The launch period for the UCITS III equity vehicle, which recently received FSA approval, will run from 11 March to 7 April.
The fund will be managed by SVM managing director Colin McLean, who has over 10 years experience managing long short portfolios. McLean currently co-manages a number of the firm’s funds; the Three Crown rated SVM UK 100 Select, UK Emerging, UK Active and Global equity funds, plus the Dublin-domiciled hedge funds, Highlander and Saltire.
We spoke to Colin McLean and started by asking him to explain the background to the company and the UK Absolute Alpha Fund in particular.
A: "We have been running absolute return equity long/short strategies for quite a long period of time, in fact a lot longer than most since 1992. Our European-focussed long/short hedge fund – SVM Highlander - has been running since March 1999 and that has compounded at 14 per cent over its life. We also set up SVM Saltire, a UK equity long/short hedge fund in 2002, and that has compounded at over 12 per cent over the six years. That takes us over the whole market cycle.
"We found it quite difficult to market hedge funds into the UK and a UK fund into Europe, despite the performance in growing Saltire. Now that there is more interest in UCITS III funds we realised that we could offer much of the same strategy that we employ with the Saltire fund in the form of an absolute return UCITS III fund, which we could then let UK advisers buy.”
SVM Highlander fund progress data
SVM Saltire fund progress data
Source: SVM
Q: What was the thinking behind using hedge fund strategies in an absolute return vehicle?
A: "It sits in the absolute return sector. We make the point that it is an equity fund. The bull market started in 2003 – SVM Saltire was launched in October 2002 – but we caught that market rally right the way through to the middle of 2007 when it ended to capture 80 per cent of the upside in the fund. In the period since then we have been able to use the tools that we have in the fund to be able to protect capital, in fact it has carried on growing. We have got a whole market cycle of the bull market initially and now a bear market. We have been able to show we can perform in both conditions and over the whole cycle we can achieve a better than equity return.
"A lot of IFAs that we have met that had a lot of interest in the new fund quite like the idea of us having an equity fund that should eventually be able to participate in a market rally and sustained recovery but which meanwhile will leave them a bit less exposed in the timing of that. Maybe we can time that better and protect capital while we still have these fairly choppy conditions. That is the way we look at it rather than think of it as returning 1 per cent a month quite regularly. It has never lost money over a twelve month period but it is one which will be a bit more tactical in terms of market exposure."
Q: What is your investment strategy?
A: "We have a core of long positions that represent our highest conviction ideas for all the funds, and all the team contribute long ideas. We also work alongside it with short positions and use the risk techniques we have used with the hedge funds to reduce a lot of market exposure. So we are looking to collect alpha long and short. Over the period of the two hedge funds we have achieved quite a lot, particularly short alpha. We will be running some short positions in equities as well as long positions. We obtained FSA approval this week."
Q: Are there any strategies you are avoiding?
A: "We don’t run pairs trades. I know some people try and pair things within sectors. We don’t try and trade futures or do that sort of overlay. Some people just hold long stocks and then sell market indices. So we are not using direct overlays and we are not using pairs trades. There is generally a long/short equity strategy but those particular strategies we won’t be using."
Q: Will you target any particular sectors?
A: "It will be quite flexible over its life in terms of different sectors. Certainly over the last year or so in our hedge funds we have had some bias towards more defensive areas pharmaceuticals in particular and food retailers. We have had – and still have - a negative position in financials, and have been slightly net short in that area overall. We have been more neutral in other areas. Generally our other short positions have been in more leveraged businesses, such as in the consumer sector. There are some businesses like Tesco that we are quite happy with, and other like Yell or Sports Direct, for example, that we are not, mainly because of leverage."
Q: Are there any regions you favour?
A: "It will be focussed with a minimum of 80 per cent in the UK, but we have included some European exposure. In general the pattern in a lot of our European exposure apart from leverage is that we have run some short positions in businesses with exposure to Russia and Eastern Europe. Some of the Austrian, Swedish and Finnish businesses in particular have got disproportionate exposure to Eastern Europe and Russia. So that within Europe has been more of a theme."
Q: What type of investors have you attracted?
A: "The offer period will begin in March and span over into the next tax year so we will now finally in early Europe just where we are. We have though done with the unique boutiques marketing quite a lot of individual contact with IFAs and other wealth managers, and the response has been encouraging so far."
Q: Do you think the reputation of the existing hedge funds has helped?
A: "I think it has. We do see the UCITS III area and attempts to offer absolute return within that as being something that more people will enter, but I think a lot of advisers think that there are a limited number of groups that will be credible within that space. Clearly those that have entered, such as Cazenove, Gartmore and BlackRock, are certainly credible. There may even be others who can but I think a lot of IFAs will think that many of the groups specialising in conventional funds would not be able to adapt readily, and they would rather see people with an existing and transparent record in this area coming into it. I don’t think there are that many groups that would be necessary credible to IFAs in the area, but I am sure others will enter."
Q: Some absolute return funds have done well but a lot have slipped into negative territory in the last six months. Has there been any concern from IFAs about the absolute return model per se?
A: "No, I would think in general not yet. I would say that the only concerns that we have seen across the industry is perhaps not wanting to see any funds get too big for the flexibility they might need in their strategy, but that does not reflect any particular funds right now. I think IFAs would like to stick to managers they know and funds with a reasonable degree of liquidity which are not too large.
"I think to date a lot have found it difficult to know just where they should position the funds within their portfolios. However, they have probably in general come to the conclusion that they are equity funds, rather than a bond-type investment, and if they make an allocation to part of a client’s equity funds then most of the managers have done a reasonably good job of protecting capital to date."
Q: What will you do differently from other similar funds?
A: "We don’t set quite so much store in an attempt to be market-neutral or to run pairs trading so I think the fund will be a bit more tactical. We have shown in our record that we are capable of picking up a degree of market direction. We won’t end up being 100 per cent long or market exposed, but we have captured a fair degree of that. I think some other funds have more of an aim of remaining near market-neutral than we would do.”
Q: Do you have a particular investment philosophy?
A: “We in general research things based more on business topline analysis - and by that I mean sales, operating profit margins, cash conversion. We pay much less attention to the stock market measures like price/earnings and yield. A lot of investors who have come unstuck over the last year or eighteen months have done so particularly by looking at stocks that appeared to be cheap – and not just banks but a lot of consumer stocks such as Yell or Punch look like they have very low price/earnings but without debt it is not the right way of looking at it.
"On the other side of things some stocks that have had higher than average ratings, such as some of the supermarkets particularly Morrison, Sainsbury, but also companies such as Compass or Invensys, actually it has been right to pay a premium for that in price/earnings terms, because they have been quite cheap in sales and a lot of potential for margin improvement. So we are more concerned with business analysis rather than using stock market ratios like price/earnings."
Q: What will be the key drivers of asset growth for the new fund?
A: "In terms of short positions we have more of a focus on companies where business models we think are breaking down, that is it is not just a question of debt but they will struggle to come out of recession. We found that when we were first running hedge accounts in 1992 - when it was not quite such a severe time but there was a recession then – and quite a few companies had too much leverage then, and we right in running short positions then when a number of companies did not’t manage to pick up. So I think on the short side if we are right about our business analysis, and that some business models have relied on leverage or effectively are not’t sustainable business models, they won’t get refinanced and they won’t recover.
"On the other side of things we are backing some management teams and businesses that we think are quite robust, ranging from the pharmaceuticals, food retailers and also some industrials, where we rate the management. We think they have got a good global franchise, such as Cookson and Invensys. The test will be largely as the economy perhaps starts to recover we will see the better businesses start to emerge strongly. But I think there are some businesses that are not going to recover before things pick up and they might well fail before that."
Q: Do you have any expectation of future growth?
A: "We have indicated our own target of 10 per cent per annum, and going by what we have achieved historically with Saltire allowing for differences in expenses and slight differences in risk and exposure we think that should be achievable, taking periods of 12 months or more, certainly over three years or more we have achieved that target of return. The aim is over a whole market cycle of five or six years, encompassing up and down markets to beat equities over that longer haul of the full market cycle. Over the shorter term over 12 month periods we are aiming not to lose money. We are aiming to out perform cash over 12 month periods."
Q: Do you have any predictions for the market and the fund moving forward?
A: "We are running it as a dummy portfolio and we are running other funds at the moment so we can understand its characteristics pretty well. I do think the market is testing the lows in some sectors, like financials, and we would see in those sectors a further 10 per cent downside from here. I think with the strategy we have currently we would see financials weakening further across life assurance and banks.
"In other areas it is a more mixed picture. Some industrials are refinancing. Some businesses that are economically sensitive have good franchises and despite quite weak profitability just now we think should pull through, such as Invensys and others. So it is a mixed picture. There are some cyclicals that we think have fallen far enough but overall on the long side we still think we should be predominantly defensive in the positions that we own, such as pharmaceuticals, some utilities, food retailers and stables. We would expect that to stay the same for the next few months."