Trading, diversity ?

David Smith of GAM can boast great performance, but he doesn’t

David Smith, chief investment officer at Global Asset Management, comes across as an unusual sort of chap to be looking after one’s money. On first talking to him, he gives the distinct impression that he lacks many of the traits that his fund manager brethren and sistren seem to possess in abundance.

He is so ordinary, personable, polite and pleasant that one keeps wondering: “is this guy really the person who runs all that money for all those investors”? “Am I talking to the organ grinder or the monkey here?”

The first, most striking, thing about Mr Smith is that he isn’t a persistently confident or upbeat man. It’s not that he lacks confidence - he doesn’t - but his vocabulary is not littered with words of certainty, which is the norm among a sizeable majority of fund managers. He is not a ramper. And he is a fairly quiet, self-deprecating sort of a chap who is easy to ‘crack’. Some fund managers have a ready answer for every possible question a journalist might ask them, Smith occassionally uses that most disconcerting defence “I don’t know”.

He says things like “we were lucky enough to make 25 per cent that year” or “to be completely honest with you, I don’t know how we select strategies, I suppose it’s a bit of experience really”. Where’s the certainty? Where’s the self-satisfaction?

Smith is just too unassuming and pleasant a human being to be one of the world’s leading authorities on the dark arts that are hedge funds – which is what he is.

Nonetheless, the numbers stack up firmly in Smith’s favour, and as chief investment officer at GAM, he is the chief organ grinder, not the monkey. Among the assets Smith oversees, this feature and interview focuses on two fund ranges that any investor seeking a reduction in portfolio volatility would do well to at least explore.

These fund ranges are Diversity (the first fund, now around $3.3bn in size, was so successful GAM closed it to new money and opened a second version, Diversity II) and Trading (GAM has just launched the fifth version of this particular fund) assets under management are also huge.

Now, without wishing to overhype these funds, not one of them – Trading I, II, III, IV, or V, or Diversity I and II - has ever suffered a loss-making year since inception at the start of the 1990s, and both ranges can boast averaged annualised returns, net of charges, that are above 10 per cent in dollar terms – way, way above the rate of inflation over that period.

(If you can’t picture what 10 per cent annualsed means over 10 years, it equates to a total growth of 159 per cent, so $10,000 grows to $25,900, or $300,000 grows to $777,000). And both fund ranges have beaten 10 per cent annualised.

Contrast that to your average long-only equity or bond fund which has yo-yoed depending on the whims of markets and interest rate setters, and the attraction becomes clearer – especially if we are still in an equity bear market (and generally produce returns nothing like these).

The basics

Both the fund ranges – Diversity and Trading – seek to produce absolute returns with as little correlation as possible to either equity or bond indices.

Smith says the team tries to achieve this from the outset via fund selection (they are fund of hedge fund investors, so they invest in funds, not in individual securities or strategies).

So, to begin with, the team will be searching for fund managers whose performances are not necessarily linked to equity and bond markets, then they’ll seek a mix of assets within those strategies to produce a zero correlation to stock markets, and then the mix of over-arching strategies with a view to having zero correlation.

“What we try to do is create four sub strategies within one to try and eliminate correlation with traditional markets. For example we would create one macro portfolio which in itself has low correlation with the equity market. 3/4 managers are non-correlated.

“We are basically trying to build this up from the bottom in terms of non-correlation.”
“How do we come up with the right mix? We speak about what strategies would work but I think it is about optimisation of experience really.”

What does all this mean when it comes to numbers and correlation? GAM Diversity has a long term correlation of about .5 to the equity market, Trading has a correlation of about .1 per cent.

But these correlations are a nonsense because when the equity markets are negative and the fund is positive, this might create a ‘negative correlation’ of, say, -10, and when the fund is positive and the equity markets are positive, this might create – purely for argument’s sake – a positive correlation of +10. So when you add these together and average them out, you get a correlation of zero, which provides no sensible idea of correlation – except to say that there isn’t much correlation.

So what question really does matter? “The most important number investors need to keep in mind is that we have achieved an absolute return each and every year. That really is the key,” says Smith.

But is all this going to come crashing down? Will the day come when GAM has simply opened too many Diversity and Trading funds, and performance is diluted.
“I’ve got no ambition to run funds that are sub-optimal,” Smith says. “If I didn’t believe these potfolios could perform, then we wouldn’t open new ones.

“But all the portfolos are in excess of 5 per cent up year to date. Trading 1 happens to be up 9 per cent YTD because one of the managers is up 25 per cent, but Trading two, three, and four are all up 5.5 per cent to 6.5 per cent. But if we can’t find the talent, then we won’t open the funds.”

Trading V launched last month. There is a minimum investment of €15,000 or $15,000. The fund has a 5 per cent initial fee, a 1.76 per cent annual fee, and there is no performance fee at the multi-manager level.

Good brokers should get you into the fund at a very hefty discount to the 5 per cent initial fee.

Diversity and you

You may find all of this talk of absolute returns extremely alluring. But you should also think carefully about the fact that the FTSE 100 has gained around 21 per cent since it hit a recent low of around 3300.

You need to consider that, in any given year, stock markets can easily gain 10 per cent, 20 per cent, 30 per cent or 40 per cent.

And this, of course, begs two basic questions: should you invest in funds such as these – absolute return vehicles that have performed year after year, and, if you come to the conclusion that the answer is yes, then you need to think about

Smith himself reckons investors should only put a portion – perhaps 20 per cent – of their assets into his funds. It is tempting to disagree, given the current markets, and suggest a greater weighting – but with hedge fund blow-ups and collapses still not uncommon (this shouldn’t harm Diversity or Trading too badly because they are funds of hedge funds and, as such, have limited exposure), it won’t do you any harm to take a cautious, sceptical approach and build up your confidence and knoweldge as years go by.