Finding the right fit
When the French financier Arpad Busson set up EIM as a fund of hedge funds manager in 1992, his only database of managers was his address book.
Today, things are done rather differently. EIM operates an intranet ‘window’ with software which enables its 41 analysts and portfolio managers to gain access to every manager contact worldwide, as well as the 180 managers on its list of approved funds.
This level of sophistication reflects the extent to which EIM has expanded its operations in the past decade. EIM now has a staff of 163 people located across the globe, in Nyon near Geneva, New York, London, Paris, Zurich, Gibraltar, Monaco and Tokyo.
Assets have grown commensurately. It has more than $7bn (€5.8bn) assets under management. Most (71%) is European. The rest are drawn from North America (15%) the Middle East. (8%) Asia (3%) Africa (2%) and South America (1%).
The sources of these assets have also changed, in line with the rest of the hedge fund industry, from private to institutional clients. Initially high net worth customers and private offices constituted 100% of EIM’s client base. Today they account for only 4%.
EIM set out its stall early on as a provider of customised rather then standardised fund of hedge fund offerings, says William Glass, senior partner at EIM’s Geneva operation.
“We made a strategic decision to be the tailor makers of the industry and for very straightforward reasons. Our first institutional clients were banks for whom we built white label products. If we’d started to build EIM products we would have been in competition with these clients. We didn’t wish to do that, so we made an opportunistic decision to focus on being providers of tailor-made solutions to other institutionals.”
Today, EIM runs two small commingled funds of its own, representing less than 2% of its assets. “Their purpose is not to sell an EIM product but to allow access to certain pension funds or others who for statutory or other reasons cannot be the sole investors in a product,” says Glass.
“It’s a vanishingly small part of our activity and not one that we intend to grow,” he says.
Today EIM’s main institutional clients are banks, which account for 28% of assets, followed by pension funds at 25% and asset management companies at 21%. “Pension funds are one of the areas of EIM’s business that is growing rapidly. The tailor making approach is a natural for them because they require much tighter oversight of their investment programmes than standardised products can offer,” says Glass.
The attraction of funds of hedge funds has changed for pension funds over the past 10 years. “Originally pension funds were interested in hedge funds of funds as a first order diversifier. But as pension funds have become more sophisticated, they are looking for more than that. Today there’s more concern about what the impact of possible economic scenarios will be on both the asset and liability side of a fund’s balance sheet.”
EIM provides two kinds of tailoring for institutional investors – stand-alone portfolios or funds tailored to enhance the risk-adjusted profile of an institutional investor’s existing asset mix. “Not all institutional investors are asking for a high degree of tailoring at all times. For some the definition of the mandate would remain in fairly broad terms, but in other cases the objectives of the mandate can extend to several very detailed pages,” he says.
“Each plan has a different set of liabilities, and a different objective for generating its return enhancing overlays. We talk to them specifically about what we’re expected to enhance and what characteristics we should be trying to neutralise through our portfolio construction process.
“It’s a very close level of dialogue on what the hedge fund portfolio is expected to achieve and what economic scenarios the pension fund or other financial institution is preoccupied with.”
EIM works just as closely with its asset managers, Glass says. “We have a multi-disciplinary team of 24 analysts who base their selection of investment managers on a thorough ‘hands on’ knowledge of each manager. “
EIM can achieve t his thoroughness because it has an exceptionally low manager-to-analyst ratio, he says. “The only way to ensure that analysts have time to think about what they are doing is for them to have a reasonable workload. Our target manager-to-analyst ratio is set at one analyst for a maximum of 10 managers, which is significantly lower than the industry average.”
Before managers are approved they are subjected to detailed due diligence to evaluate their risk management skills. EIM was the first company in Switzerland to establish systematic due diligence processes that have been certified as meeting the ISO 9001 quality control norms.
Due diligence is both quantitative and qualitative, says Glass. “EIM was long known for its thorough qualitative approach but it has over the past few years also acquired leadership in its quantitative skills. You need to be able to assess formal things, such as the investment strategy itself and the risk. You also need to be able to assess softer items, like passion, character and focus.
“That has always been one of EIM’s strengths. It comes from the highly unusual view of the world that our founder had and succeeded in inculcating in the analysts that he hired.”
This assessment provides the level of transparency that institutional investors demand, says Glass. “Although the requirements for transparency unquestionably have increased as we’ve moved from private to institutional investor, there is also a realistic view of the level of transparency that’s needed to be able to properly control your risk,” he says.
“Being able to ascertain the risk and return position of a hedge fund doesn’t require us seeing all the underlying positions. What is essential is to have a very clear idea of the risk and return drivers in each individual hedge fund, and most important, to understand how a hedge fund manager thinks.”
EIM uses two processes when it selects its managers, Glass explains. “The first is the research process that feeds into the list of approved funds that are available to the portfolio manager. Manager level decisions are made in that process – hiring or firing managers. There is also an active management of capacity, so that we’re not constrained in our management decisions by a lack of capacity.”
The second is a top-down process, a firm-wide view of the future that EIM takes in a monthly strategy call. “Here we’re trying to look forward and set out a number of plausible scenarios. For example, what happens if growth remains benign but credit spreads widen brutally because of a credit event?” asks Glass.
“Our analysts and quant team work together to determine how that type of scenario might be expected to change various risk factors such as interest rates, curves, equity market direction, volatility and credit spreads, and how we would expect various hedge fund strategies, and individual managers, to be impacted. The portfolio manager’s role is to build a portfolio structure that reconciles the firm’s macro view of the opportunity set in each individual hedge fund strategy and then to populate those strategies with individual managers.”
Because EIM manages a multiplicity of discretionary portfolios rather than a few proprietary funds, it faces a challenge in demonstrating the consistency of its process. One solution to this has been to comply with Global Investment Performance Standards (GIPS).
EIM is one of the few funds of hedge fund houses to be GIPS compliant. GIPS guarantee the reliability and integrity of its performance calculations, in particular calculating and presenting its composites, says Glass.
“As tailor makers we face an unusual challenge. A fund of funds company that has a large flagship fund can walk into a prospective client and put down an extensive track record. Because we’re going in and saying we’re going to build a brand new portfolio for you the only thing we can offer on that portfolio is a back test, and everybody knows the limitations and biases of back tests.
“So how does EIM propose to build a new portfolio for a client but also provide comfort to the client that the portfolio has a high probability of behaving like all the other portfolios EIM has been building over the years?”
GIPS provides an answer, says Glass. “The advantage of GIPs is twofold. First, it is entirely objective. Second, it’s exhaustive, so you’re not cherry picking your best portfolios to show the client.
“You are required to publish for a given composite, or set of portfolios, dispersion statistics. If you take our composite last year, it’s composed of around 25 different mandates, you’ll find that the dispersion statistics are very narrow.
“The 25 portfolios include both seasoned mandates that have been around for many years and others that opened just a month ago. So although the individual manager names in a portfolio are entirely different, and there may be no overlap whatsoever, the performance behaviour is extremely similar.
“This shows that it is EIM’s way of constructing and managing portfolios, rather than the individual managers’ names, that brings the results.”
EIM now plans to extend its funds of hedge fund construction and management skills to long-only portfolios. It has operated a long-only programme for Swiss pension funds, the AAA Foundation, or Fondation pour l’Accès à l’Allocation d’Actifs, since 1994.
“We’re expanding that,” says Glass. “We think we can leverage the long experience that we have in the hedge fund world by branching out to more absolute return oriented long-only strategies. We’re used to looking for managers who have a certain view of opportunity sets and risk, and who are unconstrained by the benchmark targets that you find in the traditional investment world.”
Growth of long-only activity at EIM is likely to be rapid, he predicts. “The long-only business should represent a considerable pillar of EIM’s activity a couple of years down the road.”