Finles Capital Management, a Dutch investment management boutique based in Utrecht, is unusual for at least two reasons.

First, it has chosen to specialise in funds of hedge funds in a country where interest in hedge funds from all but the largest pension funds is lukewarm.

Second, it offers a unique ‘no cure, no pay’ cost structure for two of its fund of hedge fund products, whereby the investment manager receives a performance fee only if the investor makes a positive return.

Finles began to focus on absolute return strategies following the arrival of Rob van Kuijk (pictured above) and Hans van der Holst as co-chief executives in 1994. They became joint owners of Finles when they bought out the 50% share held by Achmea and AXA in 2006.

Van Kuijk, a former director of sales at insurer Delta Lloyd, is also chief investment officer at Finles. He recalls that when he arrived, the flagship product was the Finles Collectief Beheer Fonds, a long-only global balanced fund invested 70% in equity and 30% in bonds.

“It was common in those days to sell these sort of mixed funds as safe funds. I became concerned that I was selling something as a safe product when it was matching market volatility. I felt there was an incongruence with what we were actually delivering and what we were telling them we were delivering.”

In 1997, Van Kuijk and Van der Holst began to look for asset classes other than bonds and equities that would offer higher returns and less ‘left tail’ risk, where the return is skewed to the left because of large losses and below average gains. “Protecting your client’s capital is all about managing your left tail risk,” says Van Kuijk. “You could say, as many pension funds do, that you’re doing better than the benchmark. But you’re losing money, and if it’s pension money you’re not supposed to lose it.”

Finles took its first steps into alternatives in 1998, investing in a New York-based Commodity Trade Advisor (CTA). By 2000, 20% of assets under management were invested in alternatives. Today, the percentage in the hybrid Collectief Beheer fund is 65%. This fund is nominated by Morningstar as best in its class for 2007.

Finles now has seven multi-manager funds - three of them pure hedge funds - and assets under management of $370m (€253m). It has concentrated on designing funds of hedge funds that provide low volatility and high returns, says Van Kuijk. “The problem with most funds of hedge funds is that they are best as bond proxies. If you look at the biggest category of funds of hedge funds they provide low volatility but also low returns.

“If someone wants 4% to 5% return annually and low risk, this might be the right choice. But we found some very good funds of hedge funds that have a volatility of between 2 and 5 and an average return of between 7% and 12%.”

In 2006, Finles launched its Star Selector fund, the first multi-manager hedge fund in the Netherlands, with a performance fee-only cost structure. The fund will invest up to €200m in a concentrated portfolio of up to 20 niche managers. In return for their €10m, Van Kuijk requires two things of hedge fund managers in the Star Selector fund. “First, each manager must do something unique, something completely different from all the others. Second, each manager must be able to achieve an annual return of 20% or more.”

Last year the fund had a net return of 11.13% with a volatility of 5.5.

The latest fund from Finles, the Alternative Bond fund, has the same performance fee-only cost structure but is diametrically different. It can manage around €1bn with a portfolio of some 50 managers. Van Kuijk says the aim is to have a volatility below 3 and an annual net return of between 8% and 12%.

The fund is designed to avoid market risk, he says. “Every single manager must have the ability to have a performance that does not depend on market risk. So what you’ll find in there is deal risk, manager risk, all kinds of operational risks but not market risk. All underlying managers have proved to be able to avoid down months, also in the current market environment. To avoid left tail risk I am putting in a lot of managers, because all these managers have deal risk.”

The priority is preserving capital, he says. “My personal target is never to have a down month.”

Both the Star Selector and Alternative Bond funds come with a novel cost structure that breaks with the traditional ‘two and 20’ structure. “A large proportion of funds of hedge funds offer their client a net return of between 4% and 6% per year. If they take two and 20 on top of the two and 20 the underlying managers are taking, the client will get hardly anything of the gross performance,” says van Kuijk.

“We felt that if we can deliver what we say we can, then we should put our money where our mouth is. So, first we invest our own money in our funds. And, second we charge only a performance fee of 20%.”

In spite of such incentives, Van Kuijk admits that Dutch pension funds have yet to show much interest in funds of hedge fund investment. Large pension funds are not interested in managing small tranches of money, he says.

“The alternative investment teams at the big pensions funds are pretty small, so their research capacity, risk management capacity and monitoring is limited in relation to the amount of money they are managing. They need to do tickets of at least €100m.”

This far exceeds the capacity of the Dutch single manager hedge fund industry, where funds are relatively small. “There is a capacity mismatch which can only be resolved by the Dutch hedge fund industry, through multi-manager funds of hedge funds,” says Van Kuijk.

Smaller pension funds offer better prospects, and Finles has begun to target the 600 small- and medium-sized pension funds. Yet progress is slow, says Van Kuijk. “Pension funds are risk averse, that’s their nature. Being risk-averse it’s easy for the smaller funds to say we’re not going to do hedge funds because it’s spooky and mysterious and we don’t understand it.”

A more serious problem is the smaller funds’ lack of knowledge of alternative investments, he says. “Alternative investing needs a new knowledge set. If you go in without it, you will get burnt. So our job in the Netherlands is to educate, to coach and to help pension funds build their own knowledge base and their own team that can do research, risk management and single manager investing.”

Although Finles is building a network of representatives outside the Netherlands - in Hong Kong, Tokyo, London and New York - the primary target is the Netherlands. “Our aim is to become a big player in our home market,” says Van Kuijk. “We have already moved from a situation where we had only private clients to one where 40% of the assets we manage is institutional money and of the new money coming in, 90% to 95% is institutional. We are now determined to break through into the Dutch pension market.”

In the longer term, Van Kuijk has more ambitious plans for Finles - notably as a pump primer for start-up single manager hedge funds in the Netherlands. “If people want to start up as hedge fund managers in Holland they face big problems in raising capital. We have come with a solution to become a provider of services to help newcomers to the hedge fund industry in the Netherlands to get started.”

Finles plans to establish a fund, provisionally titled ‘Dutch Pioneers’, which will invest predominantly into a platform. “We are going to give a manager the opportunity to do his or her thing and nothing else. We will supply them with an office in the south part of Amsterdam, a desk, a Bloomberg screen, compliance, admin - everything will be arranged for them, even seed capital, marketing and sales. They just rent it, plug in and start.

“The platform itself will be a knowledge centre, a talent factory, with senior managers to coach the younger managers. The idea is that within two or three years, these people can get off the platform when they have an operation that is big enough to do everything themselves.”

The platform could also protect potential hedge fund investors, Van Kuijk suggests. “Starting managers operational risk is always a big issue. What we’re doing is ensuring that operational risk is covered.”

Finles also plans with the Dutch Pioneers fund to invest in single manager hedge funds in the Netherlands, Dutch single managers hedge funds based outside the Netherlands, and foreign managers that want to locate in the Netherlands. It plans to launch its initiative with €500m provided by Dutch institutions.

The ability to launch such initiatives is one of the benefits of Finles’ new ownership structure, following the management buyout in 2006, Van Kuijk says. “It gives us the ability to be take big steps like this. Independence gives us the freedom to be entrepreneurial.”