own; for the moment, though, most U.S. pension plans prefer funds of hedge funds. “Our single-strategy hedge fund business is very European-focused in terms of strategies and clients,” he says. “Riverview gives us a window into what is happening in the U.S., which is still by far the most important market in the world.”

With each new fund Gartmore followed the pattern established with the AlphaGen Capella debut in 1999: When introducing a new hedge fund, Gartmore first sets up a managed account with seed capital from an outside investor. After a few months, if performance is strong, the firm embarks on an official launch.

Gartmore’s AlphaGen Currency Fund began as a managed account in April 2003 with seed capital from Lyxor Asset Management, a division of Société Générale that had backed three other Gartmore hedge funds. AlphaGen Currency formally debuted in February of this year with $70 million in assets; as of mid-June the asset total remained the same. Managed by Bob Jolly, a 20-year Gartmore veteran, AlphaGen Currency is down 0.6 percent since inception.

“Throughout the 1990s it was clear that overlay, which was driven by a desire to take currency risk out of equity portfolios, was generating returns,” says Jolly. “But it became clear that currency can generate returns, as well. They look modest when equity markets are booming, but they are significant. Many overlay mandates now allow us to short currencies, so in many ways they look like low-risk hedge funds.”

Currently, more than 80 percent of the money invested in Gartmore’s single-manager hedge funds comes from fund-of-hedge-funds investors. Funds of funds often negotiate deals that give their clients some break on the double layer of fees, the fund-of-hedge-fund fees (usually 150 basis points) and individual manager fees (typically a 1.5 to 2 percent management fee and a 20 percent performance fee). Gartmore, like many hedge fund managers, would like to pull in more direct investments.

With an incumbent institutional client base and 12 institutional marketers on staff, Gartmore boasts strong connections to the plan sponsor community. Last year, in a nod to Gartmore’s sales savvy, Aspect Capital, a $3 billion-in-assets London-based managed-futures hedge fund, outsourced its pension plan marketing to Gartmore.

Slowly, the firm is attracting more direct investments. In the first five months of this year, Gartmore received four direct investments, totaling £100 million, from pension funds. These included an £11 million mandate from Flintshire County Council, a £560 million U.K. pension fund, for AlphaGen Currency.

“The fact that we have a long institutional heritage helps enormously in winning this business,” says Charles Beazley, head of Gartmore’s alternative and institutional operations. “I don’t know how many pension funds will invest directly next year, but I guarantee it will be more.”

Jones is convinced that Gartmore’s hedge fund foray has bolstered the firm’s long-only business by intensifying focus on alpha generation and helping to attract and retain talent. Good long-only portfolio managers at Gartmore know that they stand a decent chance to one day run a hedge fund. “Fund management is about talent first and foremost,” Jones says.

Certainly, Gartmore has worked to lure some top people. In late 2002 the money manager hired David Thompson, a sell-side analyst Guy admired, from Credit Suisse First Boston. Thompson took the reins of a new directional European equities hedge fund, AlphaGen Velas, in May 2003; it has pulled in $162 million and returned 9.1 percent for its first year.

In August 2003, Gartmore launched the AlphaGen Credit Fund, managed by Mark Wauton, former head of European fixed income at UBS Global Asset Management, and Varkki Chacko, who had overseen European credit research at Goldman Sachs International. Today fund assets total more than $100 million.

Once shunned by consultants, Gartmore is back on many buy lists. Indeed, the firm’s high-alpha, long-only institutional portfolios have won close to $800 million in the past 12 months. Among the new clients are the pension funds of U.K. catalogue retailer Argos and German utility E.ON.

The firm’s long-only retail funds are also winning praise from a growing contingent of independent financial advisers. “Gartmore has kept a low profile in the past few years, but we sense this is a house on the up,” says Meera Patel, a fund analyst at Hargreaves Lansdown in Bristol.

Nor do Gartmore’s investors seem concerned about the potential for conflicts of interest as the firm straddles the worlds of hedge funds and long-only mutual funds. Jones acknowledges that clients and prospects have questioned this, but he says he is not aware of a single investor who has walked away from Gartmore as a result.

“Of course we recognize the issue,” he says. “When one fund has the potential to generate fees of 300 basis points and another fees of 100, then there is an issue. But there is already a conflict if a manager is running an institutional segregated account where the fees may be half that of a mutual fund. These are issues that are dealt with all the time already.”

For example, Gartmore imposes stringent rules on the allocation of trades and the timing of dissemination of research from analysts. In addition, the fact that Gartmore manages long-only funds for retail investors means that all of its individual fund managers are subject to the tough regulatory regime of the U.K.'s Financial Services Authority.

Although the firm has found a way to meet the considerable challenges of running a hedge fund operation within a traditional asset management shop, it’s doubtful that many of its peers will follow suit. Says Allianz’s Misra, who helped set Gartmore on the hedge fund trail five years ago: “Ninety percent of the money managers that try to run hedge funds will fail. Gartmore is the exception, not the rule.”

Gartmore?s hedge portfolio
With a top-notch crew of managers, led by star stock picker Roger Guy, the firm has $6 billion across a range of styles and strategies.

Date Assets Annualized return Investment
Fund launched ($ millions) since inception* approach
AlphaGen Capella 11/1/1999 $1,682 21.40% Large-cap European

equity long-short
AlphaGen Hokuto 11/6/2000 286 7.3 Japanese equity

long-short
AlphaGen Cepheus 3/1/2001 197 7.7 Small-cap European

equity long-short
AlphaGen Pictor 7/2/2001 114 6.9 Pacific and emerging-

markets equity

long-short
AlphaGen Avior 11/1/2001 546 9.3 Large-cap U.K. equity

long-short
AlphaGen Altai 12/13/2001 272 2.4 European equity

sector-neutral
AlphaGen Volantis 5/1/2002 179 28 Small-cap U.K.

equity long-short
AlphaGen Currency 4/1/2003 70 ?0.6 Currencies
AlphaGen Velas 5/1/2003 162 9.1 Large-cap European

equity directional

long-short
AlphaGen Credit 8/1/2003 103 11.5 Global credit

long-short
AlphaGen Arneb 12/28/2003 74 10.1 Global health care

long-short
AlphaGen Rhocas 7/1/2004 Aims for N/A European financial

$150?$200

sector equity

on first close

long-short
*Through May 31, 2004.
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