Author: Eric Uhlfelder

17 May 2010 Barron’s

One of The City’s oldest hedge funds have been quietly doing things a bit differently and very well, finds Eric Uhlfelder.

They are known as “Loz ‘N’ Belly” via Podcasts where every week they chat casually amongst themselves and the thousands of mostly Brits across the Internet on a wide range of topics from the trillion dollar bailout of the eurozone to the politics surrounding the latest occupants of 10 Downing Street, not to mention the latest soccer matches, especially when they involve West Ham and Newcastle United.

For Wall Street, this may seem to be pushing the regulatory envelope a wee bit far. But over there, as long as the managers aren’t promoting their funds, it’s considered cricket. And not only do the guys, otherwise known as Lawrence Staden and Steven Bell, enjoy bantering amongst themselves, they find it a helpful way to step back from their work and organize their thoughts. And other fund managers they work with consider it required listening.

Most remarkable about their folksy discourse is how it belies the fact that they are part of one of London’s oldest hedge fund firms, GLC Ltd–which Staden, 48, started in 1992; or that the firm manages over $1.6 billion in assets; or that their own Diversified Fund has been trumping most of its peers for quite some time.

Through April, the $320 million multi-strategy fund, which makes 1,000s of trades every year, was up nearly 18 percent annually over the past three years. During this time, it outperformed the Hedge Fund Research Multi-Strategy Index by more than 16 percent per annum, with an annual standard deviation of less than 12 percent.

Since it opened on July 1993, Diversified has had only three down years with the worst having been 3.62 percent in 2003. The fund ranked 34th in last week’s Barron’s Top 100 Hedge Fund Survey. And over its 17-year history, Diversified has generated annual returns of 10.96 percent, outdistancing HFR’s broad hedge fund index by 51 basis points a year.

[Note: HFR’s Diversified index does not go back to 1993. But annualized returns of the broad HFRI Fund Weighted Composite Index from July 1993 to April 2010 is 10.45 percent. BarclayHedge has a 10-year record for Multi Strategy funds: 8.27%; Diversified was up an annualized rate of 10.84% during that time.]

Steven Bell, 57, who runs the global macro side of the fund, explains that the fund has been able to deliver consistent long-term returns because one, it relies on uncorrelated strategies that invest across various markets, enabling it to deliver positive returns in virtually any investment climate. Two, it seeks modest short-term gains, instead of swinging for the fences on high-risk wagers. And three, it strictly monitors and limits downside risk by systematically reducing exposure as performance of individual investments deteriorate. For example, with every 10 percent drawdown [drop from peak to trough], the managers reduce exposure by paring back leverage 20 percent. Leverage is typically maintained around 1.8 times asset value.

“The worse drawdown the fund has ever suffered,” recalls Lawrence Staden, who oversees the long-short equity side of the fund, “was less than 16 percent between 2002 and 2004.”

Drilling down into its portfolio reveals that the Diversified Fund combines five distinct in-house trading strategies, run with the assistance of two additional portfolio managers, 12 researchers, and 17 traders.

The heaviest weighted strategy, comprising one third of the fund’s total exposure is a market neutral statistical arbitrage program that seeks to profit by investing in equities that have temporarily overshot–long or short–their fair market value. Investment duration is typically less than a week.

Nearly 40 percent of the fund’s exposure is in two systematic Commodities Trading Advisors [CTAs] that bet on currencies, bond prices, interest rates, equity indices, and commodities. One makes short-term directional trades that on average are no more than three days long. The other strategy involves longer-term behavioral investments that play out over several weeks.

A discretionary global macro strategy, representing another 20 percent of the fund, is designed to prosper in volatile markets through exposure to the same broad asset classes in which the CTAs invest. And a small portion of the fund, typically less than 10 percent, provides ballast through low-risk carry trades.

The effectiveness of integrating these strategies was made clear in 2008. When the average hedge fund declined by more than 21 percent, according to BarclayHedge, GLC’s Diversified fund was up 25.70 percent. All strategies were in the black. But statistical arbitrage surged 12.6 percent on institutional search for liquidity that produced asset rotation in and out of industries, which the model was able to exploit. The longer-term CTA soared 37 percent for the year after the collapse of Lehman Brothers solidified equity and Treasury market trends.

More recently, the fund has been profiting from the financial turbulence caused by recession and the sovereign debt crisis. In March, as negative sentiment toward British sterling continued to mount in light of the country’s increasing fiscal crisis and election uncertainties, Staden and Bell thought the pound was poised to rebound. “Over the past year and a half, it had already lost 27 percent versus a basket of develop market currencies,” says Bell. “We thought the country’s relatively high interest rates and low inflation prospects suggested the currency was undervalued.”

Bell saw the pending release off Britain’s fourth quarter current account deficit in late March as a potential trigger for a rally. “The market was expecting it to exceed £5 billion,” he recalls, “but we projected better numbers.” So before the data was released, the fund established long sterling positions against the euro and the dollar, representing 25 percent of the Global Macro portfolio. Several weeks later, the government reported a deficit of just £1.7 billion—the lowest quarterly figure in seven years—which sent sterling higher.

In the latter part of April, soon after the European Central Bank agreed to a €110 billion Greek bailout, major stock indices slid. The directional CTA model was suggesting the selloff was part of a longer-term trend. But it was simultaneously signaling the likelihood of a powerful near-term bounce. So during the black Friday when the markets were in free fall, the fund bought out-of-the-money calls on both the EURO STOXX 50 and the S&P 500. The following week, the options soared as markets rallied.

In early May, markets were still skeptical about government response to the European sovereign debt crisis, and continental stocks slid. The selloff hit the PIIGS [Portugal, Italy, Ireland, Greece and Spain] especially hard. However, the fund’s statistical arbitrage strategy saw these regional stocks oversold and safe haven equities overbought.

The model recommended a relative trade: long Spanish oil producer Repsol [whose underlying value was unaffected by the turmoil] and short German utility RwE. The following week, after European governments’ agreed to the trillion euro bailout package, money temporarily flowed back into regionally vulnerable markets and moved out of safer, lower-risk equities. This sent the value of this relative trade rising.

But many trades GLC makes don’t work out. “Even with 40 percent of our investments not being profitable,” says Staden, “we can still do very well.” One such misfire occurred early this year when GLC saw an opportunity to go long the Indian rupee against the US dollar. It was purely a technical trade. The rupee had been range bound for several months, and fund’s behavioral model saw it ready to breakout.

The longer-term CTA strategy established a 17.5 percent position in the currency at InR 46.11 per dollar, and initially the rupee did rally. But the currency reversed course, and a month later the model traded out of the position at InR 46.27.

Despite uncertainties surrounding European credit and growth, Bell is generally sanguine about the markets. “That’s not to say that Greece will avoid a tragedy,” quips Bell, “I don’t think it will and the country will likely restructure its debt, with bondholders taking a substantial hair cut. But pretty much every where else looks promising.”

He thinks emerging markets never looked healthier. The US is out of recession and growing. And even developed European economies are performing better than expected.

Staden and Bell see European leaders having drawn a line in the sand with Greece to stop contagion. They think the bailout package should buy troubled countries needed time to make structural changes and this will likely quell market fear of default.

Even if things don’t turn out that well, investors should take comfort in knowing “Loz ‘N’ Belly” appear to have developed a system that so far has been able to sidestep most landmines that have laid low many other hedge funds.

Exposure by Asset Class
30 April 2010
Interest Rate Futures 45%
FX 20%
Stocks 15%
Bond Futures 10%
Stock Index Futures 5%
Commodity Futures 5%

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