San
Francisco
October 10, 2005
Lou Gerken, Founder & CEO of SF based alternative asset manager, Gerken Capital Associates, asserts that today’s investors require hedge fund managers with a non-traditional approach towards managing emerging market funds. The Solution - The “Manager / Sub-Advisor Model”. Gerken asserts that utilizing the “right stuff” will yield a 500+ bp increase in risk-adjusted investment performance. The following interview set forth a number of questions challenging the firm’s assertions.
Why is there a need?
- 97% of the c. 8000 hedge funds globally with $1 trillion in AUM are focused on the U.S. and European capital markets
- U.S. and EU investment spreads and margins have dramatically narrowed compared with the last decade
- BRIC GDP growth is firmly set for 5-8% p.a. for the next 10+ years vs. 2-3% for the G7 nations…
- With less than 3% of global assets, BRIC hedge fund managers have not matured as a group
- Therefore, the investment decision is “not if, but with whom”
- Today the choices are scarce
What choices do emerging market investors have today?
- Large, global regional allocators
- Small, regional firms
- Long only funds and absolute return players
- U.S. and EU based managers
- Non regional ethnic managers
What is unique about the Manager/Sub-Advisor Model?
- The M/A model combines the best of both large and small manager strengths and benefits without the associated risks
- Right sized for optimal performance
- Research and due diligence bandwidth
- Fund operations and risk management infrastructure
- Established track record
- Established best of breed practices in place
- Flexible, agile and motivated
- Mitigate start-up “operating risks”
- Keeps the team in toe and ring fenced
- Emerging markets overlay
- Cross market and sector trade opportunities
- Insures Manager/Investor economic alignment
- Readily scaleable across all asset classes
- Significant investment capacity
What does the Manager do in the M/A model?
- Sponsor to the fund
- Provides working capital and initial close investment capital
- Chair, Investment Committee
- Portfolio Manager to the Fund
- Establishes investment strategy and dynamic asset allocation
- Provide global emerging markets over-lay
- Cross market and sector investment recommendations
- Review daily recommendations and approve daily trades
- Fund Governance
- Fund Operations
- Risk Management (operating, trading)
- Selection and management of Outside Service Providers
- Oversee Third Party Marketing and Capital Introductions
What are the Sub-Advisor’s responsibilities?
- Responsible for “bottom-up” fundamental and technical investment recommendations
- Alpha idea generation, i.e. stock picks and portfolio construction
- Beta exposure fine tuning through indexes, options and futures
- Gamma volatility measures
- Ongoing monitoring of the portfolio investments
- Buy/sell/ hold recommendations to the Manager
Why does the Sub-Advisor need the Manger…why not go it alone?
- Typically their first standalone hedge fund
- No hedge fund marketing experience
- Prior working relationship with Manager yields trust
- Manager emerging market/manager experience
- Risk adjusted benefits of the Manager/Sub-Advisor model
- Operating risk mitigation
- Manager emerging market global overlay
- Cross market and sector trades
- Alignment of objectives and economic interests
Why not invest direct in the Sub-Advisor Funds?
- The Sub-Advisor does not have a hedge fund to invest in
- The Sub-Advisor’s fund is not an apple-to-apples comparison and has limited appeal
- The Manager / Sub-Advisor Agreement contains non compete commercial provisions
What is the weakness, if any in the Manager / Sub-Advisor model?
- The Manager or Sub-Advisor can terminate the association with 90-days notice
- Key Man Clause in place to protect investors
- Manager has 90 days to remedy with investor majority approval or can immediately redeem
- Integrity of the working partners and prior working experience are of paramount importance
- Even IBM can lose a “top 10” revenue client relationship
What can the Manager do to mitigate this risk?
- GCA’s team consists of eight investment professionals
- Every professional has 20+ years of investment experience
- Save one, every professional has known the team for 20+ years
- GCA is building its “second tier” management infrastructure
How does the Manager/Sub-Advisor relationship work?
- Manager and Sub-Advisor jointly architect detailed investment strategy and policy procedures
- Manager PM confers with
Sub-Advisor daily to review/approve investment
recommendations and trades
- PM is the tough and critical taskmaster that keeps Advisors on track
- PM acts as catalyst for cross border and sector trade recommendations
- Monthly Investment Committee meeting to review prevailing investment outlook, strategy and operations
Why not just invest in a long only fund?
- Emerging markets risk aversion and volatility control
- Absolute return focus to generate profits in up and down markets
Why single out the emerging markets?
- The emerging markets are singled out because they do not today have a broad spectrum of established managers
What goes into selecting the right Sub-Advisor?
- Regional financial services powerhouse and/or specifically identifiable market targeted hedge fund experience
- #1, 2 or 3 in all asset classes
- Specific hedge fund management experience
- Established, on the ground indigenous team
- Skin in the game
- Key investment professional to directly participate in the economic performance
- Non competing hedge fund activity
- Committed to building a $1 billion hedge fund in five years
- Prior knowledge and/or experience working with the Sub-Advisor
Can you have more than one Sub-Advisor?
- Yes, if the underlying market dynamics justify
- Taiwan is the world’s 3rd largest daily trading volume and 4th largest derivatives market
- Taiwan market very different from the HK and China markets
- Although tightly correlated do not move simultaneously opening up cross market and sector trade opportunities
What case history do you have?
- Twenty alternative asset fund start-ups since 1974
- Emerging markets and emerging manager focus
- Special skill set akin to Silicon Valley, early stage VC’s
- Not readily replicable in large organizations or where there is a lack or direct experience
Where else might the M/A model work?
- Appropriate fit for emerging manager allocations
- Emerging manager and emerging markets are the only realistic ways for investors to generate significant alpha
Lou Gerken
Gerken Capital Associates
110 Tiburon Blvd., Suite 5
Mill Valley, CA 94941,USA
Office: (415) 383-1464
Mobile: (415) 272-1464
Fax: (415) 383-1253
Email: lou@gerkencapital.com
This message contains information that may be confidential or privileged and is intended only for the individual or entity named above. It is prohibited for anyone else to disclose, copy, distribute or use the contents of this message. This message is provided for informational purposes only and should not be construed in any way as an offer to sell, or the solicitation of an offer to buy, any interest in any entity or other investment vehicle. If you received this message in error, please notify us immediately at info@gerkencapital.com. Any views expressed herein are solely those of the author and do not necessarily represent those of Gerken Capital Associates or its affiliates. |
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