Dexion Capital, a fund of hedge funds manager, has made its mark evaluating hedge funds. CEO Robin Bowie tells Fionnuala Synnott
where he believes future value lies
At a time when other asset classes are suffering from investor jitters following the US subprime crisis, hedge fund performance – with the exception of a few headline-grabbing cases – does not generally appear to have been hit significantly. “Hedge funds are relatively well-positioned, particularly when you compare them to equities where there is a tremendous weight of excess cash,” says Robin Bowie, chief executive of Dexion Capital. “It is unclear at this time as to how the contagion effect will take place from subprime. There has been a dent but we don’t think it’s significant. When you look at hedge fund performance year-to-date, most fund of hedge funds were up by 7-8% coming into the end of July and they’ve probably given back between 1-4% in August. That takes them to 6% year-to-date, so most fund of hedge funds are still up.”
Closing the loop
If anyone should know it’s Bowie who, in his time as CEO at Dexion, has made a successful living from evaluating fund of hedge fund organisations. The firm was founded in 2000, when Bowie recognised that hedge funds were an effective way of managing both alternative and traditional assets. “We thought that if institutions were going to go into this asset class they would need some guidance as to which managers to pick,” he says. While acting as a consultant to insurance companies and pension funds, Dexion discovered that it could use its research capability to develop product lines and sell them to institutional investors.
“We felt that there was a mismatch between hedge fund liquidity and the liquidity that private wealth managers and institutional investors wanted when investing in hedge funds. We tried to close that loop by developing the closed-end investment company structure.
We revamped the structure and made it more client friendly by protecting investors’ rights, not just managers’ rights.”
But dealing with listed alternative vehicles can be challenging. “The traditional problem with closed-end investment companies is that you run the risk of them trading at a discount, mainly because they either underperform investor expectations or are not properly marketed to new investors. We wanted to mitigate that risk when we set up our first closed-end company, Dexion Absolute.
“We said that if the closed-end company traded at a discount of (on average) more than 5% in a calendar year we would allow investors to have a continuation date put to them by the board and if they didn’t want to continue they could wind the company up and get money out of that. Effectively, this meant that if there was a big discount they would be able to get their money back and would be protected. In addition, issues didn’t trade at significantly more than 5%.”
But, more recently, Dexion has changed its approach. “We decided that as the market has evolved issues should be trading at +3 and -3 to NAV. We use Treasury and cancellation buyback to control the discounts as it is not in investors’ interests to have a significant discount on issues. If you can control discounts you can get performance and grow the business. We are prepared to take action in order to protect investors as we want repeat business.”
Bowie describes the Dexion business model as “slightly lopsided” with its closed-ended business producing around two thirds of total revenue. He says: “I’d like to balance that off a bit more. But different parts of the business have contributed different things at various stages.” There are three main parts to Dexion’s business: advising institutions on allocations to fund of hedge funds (the consultancy business behind the foundation of the firm); a product division; and a capital raising business for single-manager start-ups looking to raise capital, as well as for established funds looking to raise money from big pension funds and insurance companies.
“What we are is a marketing organisation. We sit in our own space because most marketing organisations are bolted on to manufacturers. But our view is that you can build a much better distribution network if you can select the best of breed asset manufacturer to manage the money that you put into a product.”
Dexion is focused on growing its existing vehicles as size and liquidity are important to its investor base, which is split almost equally between private wealth managers (55%) and institutional investors (45%) and is largely made up of life insurance companies, family offices and banks. The company is keen to increase its distribution into mainland Europe as, at the moment, 80% of its investors are based in the UK. Dexion is also in the process of setting up an Australian office in a bid to increase its distribution into Australia and Asia. “We’ve got brand recognition in the UK. We need to roll that out internationally by targeting specific countries, rather than taking a broad brush approach.”
One of the main challenges of growing the business is infrastructure: “When growing the business, you have to foresee how you will build out the structure of the firm so you can support the remote offices. We want to give the satellites freedom but at the same time you need to have control because you always have the regulatory risk of misselling or something like that. You need to have good procedures in place.”
When it comes to the future of hedge funds, Bowie thinks the sector should be looked at in the context of the asset management industry. “You have to think of hedge funds as two things: they are either alternative ways of managing traditional assets, or alternative assets. If you want to give your portfolio directionality you buy beta. If you want to create alpha you create it through long-short strategies. Alternative assets are more difficult because the risks and returns are very idiosyncratic. Those products need specialist research. Fund of hedge funds are well positioned as they are good at manager selection and portfolio construction.”
Selection and construction
At this stage, Dexion is very focused on what Bowie refers to as “the hedge fund side of the equation”. He adds: “But we realise that the closed-end company is ideally suited to liquefying less liquid asset pools, as it gives the buyer the ability to trade in and out. On that basis we can put research resources in place, and build out a business that has other alpha asset classes in it, looking at areas such as infrastructure and agriculture.”
Bowie thinks that the domain between private equity and hedge funds – where there’s a lot of illiquidity and complexity – is where the best value will come from in the future. “We will develop our research capability where we see the opportunities developing.
It is not just a question of growth for growth’s sake. The really important thing is to get the quality of the products right as it makes them much easier to market.
The selection and construction process are the most important things. Marketing comes on the back of that”.
© fe October 2007