Beehive Capital (BC): ThreeAM, Cayman, Ltd is currently seeking equity investments for two of its Fund of Hedge Funds: the ThreeAM Fund of Hedge Funds and the ThreeAM Leveraged Fund of Hedge Funds. Jon Malmsäter, welcome.
Jon Malmsäter (JM): Thank you very much, it's a true pleasure to be here.
BC: You are the Managing Partner of ThreeAM Cayman, Ltd, a portfolio management company, which is dedicated to creating funds that seek risk adjusted returns without covariation to stocks, bonds or commodities. We'll go into more detail about the company's strategy and its track record, but first, would you please tell us a few words about your background, your experience and your track record as an investment manager?
JM: I've been doing Fund of Funds since 2003 and the funds that I'm involved in have been open to outside investors since June 20, 2004. Before I started doing Fund of Funds, I have been involved in trading in investment banks all my working life. I started working in 1987 as an equity options trader for a company called O'Connor & Associates out of Chicago. That was a reasonably successful venture, so we very quickly moved on to not only trading equity derivatives but also the underlying instruments and we also branched out to trading all kinds of fixed income instruments. The company got sold to Swiss Bank Corporation in 1992, so what now is the investment banking division within UBS is pretty much based on the O'Connor acquisition. After leaving Swiss Bank I was also running the trading operation for Bear & Stearns in London on the equity derivatives side and later, at Bankers' Trust, I did manage their European equity trading. And I think that all the trading experience is very relevant to understanding the trading strategies for the Funds that we invest in now.
BC: Your two Funds of Hedge Funds have delivered superior returns with low market correlation. What is ThreeAM's investment strategy and why have you delivered such a strong performance?
JM: I think that the strong performance is based on the fact that we have a very formalised investment process. We analyse over 10 thousand hedge funds through our quantitative scanning on a bi-monthly basis and then we find a very small and manageable sub-set of funds that we look at in thorough detail. We fundamentally analyse about 50 funds on a continuous basis and right now we're invested in 22 funds.
BC: Investors watching today need to understand better ThreeAM's funds' track-record to date. How long is the track record, and how have your funds performed more recently?
JM: We have had a very good performance. We basically have made 1% per month in US dollars since the inception and with a standard deviation of 2.4% on a annualised basis which we're very proud about and that actually makes us in the top half percent in the world when one looks at the Fund of Hedge Funds that report to the database HEDGEFUND.NET.
The track record starts in June 2004, as I mentioned before, when I started running an onshore fund. The offshore fund that we're talking about now started accepting investments in May 2006.
BC: How does ThreeAM set the performance and risk targets for its two Fund of Hedge Funds.
JM: We try and listen to our investors and their risk and return preferences. The unleveraged Fund of Hedge Fund, the ThreeAM Fund of Hedge Funds is very comparable to an investment in fixed income instruments. The return is two and a half times higher, whereas the risk is less than half of a well diversified bond portfolio. The ThreeAM Leveraged Fund of Hedge Funds offers a three times leveraged version of that fund which gives an expected return which is three times higher than the expected long-term return of the stock market, with only half the risk.
BC: How does ThreeAM select the funds it invests in?
JM: As I hinted on before, we have an investment process that is a combination of a quantitative and a fundamental screening. We screen - it's actually close to 11,000 hedge funds now - twice a month. Then from that quantitative screen we get down to an attractive universal of about 100 funds. Then, we manually screen out the ones that for some reason have been lucky. Any fund can make money by for instance being long on Russia or India over the last two years. So we screen out the funds that actually have some sort of market correlation. And then we get down to about 50 where we do real fundamental analysis and try to understand how the managers have managed to build barriers to entry around their business.
BC: Most other funds of funds emphasize style analysis. ThreeAM's do not; how come?
JM: Well, it's because we haven't managed to find any kind of statistical significance to style analysis. To me, style analysis is a little bit like when somebody comes and tells me- "I know that the stock market is going up, therefore one should be investing in equity long-short funds". My argument against that is that if you really know that the stock market is going up, why don't you go and buy the Nasdaq future that you can trade in and out of 24 hours a day and you also get the fun out of trading it.
BC: How frequently do you monitor your investments and how many funds do you monitor in your investment universe?
JM: If we look at the funds that we've invested in - the 22 funds that are in the portfolio right now - we monitor those on a weekly basis. These managers are very busy, focused on their actual trading or the business that they are in, so that communication is usually done by e-mail. We also monitor in our attractive universe about 50 funds on a close basis.
BC: What is your risk management philosophy, and what risk management concepts do you apply to the fund's underlying managers?
JM: In our allocation process, we attempt to make sure that the risk contribution from each fund is the same to the portfolio. That means that a fund that is highly correlated with the rest of the funds in the portfolio will have a lower allocation than it otherwise would have had. When it comes to risk management measures we try and look at stable and robust statistics, such as the ratio between the best month and the worst month, to get a feel for the distribution of the risk and return of the fund that we're looking at.
BC: Why would you decide to drop an investment manager?
JM: The basic premise for dropping an investment manager is that they change the business. We like the businesses that we're invested in, but we do not want the managers to change them into something that they do not know. The average age of our investment managers is over fifty years, and they typically have been doing the same thing for about thirty years, and that we like. We have a bunch of statistics and also fundamental questions that we ask frequently to try and figure out whether they are straying from the script that we have invested in. So the simple answer to the question is that, what is generally known as a "style drift" is what we don't like, then we will drop the manager.
BC: How do you approach finding a better replacement?
JM: We are not religious about the number of funds that are in the portfolio. If we feel that some managers do not fit we will divest out of them and if there are other ones that we like we will invest in them. But we try and make sure on a monthly basis that we have the best set of funds available at that point.
BC: Security of Assets is also a major aspect of many institutional investors' due-diligence process. What due-diligence do you perform on the funds custody arrangements?
JM: First of all, I'd like to say that the most important thing is not to get fooled by brand names. The debacle at Refco one and a half years ago clearly shows that it does not matter if you're big and well known, you can still go down. So we try and make sure that all our funds have at least two custodians, so that they can easily move assets if one custodian starts to have problems. Secondly, we try and ensure that the valuation of the portfolio is not done only by the prime broker, the custodian, but also by an outside administrator.
BC: What is the added value of your Fund of Hedge Fund strategies for sophisticated investors watching us today?
JM: We do all the tedious work that is involved in hedge fund investing. I can give you an example of an individual who has a very large hedge fund portfolio himself, he has achieved basically the same kind of returns as we have done, net of fees, but with twice the risk. And he's now moving his whole hedge fund portfolio, which is considerable for an individual - about 25 million dollars - into our leveraged Fund of Hedge Funds because he's not only having all the risk, but he also tells me that he does not have to do all the tedious work that is involved in the investing in these things.
BC: Jon Malmsäter, managing partner of ThreeAM Cayman limited, thank you very much.
JM: Thank you for having me.
