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Trader-Investor Finds Value in Niches
At a time when the worldwide stock market rally may be diverting attention from other strategies, we looked for an investor who persistently seeks the less crowded niches. Nick England, founding director of Guernsey-based Channel Islands Alternatives Ltd. (CIA), fits the bill.
Mr. England came to hedge funds and commodity trading advisors initially to invest his own money, after 12 years of options trading and market making on the LIFFE Exchange in London. He had developed an option trading and risk model and set up an option market-making firm specializing in short-term interest rates and the FTSE index in the mid-1990s. He has worked for several City institutions, including Salomon Brothers, Morgan Grenfell and NatWest Investment Bank.
He now runs the Hurdle Fund, an exchange-listed fund of hedge funds that has an annualized return of 9.2% since inception, with a Sharpe Ratio of two. It was one of the few fund of funds that did not lose money in 2008, returning 3% in GBP, 0.81% in Euros and -0.68% in USD.
The fund has a relatively large allocation to managed futures. As of July, 16% of assets were invested with systematic CTAs while 6.9% was in commodity funds, 1.9% in macro and 3.7% in currency. Below he talks about the strategies that offer better value this year.
His partner, Steve Brawn, was previously an executive director at Sanwa International, where he was responsible for volatility trading, running proprietary activities and hedging strategies for the structured product group until 2002. Between 1987 and 1994 Mr. Brawn worked for the derivatives divisions of the Bank of Nova Scotia and Midland Montagu.
Nick England , "We like to drill down to the details and build macro exposure by finding specialists in particular spaces."
Opalesque Futures Intelligence: How did you become a hedge fund investor?
Nick England: I started my career as an options trader and later became a market maker. When electronic trading became dominant, I co-founded an inter-dealer broker firm, set up to capture the increased volume in traded futures and options. The capital that I¢â‚¬â„¢d been trading was then invested in some hedge funds I happened to know, whose investment style I liked. Subsequently I wanted to invest in hedge funds more systematically so I studied them in depth.
OFI: Why didn't you invest through a fund of funds?
NE: Realizing that many investors rely too much on leveraged beta made me uncomfortable about putting my money into funds of funds. In 2004 Steve Brawn and I developed a process to build a better risk-adjusted hedge fund portfolio. We developed a portfolio heavy on trading strategies and with a focus on reducing drawdowns. Initially we had private investors but in 2006 we created the Hurdle Fund, which is listed on the Channel Islands Stock Exchange.
OFI: What's distinctive about your approach?
NE: We try to stay out of wherever the hot money is going and to find better risk vs. reward tradeoffs. Our universe is probably wider than the norm, considering that many investors focus so much on long/short equity. Many fund of funds people have an equity background and are more comfortable with equity investing. We think long/short equity is expensive, so we don't want too much exposure in that area. Having traded complex options, we have a different perspective on risk than an allocator who's never traded. Our process proved itself in 2008. We were among the few hedge fund investors who did not have a double-digit loss.
OFI: Which strategies look promising for the near future?
NE: We see more risk in inflation rather than deflation, despite all the talk about deflation in recent months. Inflation risk favors commodities, but with a discretionary approach rather than systematic trend-following.
OFI: Aren't commodities extremely volatile?
NE: Our view is that the reward is worth the risk if you pick managers who've been in the commodity space for a very long time, understand it inside-out and have great connections and information flow. There's no point in backing a trader who trades on information that's in the news. We like specialists. Also, we tend to go for managers with less assets under management because we feel more comfortable about their ability to extract alpha. Managers trading large capital may get stuck in a position, have more slippage in trading and there are other additional risks to take into account.
OFI: Why do you favor discretionary approaches rather than systematic commodity trading advisors?
NE: This year there are definitely opportunities for alpha in discretionary macro strategies. We like to drill down to the details and build macro exposure by finding specialists in particular spaces. Right now we're not looking to allocate more money to trend-following CTAs because they don't do well in choppy markets. But we've been actively looking for other CTAs whose algorithms have a better chance in markets where there are sharp moves.
OFI: Do you find that CTAs are prone to big drawdowns?
NE: CTAs can have large drawdowns but it depends on their algorithm. They can dynamically reduce drawdowns by shrinking positions when there's a loss and letting positions get large when they're profitable. The other consideration is that if the CTA is negatively correlated to the rest of your portfolio, then the other investments will make money when the CTA has drawdowns. It's important to understand the algorithm and to understand how the fund fits into your overall portfolio.
OFI: What other strategies do you like this year?
NE: In general we like trading strategies, whether trading spreads or directional exposure. For instance, we invest in markets like freight and property largely through relative value strategies. We've invested in a property fund that uses a relative value approach. It's very different from the long-only, high-yield property investments that you find in many portfolios. Similarly, we found a relative value freight trading fund.
OFI: Do you seed new managers?
NE: We don't have a problem investing in small funds but we don't seed managers because we believe it creates a conflict of interest. When seeding, you have equity with the manager and you usually have to invest in the fund. We like to make pure investment-based decisions.
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