September 2008

COVER STORY: The American Way

Lombard Odier sought US value managers for European and global funds, preferring their more dogged approach to the investment style. The bank has also shown the industry how to make solid distribution partnerships, writes Nick Fitzpatrick ... Fund managers can be critical of their independent distributors, but when partnerships between a manager and a distribution platform work well, they work really well.

An example of this comes from Lombard Odier Darier Hentsch & Cie (LODH), the Swiss private bank, which turned to American investment houses for partnerships when launching two value equity funds ­– including one that invests in European stocks.

The bank felt it could not find an adequate European manager and so appointed California-based Brandes Investment Partners for the European equities value fund and Pzena Investment Management for the global brief.

Pzena benefited from the relationship with more than just a bit of new business, however. Pzena, with US$18bn (£9.03bn) under management as at end June 2008, had no European distribution capacity prior to its association with LODH. But the Swiss bank helped it build one, meaning the appointment was a coup for the New York-based boutique, particularly as many larger American managers face a hefty spend to access the European marketplace.

“This has been an interesting partnership because Pzena had no mutual fund or distribution capacity in Europe, so we gave them access to lawyers and helped them create one,” says Laurent Auchlin, senior vice president, fund research & multi-management at LODH.

“Pzena is a value boutique and they manage a global value fund for us. We used various data providers to research the US mutual fund range and we came across Pzena. We liked their philosophy. They call themselves deep-value investors and their portfolios are very concentrated – about 30-40 stocks in total.

“We followed them on a quarterly basis and then decided to go in a bit deeper.”

Strong backing
The support for Pzena is also a reflection of a committed relationship. The LODH Pzena Global Value Fund launched a year ago and despite underperforming by 20% in the first year, LODH continues to back the manager.

“We are convinced they have the knowledge to add value going forward,” says Auchlin.

This is not the first time Auchlin has backed a fund manager through a tough period. UK firm New Star has also benefited from LODH’s support. “Richard Pease at New Star underperformed by 12% but we will still stick with him. Some of our clients reduced their assets but not by very much. With Pzena we have not reduced at all.”

In Switzerland, where hedge funds claim a large amount of asset allocation from wealthy clients of LODH, it cannot be easy to convince clients to stick with long-only managers through difficult times – particularly with high expectations of absolute returns from mainstream managers.

Auchlin says: “People might understand absolute returns as a zero loss at any time. But that is not the case. I think the absolute-return theme has been hit because of raised expectations about
what it is.”

He adds: “We have the discipline to stick with managers through bad periods. As a long-only manager you are going to have bad periods.

“We are not traders, after all. We try to make manager selections that will cover the full market cycle.”

Auchlin’s fund research team provides Lombard Odier with bottom-up research. The investment strategy of the bank is currently weighted towards big growth companies, avoiding traditional financials.

Why, though, did the bank settle for US managers for the two value funds? Although Brandes Investment Partners, manager of the European value portfolio, had already been with LODH since 2002 in another European equities fund, the appointment of Brandes and Pzena nevertheless reflected some dissatisfaction with European providers of the same type of strategy.

“We only found a few deep value managers in Europe for European equities,” says Auchlin. “When value goes down European value managers will blend styles for a while and later they will start to take risk again. Americans will just stick or die.”

He adds: “Between 1998 and 2001 a US value manager told us he lost half of his business, but he still stuck with his philosophy. Americans are more inclined to do that and that’s what we like. We do not turn over funds very much. Turnover is about 15% to 20%, which is not high.”

Value driven
Pzena Investment Management is an independent firm that employs a classic value investment approach for domestic and international portfolios. The firm was founded in 1995 by Richard Pzena and comprises around 80 employees, all based in New York City.

The firm says its investment approach is simply to buy good businesses when they go on sale, using five criteria. These are: a low price relative to the company’s normal earnings power; current earnings are below normal; management has a sound plan for earnings recovery; the business has a history of earning attractive long-term returns; and there is tangible downside protection.

Brandes has been in business since 1974 and has total assets under management of  $86.4bn (£47bn), of which institutional and private client assets account for $65.1bn. The firm has 506 employees worldwide.

The firm was set up by Charles Brandes, who is the chairman. Perhaps he can shed some light on why some European managers may find it difficult to run value funds.

“Value investing has been a successful strategy over long time periods, yet only a handful of market participants are able to adhere to its tenets,” he writes in a report.

Brandes believes that two reasons why value is a difficult discipline to follow relate to behavioural economics.

It is totally different from conventional wisdom, he feels. “That’s the first thing that I think makes value investing so difficult. It’s unnatural for humans to think totally different from the crowd.”

He adds: “The second reason value investing is so difficult is that everybody has a tendency to think about what has just happened in the immediate past and extrapolate that into the immediate future. We all have the tendency to be influenced by short-term events – and that tendency makes people stock market speculators.”

The fact that LODH went to the lengths of appointing US managers and even constructing a European infrastructure for one of them, was driven partly by a discerning investor base.

Auchlin explains: “In Switzerland investors have a huge historic investment in hedge funds. Most are high-net-worth investors and have been invested in hedge funds for the last ten years with about 20% allocation. Therefore as a long-only manager we have to find alpha.”

Alpha means finding strategies ahead of the crowd. Auchlin explains: “When we selected the JPMF Euro Strategic Value Fund, a growth fund, in 2000, it was a new approach to investing and added value to our list. They originally had a total amount of assets that came to less than €400m (£318m). But this increased to €40bn and 90% of fund providers [now have] this fund on their list.”

Team work
Auchlin took over the role of long-only research at LODH four months ago. The team was set up by Cyrille Urfer and Auchlin eight years ago and currently has eleven people. Another team, led by Christophe Khaw and Michel Nassif, is responsible for alternatives research.

Auchlin says that all decision-making is in Geneva, but adds: “We take advantage of our international network with our 16 external offices in which we try to have a contact person for our activity.
“We differentiate ourselves in that we hire people that have not only financial interests in the countries or regions they cover but cultural interests as well.”

High-net-worth investors are LODH’s largest client segment, accounting for about two-thirds of assets. But institutions are also clients. For example, says Auchlin, the bank serves pension fund clients that want to obtain international exposure through funds.

He says that 120 external fund managers make up LODH’s selection list. About 15 of them manage LODH funds and the rest run their own. There are also an additional 50 internal funds that LODH can choose from.

“From our Masterlist, we take into account the bank investment strategy and construct the Focus List in which we select a maximum of 30 managers.”

Auchlin adds: “To monitor our managers after we have selected them, we meet managers about four times a year.

“We also travel by pairs to combine knowledge and experience, so the person in charge of the US might travel to Asia, for example.”

160 degrees of risk
LODH has demonstrated that open architecture relationships can work well. Finding support from distributors in tough times like Pzena has is something to be envied.

But even though innovation is clearly a big selling point for fund managers looking for private-bank business like this, Auchlin is slightly wary of the long-only world’s latest fund innovation: he’s not ready to invest in 130/30 funds, at least not yet.

“A lot of managers with 130/30 funds argue they are less risky. They are right when you think about market risk, but my risk is higher because the asset manager has to be right on the 100, and on the 30 long, and on the 30 short. That’s ‘160’ risk for me!”

Auchlin is not convinced that all managers have the ability to invest long/short-type funds. And he has reason to. “A year ago we chose a European small cap UK-based manager. They also launched a long-short fund, though not 130/30.

“We met them recently and the fund manager admitted that despite good performance in the long-short portfolio, his natural bias is long-only with a long-term view. They decided to hire a new manager for the long-short portfolio.” © 2008 Funds Europe

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