The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds (9 page)

Still, AHL is hardly invulnerable. The financial crisis brought on a sharp reversal, and the firm remains vulnerable to the Fed-induced drop in market volatility. In response, says Wong, the company has developed “a number of computerized trading models designed to respond better in the current macro environment.” The fund’s 15 percent rebound last year substantiates this view, and Wong anticipates further growth” beyond its 2010 size of $22.6 billion.

“I think that it is quite important to really understand the risk of your business and not overreact,” says Wong. “Quite a lot of people have gone out of business because either they couldn’t explain to the investors why the market behaves as it does or they fundamentally change what they do, and then cannot recover and make back the losses. So I think that’s what we do very well—that is, we really understand the performance that we’ve generated, and we really understand the volatility and the risk.”

Wong recalls that when he started at AHL, he worked under then research head David Huyton. One day, Wong expressed surprise that between 1991 and 1999, AHL’s positions on the S&P had lost money every year. Huyton shrugged. “When you have a hundred different markets in your portfolio, the finding that one market has consistently lost money for many years is not that surprising.” The key is to identify the long-term trends. “This business is about accumulating your odds over a long period of time.” Wong says he recalls that when AHL first began selling its funds in Hong Kong, investors were not very patient with the markets. “They all wanted a fund that would make them 40 percent during the first year,” Wong says. “They were skeptical about letting us hold their money for three to five years, and make a 16 or 17 percent average return, even when they saw proof of our performance. It took us three, four years of really very persistent effort before people began to give us a chance.” Today, Hong Kong is one of AHL’s our most successful investment markets.

“Most traders want to be very good gamblers and beat the roulette table,” says Wong. “I would rather be the house and own the roulette table. Every day, somebody is going to bet against us and win, and, from time to time, lots of people may bet against us and win. We’ll have losing nights and losing weeks. But if we play the game over and over again, eventually we’ll win because of the statistical advantage that we have.” Pushing this advantage is the most important job of a hedge fund, says Wong.

“My boss used to tell me that to win at either gambling or investing, you have to bet. And in order to do that, you have to have some chips left. If you lost all your chips, then, game over. So, risk management is actually the most important part of what we do. In our business, you don’t have to lose 100 percent. Even if you lose 40 or 50 percent, you could be out of the game. Protecting your chips is the trick.”

Though Wong does admit to having been worried about a culture clash emerging from the union with GLG, his fears have been dispelled. “I talked to the people and found out that we have very similar outlooks. We are all very result focused, and we all want to deliver the performance.” Wong believes any preconceptions GLG had about the old Man Group stalwarts have disappeared as well. “Many people talk about AHL as a systematic black box, very formulaic, like we’re all robots. But ultimately there’s a bunch of human beings here.”

Wong says he has seen many changes since he began at AHL. “Back then, we traded about 50 markets. Now we trade over 200. In those days,” he recalls, “you had less integration between Europe and the United States. And nowadays, if you look at the correlation between the developed markets or G-7 market, it’s much tighter. So in order to really have this less correlated position, we have to look elsewhere.” They were one of the first to trade in Korea, Taiwan, Singapore, Brazil, and South Africa. Particularly in the early days, this was expensive and difficult to do, but it was worth it to AHL. “These markets have been much less correlated to the developed world, so they kind of diversify us.”

One of Wong’s key objectives has been to develop close ties between the company and the academic community. “Having a firmer link with an academic institution would help us in terms of hiring people and getting to know the latest advances in academics and research, and might even give us some of new ideas that we could actually capitalize on,” says Wong.

After some exploration, AHL focused on Oxford, mostly because the university had a clear vision for the collaboration. The result is the Oxford Man Institute of Quantitative Finance. “They offered us an entire department within the school,” says Wong. “We have an office there with a partner who is physically on site, and about another dozen of our people are there interacting with about 50 academics on a daily basis. And that’s a great match: academics love to solve problems, and we love to ask people to solve our problems.” The Man Group has contributed 13 million pounds to the venture, and Wong believes the investment has been definitely worth it. “The financial service sector and banks and hedge funds have a bad image,” he says. “This shows Man giving back to the society. It works on many different levels.”

Pierre Lagrange: The Money Maker

At the age of 50, Pierre Lagrange, a native Belgian who is one of the richest men in England, has the long hair and casual wardrobe of a classic rocker about to uncase his guitar and unleash a few choice power chords from the stage of the Hammersmith Ballroom. Instead, he is a successful leader of hedge fund operators, and a man whose fortune and influence may yet be decades from their peak.

“I love what I do,” he says. “I love finding investments that people have missed. I love the whole discussion and arguing cases with bright people, or reviewing an obscure company, or discovering the best way to play that macro thematic on demand in that country. And I just hate to take no for an answer.”

Coincidentally, like Wong, Lagrange began his professional career studying engineering—in his case, environmental engineering at Solvay University at the Universite Libre de Bruxelles. Like many young people, Lagrange didn’t know what he wanted to do with his degree, and when J. P. Morgan invited him to join its six-month training program in New York, he jumped at the opportunity.

It was at Morgan that Lagrange had his first exposure to investing, and he took to it with enthusiasm. “It was a fantastic bank with an extraordinary training program,” he recalls. He started on the currency side and was one of the few people with a university degree to join the treasury side of the business. After the initial program, Lagrange remained with Morgan, although in time, he began to look for other opportunities. “I wanted to be in London,” he says, “and I wanted to get into equity trading.”

He joined Goldman Sachs, and found his métier. His next move came in 1995, when he and Gottseman and Green opened their own hedge fund. “Our whole philosophy of how to invest was based on getting people with different backgrounds and different views to work together so we can see something that someone else is not seeing,” he says. Few philosophies are ever practiced so perfectly. By the time of the merger, GLG had recruited a roster of elite traders from big investment banks, and built a roster of multistrategy funds with more than $30 billion under management.

As Lagrange sees it, “Man was very intelligent in looking for an active asset management business for company managed or existing products. Man had tried and failed to do this, so finding GLG, which actually needs distribution, was the perfect fit.” In the same way, GLG, which had tried and failed to build a strong business presence in the United States, benefits from Man’s expertise. “When we get that working,” Lagrange says, “that should be a killer.”

Lagrange says Man understands and respects his business: “They really understand what it takes to build what we’ve got. We both want exactly the same thing.” As opposed to other acquiring companies, Man adopted the view that it would select the people best-equipped to bring the business forward, no matter where they come from. “It’s very brave to do that,” says Lagrange, who adds that he is one of those affected. “There are many of people here who are running more money than I do, and that’s as it should be. They’re better at what they do than I will ever be.”

Lagrange believes the merger has freed GLG’s fund managers to focus on managing money. “We are good at investment management,” he says, “but we are perhaps not the best people at running a business, and we haven’t focused enough on distribution. To do so would have taken up a great deal of capital.”

Lagrange himself is an example of the new arrangement. Although he sits on Man’s executive committee, he is there to give his views, and not to run the business, which frees him to manage his $2 billion fund centered on European strategies. With its energies properly focused, GLG, which had been described as “a collection of 40 relatively small funds that are closed when they reach capacity,” could, as part of the Man Group, have $50 billion under management within the next few years. “It’s really working,” says Lagrange.

GLG built its reputation by fostering “a star culture,” one that attracted the very best proprietary traders from leading investment banks by offering them the freedom to follow their own strategies. “There’s a lot of different ways to get to the right answer,” Lagrange says. “We have a lot of people who are really smart. We don’t want to normalize their processes; we want to normalize the output. It doesn’t really matter how they arrive at the right output.”

But having a star system doesn’t mean that teamwork and process are forgotten concepts. Lagrange stresses that while autonomy is initially attractive, the deeper opportunity GLG offers a trader is to work with other elites of proven stature. Somehow, being a superstar among superstars undercuts the internecine competition. “The ability for people to take from and give to other people is massive,” says Lagrange. Once this spirit is recognized, everything becomes much easier. “People share resources, as opposed to fighting for resources,” Lagrange says. “We try to support the strengths of our managers and compensate for their weaknesses. What they are not really good at gets done by somebody else. Because it’s all about a return on capital employed. We manage the people here based on return on human capital.”

Process is also hugely important. Although portfolio managers have a lot of latitude, their results are subjected to two systems of review. First, GLG spends time analyzing companies, asking questions, and challenging managers on their convictions. When you do that, Lagrange says, “You can see who’s really looking at it from the right way.” Second, GLG places a lot of focus on the portfolio itself. Every two weeks, Lagrange and his risk managers review where they made and lost money. Each trader has a risk budget and is free to use it as he or she sees fit, but the review puts attention on why and how effectively it is being used. “Quite often, people spend 80 percent of their risk where they’re going to get 20 percent of the return, and vice versa. So, that’s where we work with them to push them toward doing very well.”

GLG also emphasizes keeping the whole portfolio in perspective. “What does the idea bring to the overall portfolio? It’s very tempting to be excited about an individual opportunity, but you have to look at things overall, at how this will change the portfolio level. Will it affect profitability? Does it create more volatility? Does it get us closer to the Holy Grail Company where you’ve got top line gross, margin improvement and multiple expansion, and balance sheet optimization policy? When you’ve got a company where you’ve got all these green lights, that’s what you look for.”

Looking ahead, GLG is long on Chinese banks, and aims to increase its position on automakers. The two strategies are connected.

First, Lagrange dismisses the concerns many observers have about Chinese banks. “Our view is that it is very easy to be scared at the level of provisioning,” he says. “In most emerging markets, the level of provisioning for back debt is much higher. But it’s also probably very myopic to really focus on that absolute level of provision without looking at the loan book that these guys have. You have to focus on the economic growth we see in this area. And really, growth is going to continue.”

Lagrange is pleased that many investors have grown bearish on China, and have begun to doubt whether the population and economic growth will match the amount of construction that is happening there. “It’s natural to have doubts,” he says, “and actually, I quite enjoy that people are doubting, because otherwise everybody’s going to be happy and long and complacent, and that would be horribly dangerous.”

GLG had begun developing a bigger presence in Asia even before the merger. Now Lagrange visits China every six weeks or so, looking for new opportunities and meeting with management and clients. He feels it’s important to be present on the ground to have information and control. The Man Group now has a hundred people in the region, and an established trading capability. He believes this gives the company an enormous edge. “You can’t underestimate the value of infrastructure in this business,” he says. “And you can’t underestimate China from an economic growth point of view. We might be a bit too big from a cyclical point of view, but from a structural point of view, you can see that we’re just looking at a kid, at an adolescent. He’s going to grow and grow. You can’t say that about the western markets. The western markets are already an older person.”