The Italian markets were shaken in recent weeks, creating opportunities for investment firms with agile trading and investment operations.
In our June show, Sean George, chief investment officer at Strukturinvest Fondkommission, explains how the trading capabilities of alternative investment funds (hedge funds) differ from long-only asset managers, and advantage that offers investors in volatile markets.
Dan Barnes Welcome to Trader TV Fixed Income – your insight into the trading climate for professional bonds, investors. I’m Dan Barnes. Within traditional fund managers, the trading desk is the point at which investment strategies are made real. Returns are realized or not as those strategies play out against market events. For hedge funds, returns can be generated through trading itself as opportunities present themselves. In June’s show we’ll be talking about alpha generation with Sean George, chief investment officer at hedge fund StrukturInvest Fondkommission, and digging into the different ways a hedge fund manager trades. Market data is provided by MTS. Sean, welcome to Trader TV.
Sean George Thank you for having me.
Dan Barnes So can you tell us a little bit about the funds that you manage, and the way that trading execution differs for you than it might for a long only asset manager?
Sean George I am the chief investment officer for a fund called Hamiltonian GCO, it’s a global credit fund I launched with about 50 million dollars.
Dan Barnes You have more flexibility than a traditional long only fund manager might, when looking at the investment and trading process combined. Can you explain how that flexibility sort of manifested?
Sean George Well, to begin with, we are an AIF (alternative investment fund), and then you have an UCITS fund, which is the format for the traditional long only funds. We looked at the UCITS format and we looked at the AIF format, and we chose the AIF format, and we did it exactly for that; the flexibility, the levers. We can short bonds, which you can’t do in a traditional UCITS fund.
Dan Barnes And that’s short selling.
So that we are betting on the price, or we’re investing in a bond that we think the price is going to fall. And fx, the people that did that in Italy had great months in May. The people that were long, Italy had terrible months in May. So, you can be risk mitigating, you can use more leverage. So, fx, if I wanted to short Italy – which we didn’t, so I’m not saying that we did – if I wanted to short Italy on the way down, and then we felt on that Tuesday, when we had the big event in the two year, that this was overdone. The market is pricing a binary event, i.e. that Italy is going to leave soon, which we didn’t believe. We can also deploy leverage, so in our fund we use a nominal amount of leverage. We can use up to 3x net leverage, which is not a lot for a hedge fund. A UCITS fund I think can do about 1x net leverage through derivatives. So we deviate from the UCITS fund, but now, as the market’s kicking up, as it’s coming back from the lows, deploying that leverage provides a greater return. So I would say that we have a break in that we can hedge via a shorting bonds and buying derivatives, and we have a turbo, where we can use the leverage coming out. If you imagine you’re coming into a turn on a racetrack, you want to have some brakes going into that corner and then you want to have the turbo coming out. And that’s the difference of flexibility you get in an AIF vs a USITCS.
Dan Barnes Do the portfolio manager in the trading function interact in a different way at a hedge fund compared to a long only fund do you think?
Sean George We’re an emerging hedge fund managers, so the PM’s and traders are one and the same. So Ulf Erlandsson and I, we are the PM, the trader and the analyst at this stage. In our instance, we think the trader/PM function works. When I started out on the buy-side in 2000, the trader was the PM as well. And that was a long only insurance company that had total rate of return assets as well. So from where I come from, I like the trader and the PM to be the same person. I know it’s very popular to segregate the trader and the PM role, but I think there’s information slippage, so what I may view as important may not come to me from the trader. And remember the corporate bond market is still very voice dominated, i.e., a lot of the transactions that we conduct are done by phone. When you’re on the phone with somebody and they know you, trust you, or you’ve worked with them for two decades, and as in my case, you’re going to get a little bit more information. You’re going to get the extra bit of color. And if the trader and the PM is the same person, all that information gets synthesized into the organization and processed properly.
Dan Barnes That means you can react quickly to things presumably, which might be more challenging if that function separated?
Sean George I mean, perfect example was Italy a couple of weeks ago. We were, for one stunned, because we were in the middle of ramping when this started to percolate and we stopped buying. So we had only invested a little bit of our funds and everything that we bought was down during that period. I don’t think there’s a lot of people that had any assets that were up during that period. But we looked at each other. We read some articles in the Constitution. I mean, it wasn’t as simple as, the market was pricing, they’re leaving now! And then we turned to each other and said, ‘I think this is way overdone.’ And then we said, ‘OK, where are the best risk-adjusted opportunities for us, so we can buy dollar, sterling, kronor?’ And we looked at the euro AT1 bank market, so the contingent capital bonds that the banks have issued, and we were looking at bonds that were down 8,9 points, in a very short period time. In a 3-4 week span, they had spiked down. We turn to each other, we said, ‘OK, we are comfortable with a tiny bit of Spain, a tiny bit of France and very comfortable with Scandinavia, very comfortable with the UK.’ And we ramped up our book on that day. Today we obviously had the ECB discussions, so are the information coming out about the the bond purchases? And two days ago, DTCC, so this is where all the derivatives are deposited and everybody can see the numbers, which is a positive to show that the market had over hedged going into this decision. And so the net positions were very, very short. The European market through main and I-tracks. They hedged a fixed rate problem, and the problem was that the underlying treasuries, the risk-free rate would be rising and they would stop buying corporates. Well, if the risk-free rate rises and we have those two indices at the same level, they were before the ECB started buying, it made a very easy decision for us. We’re supposed to be long going into this and we set along at wider levels than they were, even this morning. And that information, that decision-making process, when I turn it over, it synthesizes directly into the portfolio, you know, after we’ve done all of our homework and dotted our I’s and cross our T’s.
Dan Barnes That’s a great example, thank you. And so the flow of data and the information that you need, presumably you need a wider range of data than a portfolio manager might if they had a more limited set of choices?
Sean George Exactly. And that’s a fantastic question. Luckily, my partner, Ulf Erlandsson, is a quant, and he has several models that will alert us to moves that are bigger in the market than normal market moves. And we can go and SWAT team – if you will, to be an American – the situation. Is it AT1’s in Europe like it was these past couple of weeks? Is it Spanish covered bonds? Is it US high yield? Is it US investment grade? Is it the TMT space in the US, because of all the M&A? Whatever it may be. It is almost like a fishing line, so it will pop up like, ‘oh, there might be something on the line,’ and you reel it in, oh, it’s seaweed, or reel it in, aAnd I got a big fish and then we’ll decide, ‘OK, this looks like an interesting position to have in the portfolio,’ and then we’ll do the fundamental analysis after the fact. Two people cannot cover as much ground as we need to cover, but with the quant analysis that we do, we can cover that ground and then only focus on the things that actually have moved where we think there may be an opportunity.
Dan Barnes So what sort of scale limits are there to a hedge fund strategy?
Sean George So we have sized our fund based on the restrictions that we have around it. We’ve capped it at 500 million dollars, which is rather low for a credit hedge fund. But we did that for two reasons. One, we have a daily nav and daily liquidity. But secondly, our transaction costs are we can use three times levered, so our transaction costs become onerous, i.e. pulls away from the performance of the fund if it’s too large. So we set a cap on our fund to protect against the transaction costs.
Dan Barnes Sean, thanks very much for coming on the show.
Sean George Thank you. It was a pleasure being here.
Dan Barnes I’d like to thank Sean George for his insights today, MTS for our rates data, and you for watching. To catch our monthly reports on the market or to subscribe to our newsletter, go to TraderTV.NET.
