October Interview: Richard Williams of Caliburn Capital Partners

Caliburn Capital Partners is a thematic fund of hedge fund manager, founded in early 2005 with institutional backing of US$25 million and managed by a team of five seasoned investment professionals with 125 years combined experience of successfully managing hedge funds, funds of hedge funds and investment banking prop trading teams.

Three of Caliburn’s five managing partners set up Bayard Partners; one of London’s first hedge funds, in 1991 and became Morgan Stanley’s first non-US prime brokerage client. The Bayard Fund focused on European equity long short opportunities and delivered annualised returns of 17% for the decade from 1992 to 2002, winning a number of performance awards through the latter half of the 1990s. In 2002 external funds were returned to investors and Bayard Partners became a family office.

With offices in London, Geneva and Singapore, Caliburn now employs 31 staff; the majority involved in investment research. As at 1st September 2011, the firm’s AUM is US$760 million, of which over 55% is pension fund/insurance company/endowment investment and over 10% is partner investment.

Caliburn’s thematic research process is focused on emerging markets, commodities and non-directional developed market opportunities. Caliburn offers 3 specialised funds of hedge funds – the Caliburn Greater China Fund (US$71 million), the Caliburn Global Inefficiencies Fund (US$364 million) and the Caliburn Strategic Fund (US$255 million), and is also the first fund of hedge fund manager to successfully undertake the AAF 01/06 benchmark; a rigorous external operational review.

  1. How have your funds of funds performed in 2011, especially through the recent high volatility witnessed globally? Which of your funds has delivered the best returns? How do the returns of your funds compare to the rest of the industry?

    Caliburn’s funds have performed very well in 2011, protecting capital through the recent high volatility. The net of fees for our funds as at August 2011 YTD are as follows: Caliburn Greater China Fund = -0.95%, Caliburn Global Inefficiencies Fund = 1.83%, Caliburn Strategic Fund = -2.49%.The Caliburn Greater China Fund (CGCF) targets a risk-adjusted return profile to Chinese equity markets, represented by the MSCI Golden Dragon Index (Price). CGCF’s performance has been strong - among the best in the industry on a risk-adjusted basis, and is coupled with a genuinely institutional investment and risk management process which has been vetted by the largest global asset consultants and international private banking platforms.

    Performance for 2011 YTD:

    Jan 2011 to Aug 2011 % CGCF MSCI Golden Dragon (Price) MSCI Golden Dragon (Total Return) Eurekahedge Asia Pacific FoF HFRI Asia ex Japan Index (offshore) HFRI FoF Composite
    Return -0.95 -11.0 -8.7 -2.6 -8.3 -2.6
    Standard deviation 6.1 14.6 14.4 4.9 10.5 4.5

    Performance since April 2007 to 2011 YTD:

    Apr 2007 to Aug 2011 % CGCF MSCI Golden Dragon (Price) MSCI Golden Dragon (Total Return) Eurekahedge Asia Pacific FoF HFRI Asia ex Japan Index (offshore) HFRI FoF Composite
    Return since inception 22.7 7.0 23.4 0.4 14.2 -3.5
    Annualised standard deviation 9.5 28.1 28.2 8.2 14.7 7.0
  2. Your fund presentations state that you were able to deliver downside protection through the 2008 financial crisis through “alpha-rich non-equity strategies”. What were some of the investment themes that worked for you at that time? Are you considering similar moves given the current situation of the global marketplace?

    Ever since its inception in April 2007, CGCF has had an exposure to ‘inefficiencies’ – alpha-rich non-equity long short strategies. These ‘inefficiency’ opportunities have provided a degree of portfolio diversification away from Chinese equity market beta and also given our investors ‘early adopter’ exposure to the evolution of China’s capital markets over the last few years. These opportunities tend to have a broader Asian remit to achieve suitable scale, and those that are purely China focused are rare - there are at most a dozen such opportunities in the market at present. Examples of the strategies that have been included in this sub-theme over the last four years are Chinese asset-backed lending, Chinese non-performing loans, Asian commodity trading, Chinese convertible bond arbitrage, Asian macro trading, Asian volatility trading, Asian distressed equity and debt investing, cross border arbitrage, Asian credit long short trading, Asian capital structure arbitrage and Chinese property.

    Our invested ‘inefficiency’ opportunities performed very well in 2008, returning positive numbers for the year when the MSCI Golden Dragon Index was down over 51%.

      Performance of inefficiency-based managers in CGCF MSCI Golden Dragon
    Sep 2008 -0.9% -19.6%
    Oct 2008 0.4% -21.2%
    2008 8.1% -51.2%

    Since the inception of CGCF, the relative weight of ‘inefficiency’ opportunities within the portfolio has varied depending on our assessment of the abilities of the manager group to deliver attractive risk-adjusted returns in the prevailing macroeconomic and market environment. Consequently, the ‘inefficiencies’ themes have represented as much as 50% of the portfolio’s weight through the latter half of 2008 and into 2009, and as little as 20% as we have grown more comfortable with the downside protection capabilities of the equity long short component of the portfolio.

    It is clear to us that many Chinese equity long short managers learnt painful lessons in 2008. As a result, we now find managers more cognisant of broader macroeconomic issues and more proactive in making portfolio management decisions to protect the downside e.g. more variable gross and net exposure management, managing large cap/small cap exposures, more use of single stock shorts, etc. This has been borne out by the recent performance of our equity long short manager group, which is flat YTD against a challenging market backdrop. As a result, the current ‘inefficiencies’ weighting in the portfolio remains relatively constrained, at just below 30%.

  3. Can you explain a bit about your “evolution to a third generation fund of hedge funds”, as mentioned in your fund presentations– how do you differ from traditional funds of hedge funds? How have you introduced hedge fund techniques to the fund of hedge funds business?

    The original purpose of funds of hedge funds was to secure exposure to star managers with little research value-added. The industry then moved towards constructing portfolios comprised of different hedge fund strategy buckets, with some increase in due diligence although this remained a largely box-ticking process with little thought given to the underlying investment proposition or the broader macroeconomic environment.

    Evolution to a third generation fund of hedge funds implies an active and flexible investment process akin to that which sophisticated money managers in other parts of the alternative investment industry employ. The introduction of hedge fund techniques to the fund of hedge funds business refers to the degree of focus we apply to our analysis of both the top-down and the bottom-up opportunities with which we are presented, as well as to managing our exposure to the tightly defined set of risk factors that we are specifically interested in.

    As thematic investors, this investment process begins with an evaluation of the top-down macroeconomic and investment environment to determine which investment themes are currently most attractive, their strengths and risks, and ultimately their likely longevity. We believe that themes drive financial markets over extended periods and that strategic asset allocation has a significant impact on performance over the long term. Using a top-down approach, we aim to find two principal sorts of thematic return drivers:

    • Themes characterised by less crowded frontiers where active management can exploit inefficiencies and allow market experts to extract alpha. For this approach to add value, the manager must also be nimble enough to adapt as the frontiers shift.
    • Themes characterised by secular growth where directional exposure will help drive returns but where the use of hedge funds should improve risk adjusted returns

    China provides an example of both of these thematic return drivers.

    Subsequently, the investment team consider more tightly defined macroeconomic trends and derive top-down sub-themes, in addition to generating manager peer groups and performing bottom-up manager due diligence. The research approach goes beyond identifying managers and seeks to build an understanding of the underlying asset classes in order to improve the predictability of manager returns i.e. investment management lies at the heart of this process.

    In summary then, sophisticated fund of hedge fund investing today is a function of taking an investment view based on thorough top-down research and implementing that view through portfolios of hedge funds, each of which has been comprehensively researched and whose behavior under a variety of market scenarios we believe we can broadly predict. The process is aided by the use of industry-leading proprietary quantitative and platform management systems.

    Carried out properly, this process is clearly resource intensive. As such, Caliburn employs 31 people across our London, Geneva and Singapore offices, the majority of them investment professionals. Furthermore, we believe that local specialists are best placed to deliver attractive risk-adjusted returns, and as such we are committed to on-the-ground research making use of our analysts’ local cultural and language skills to extract better information and improve investment decision making. Our Singapore office for example, was established in May 2008 as the hub for the Asian and Chinese research we conduct has seven full time staff, five of whom are analysts focused on Chinese manager research. We will not invest with a hedge fund manager unless we have visited the manager at least twice onsite in their offices, one of which visits must be attended by a Partner and one of which visits will be a separate operational due diligence visit as part of a separate decision making process distinct from the investment case. As such, our team is typically in Hong Kong at least once a month and in Beijing and Shanghai every couple of months.

  4. Can you share with us how you achieve dynamic asset allocation between hedge fund managers? Wouldn’t the effectiveness of this strategy be constrained due to gates and different redemption frequencies?

    Part of our value-add from a top-down perspective is the weighting we apply to CGCF’s sub-themes but these are usually long term views and we are not actively trading in and out of managers. For example, we split our equity long short managers into ‘variable’ bias and ‘long bias’ themes and at certain points of the market cycle will look to adjust the weighting between these two groups. We also monitor our fund’s underlying exposure to specific equity markets within Greater China so for example we very recently have been increasing our exposure to domestic listed A shares.

    CGCF is a liquid fund of hedge funds – most of the underlying funds have monthly redemptions with 30 days notice and we can liquidate over 70% of the underlying funds within the 45 day notice period of the portfolio. A focus on maintaining a liquid portfolio, coupled with a detailed understanding of the relevant redemption restrictions of our underlying managers makes us better equipped than most to move our portfolio tactically.

  5. Can you give us an overview of the qualitative/quantitative research that goes into your investment decisions? How often do you meet the managers of the hedge funds that you invest in?

    Our qualitative research process is top-down and bottom-up.

    From a top-down perspective in relation to China, we devote significant analyst time to understanding political, social and macroeconomic (domestic, regional and global) drivers and their likely impact on asset prices. We consume investment banking research (both domestic Chinese as well as the large global banks), as well as that produced by some specialist research houses and we are in regular contact with China strategists based in Asia. Having met with more than 120 dedicated Greater China Hedge funds over the last five years, we have also identified certain managers that have a particular strength in top-down views and opportunities in different asset classes in China. Our analysts will also typically attend industry or regional investment conferences, often in a dual capacity as invited speakers and interested observers. Both our CIO and our qualitative analysts have in the past written top-down papers on specific thematic investment opportunities in relation to China. This approach provides our qualitative analysts with a meaningful competitive advantage:

    1. It allows them to fully understand and to question over time the assumptions that underpin our investment in China.
    2. It provides them with a much better knowledge base from which to perform qualitative manager research. For example, successfully interviewing a Chinese equity manager is often, in our experience, dependent on being able to engage with him on the top-down, political, sector and stock specific issues as marketing is not often part of their skill set.

    Additionally, in our view no China research is comprehensive if it is conducted solely through English language publications or without a need to speak to Chinese fund managers who may not speak English. Mandarin skills are essential in this space and a core component of our research team’s resource base.

    In addition to the above, we aggregate the top down information which we routinely collect from our managers during update calls - this is a particularly rich source of local data and micro and macro trends and has been instrumental in our investment committee being able to position the portfolio ahead of market developments.

    The bottom-up work we conduct on the Chinese hedge fund industry is comprehensive and granular. Since Caliburn’s inception, we have conducted due diligence on over 400 funds in Asia and our active peer group of Chinese hedge funds is currently just above 140. This is updated monthly. To source new managers:

    1. Prime brokers in Asia are very important. We try to maintain very good relationships with the PB teams and they are aware of our focus on China.
    2. We do the normal database searching mainly in Eurekahedge, HFR and Bloomberg.
    3. We use certain 3rd party marketers and keep an eye on the hedge fund press.
    4. We follow staff movements within hedge fund groups. When someone we rate highly leaves a company we will keep contact with them and wait to learn what their plans are.
    5. We ask hedge fund managers who they regard highly amongst their peers.

    Manager approval requires a full qualitative investment approval paper to be presented to the manager approval committee (nine senior investment staff) along with a quantitative analysis of the fund’s performance and risk management. The qualitative approval paper is generally 15 to 25 pages and includes a full appraisal of the fund’s investment personnel, strategy, risk management, portfolio construction, performance, terms, risk flags and ownership structure. References are undertaken with previous employers, investors, colleagues and brokers. Assuming a manager is approved for investment, a separate ODD process begins culminating in a separate ODD approval paper which is presented to the ODD approval committee and requires unanimous approval by our three person ODD team.

    Quantitative research at Caliburn involves developing bespoke multivariate models for each invested manager, theme and portfolio using Caliburn’s proprietary quantitative platform. Additionally, we seek to understand each manager’s and portfolio’s one month forward looking Market VaR, Market + Residual VaR and the Market + Residual + Tail VaR under a variety of scenarios (some historical, others academic) in order to further understand how each component of the portfolio and the portfolio itself will function in a range of possible market conditions.

    Our default update cycle with managers is no longer than quarterly, but in practice we speak to managers much more frequently, usually at least monthly and often more frequently if volatility spikes or we have a specific concern. In addition, we maintain a constant dialogue with other relevant market participants (stock lending teams, cap intro teams, strategists etc) in order to stay on top of developments in the Asian and Chinese hedge fund industry.

  6. As a multi-manager, what sort of risk control structures do you have in place in order to safeguard the investments of your fund? Did your risk management protocols change over recent times, due to the high volatility across different sectors?

    Right from the outset of the manager approval process, risk management is considered from 3 different angles – qualitatively, quantitatively and from an operational perspective. Each of the qualitative, quantitative and operational due diligence approval papers highlights a range of risk factors that will require ongoing monitoring for the manager in question. These risk factors may be common across all of our managers or they may be manager-specific depending on the nature of the manager’s strategy or operations. Each risk factor will be given a monitoring timetable, and typically this will be monthly. The covering analysts are responsible for reporting breaches of the relevant flags by invested managers.

    The Risk Committee is chaired by the Chief Risk Officer and consists of the head of quantitative analysis, the CFO/COO, and the Head of Operational Due Diligence. In addition, a member of the qualitative research team attends the meeting to consult on manager-specific issues.

    Portfolios are constructed on a monthly basis by the CGCF Investment Committee and are stress tested at least twice a month to ensure compliance with the various quantitative and qualitative risk limits that have been imposed. Should any limit be breached, the Risk Committee will immediately request a response from the investment team as to a plan for preventive action. This action can range for example, from a schedule of manager redemptions to a proposed portfolio hedge overlay, depending on market conditions and the relevant portfolio.

     At the individual manager level, the Risk Committee:

    1. Monitors all breaches of flags set by qualitative analysts on underlying managers.
    2. Monitors all breaches of quantitative flags, highlighting deviation in performance from the returns expected by the Caliburn quantitative models.
    3. Monitors qualitative and quantitative portfolio risk limits and ensures their compliance.
    4. Monitors liquidity of the portfolios.

    The Risk Committee may also at any time recommend an increase in the monitoring regime of any manager, that a manager be resubmitted for approval, or that a manager be redeemed immediately.

    The risk management protocols which govern the operation of the Caliburn Greater China Fund were enhanced in Q1 2009 with the inclusion of 1 month forward-looking VaR limits for market, residual and tail risk at the portfolio level. Other than this modification, the risk measurement and management process has been stable since the launch of the fund in April 2007 and they appear to be working well, given the funds’ strong capital preservation qualities to date.

  7. How do you drive synergy between the different funds? Are the same research and risk methodologies employed across the different funds and strategies?

    Fundamentally the Caliburn Greater China Fund provides an attractive risk-adjusted exposure to Chinese equity beta. The fund is by definition directional, and we have found that investors who are not familiar with the Chinese hedge fund industry therefore expect to find a broadly homogeneous group of long-biased underlying managers to reflect our return objective. This is very wide of the mark.

    The truth is that since the early days of the 2008 financial crisis, we have seen the emergence of a genuinely variable biased group of Chinese equity long short managers, who are comfortable moving their gross and net exposure aggressively up and down to reflect prevailing market conditions. These managers have demonstrated a willingness to run net short portfolios and as a result their performance in 2008 was very strong.  Further, in the peer group of long biased (not variable biased) managers, we have seen an evolution in the approach to sector rotation, cash and liquidity management, and incorporation of macroeconomic data into trading decisions that has dramatically improved capital preservation since the panic of 2008. These lessons have been ably demonstrated in August and September this year.

    Even within that group of long biased equity long short managers, we see considerable diversification from one manager to the next in terms of the marginal risk that each manager adds to the portfolio. This is a function of a very granular understanding of each manager’s trading style and likely response to a variety of trading conditions allowing our investment committee to construct smarter portfolios. Consequently, the equity portion of CGCF has protected capital well in the turbulence of the last few years but also captured an attractive portion of the upside of markets.

    The non-directional, non-equity component of the fund is designed to provide ballast and a steady diversified return stream to the portfolio despite the volatility of equity markets, and it has done just that.

    In terms of manager research, it is worth noting that the five analysts who comprise our Singapore-based manager research team have complementary skill sets and experience – within the group there is discrete expertise in equities, credit, commodities and operational analysis, together with a Chinese mainland analyst. Consequently, the team is able to draw on very relevant experience to assess each manager’s strategy. There is a basic template of information that Caliburn’s qualitative analysts are required to produce for each of the managers that are brought to approval, but there is considerable scope for customisation to reflect each manager’s opportunity set and strategy. Likewise, quantitative and ODD research is customisable within the context of a comprehensive review that covers certain issues for each and every manager examined.

  8. The fund of hedge funds sector witnessed significant redemption pressure in 2008, and since then the asset raising environment has been quite tough. How did your funds fare over the last few years in terms of asset flows?

    The Caliburn Greater China Fund had less than US$50 million under management going into the 2nd half of 2008, and much of that was seed investment and additional partner investment. As a consequence of this and strong relative performance versus Chinese benchmarks, the fund experienced virtually no redemption pressure over the period. It is also worth noting that the experience of Asian hedge fund investors in 2008, from a liquidity point of view, was positive – virtually no funds gated or suspended redemptions and our fund of hedge funds portfolio was unimpaired by the problems which plagued investors in hedge funds in other geographies.

    CGCF was only launched in April 2007 so it has taken some time to develop the necessary length of track record to attract institutional interest. We are now benefitting from the strong four year track record and have seen a significant commitment from a large institution taking AUM above US$70 million. We anticipate follow-on investments which will take the fund towards US$100 million in the next quarter. In addition, we have attracted the interest of a global asset consultant who will commence formal due diligence in Q4 2011.

  9. What sort of investors is your fund targeted towards? Can you give a general breakdown of your investor base? (e.g. 50% institutional, 70% US-based etc.)

    At the firm level, our US$760 million investor base is over 55% institutional (pension fund/insurance company/endowment) investment and over 10% partner investment. Our institutional investor base is diversified geographically between the UK, Switzerland, Japan, the USA, France and Australia.

    In relation to the US$71 million AUM of the Caliburn Greater China Fund as at 1st September, over 80% of this investor base is institutional or Managing Partner investment, with the UK, Australia and Switzerland as the largest contributors. We believe that CGCF should be a very attractive vehicle for institutional investors looking to gain risk-adjusted access to China’s exciting growth and capital market liberalisation, and we are optimistic about future growth given the strong levels of interest we are currently seeing in the fund.

  10. Lastly, could you share with us your near-term and medium-term outlook of the global markets in general and the emerging markets in particular?

    Q3 2011 has been a very difficult quarter for risk assets. The reality of extended debt deleveraging undermining growth in the US has become increasingly clear at a time when the structural problems in the Euro zone have added greatly to systemic risk further clouding the outlook for global growth. Both these issues will inevitably require coherent intervention but the risk remains that markets have to go lower before that intervention is triggered.

    There is no doubt that developed western economies require inflation as part of any long term resolution of the debt problem. To that end central banks will continue to print money and QE3 in the US and indeed elsewhere is inevitable. The only issue is timing. The worse the economic data becomes, the quicker we will see more intervention. This process may well be accelerated by some form of market dislocation caused by the European inability to address the key structural problem in the Euro zone; monetary union cannot work without fiscal union. Led by Germany, Europe seems currently unable to address this issue on a timeline that reassures markets. Given the leveraged balance sheets of the European banks and their exposure to Euroland sovereign debt this represents systemic risk for the global economy which could cause a further move down in markets.

    Short term - we remain cautious in our outlook, however we are clear that markets are compressed and valuations have come down to discount much of the risk increase. Increasingly we see valuation levels close to the lows of 2008. Moreover as we write we have seen the longest period of underperformance of emerging markets against developed markets in ten years. Emerging markets are now back to trading at a discount to the developed world.

    In trying to take a more medium term view, we are clear that current events are producing a platform from which we can anticipate significant outperformance from emerging markets. The emerging world is not burdened by the same debt burden and has room to ease monetary policy with the expectation that traction will be achieved in both the economy and the stock market.

    Emerging market equity outperformance is therefore likely to resume on the policy response that is required to address the current cause of market volatility. This outperformance will likely be led by markets such as China and India where the room to ease will be greatest.

Contact Details
Richard Howard
Caliburn Capital Partners
+44 207 518 2334+44 207 518 2334