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Tuesday 11 March 2014

Product Convergence or Incestuous Orgy in Alternatives - A Review

An FPM principal noticed this headline today 10th March 2014: “Carlyle commodity fund Vermillion's assets halved to below $1 billion” on Reuters. One may be forgiven for thinking that another hedge fund losing money in a zero-sum game – no great news! Once again, FPM reading between the lines and emphasizing joined-up thinking scored a humble bullseye in our outlook perspectives.

Here’s why we hit the bullseye on the investment-dartboard, and not just on paper: In our 2012 risk assessments entitled “Product Convergence or Incestuous Orgy in Alternatives”, published  in two parts (Part 1 & Part 2 here), we highlighted specific and broad risks in the alternative investment industry infrastructure.

Serving as a review of our rambling blogs and demonstrating understanding of risk trends we show excerpts published from the June and September 2012 about orgies in alternatives:

Excerpt 1:

In literary terms we think The Carlyle Group’s [CG] activity represents Jacob Marley’s ghosts showing Ebenezer Scrooge things that have been in the past, are currently and will come to pass. Carlyle’s activity in asset management deals are complex if not opaque beyond the reported details…” (Source: Orgy Part 2 published 19 September 2012)

To appreciate the extent to which FPM have highlighted the evolution of risks in alternative investment industry - an industry aligned as “shadow banking” - please DO read Orgy Part 2. In that blog presentation, FPM describe the industry’s evolutionary risks through its operational infrastructure as “Accumulating Risk Trends – ARTs in Alternative Investments”’ We cited “Commodity and leveraged loan products risk – a time bomb!” as one of ARTs (Accumulating Risk Trends) in Orgy Part 2. Today’s headline about Vermillion Asset Management is the latest in a string of commodities strategies that experience hot-money flows. Current Citigroup research shows that commodity products as a sector, saw a record net outflow of $50 bn in 2013 alone.

FMT Proposal Bullseye about dynamic creative-destruction has irrefutably and evidently seen many commodities operators losing money though a difficult leveraged strategy (i.e. that of using futures and options) and in a challenging global financial environment. Challenging, not least due to effects of the finally acknowledged onset of climate change, but also in-play factors like the policy-driven macro environment. We have identified ARTs contributing to the end of wild-west commodities investing. FPM have documented these hedge fund strategy risks in exclusive subscription research called “Impending Commodities Crash and Amaranth x 10”. Also, FPM have been monitoring and disseminating this strategy’s risk trends since beginning of October 2012. The examples of difficulties faced by commodity-focused hedge funds are numerous, but our first observation and subsequent monitoring was based on an uncompleted transaction i.e. FMT proposal on Touradji Capital Management LP.   

Where FPM missed the Bullseye (i.e. not biased and only indulging in self-praise) was in calling for completion of Carlyle’s strategic acquisition-interest in K2 Advisors. K2 is a prestigious fund of hedge funds operator managing US$9.3 bn in assets then, and who was part-owned by another private equity investor TA Associates, as well as the founding partnership. K2 was majority-acquired by Franklin Resources Inc [BEN], a deal announced in November 2012. Franklin Resources’s long-only investment management arm, in the traditional asset management mould, is called Franklin Templeton Investments with AuM US$731 bn at the time. From industry sources FPM tentatively understands that Carlyle walked away from the K2 bid-deal, due to high price asked by its private-equity owner, and Carlyle balking at taking on K2’s debt obligation.  TA’s sale price and deal term with Franklin Resources were not published.

Excerpt 2:

We believe the creative-destruction cycles are quicker in the alternatives space. The relative rate of growth of assets in hedge funds versus it procreator or predecessor, closed-end mutual funds, is a stark statistic FPM possesses. Remember, closed-end long-only funds were the origins of hedge funds, ETFs and multitude other pooled-assets vehicles. The first such collective investment scheme in the world is Foreign and Colonial Investment Trust, started in 1868. Coincidentally, the first fund of hedge funds is known to have started almost 100 years later in 1969…(Source: Orgy Part 1 published 27 June 2012)

In our Fund Manager Transactions - FMT investment proposals we had been recommending the vestige brand-value and other corporate existentialism embodied in F&C Asset Management Plc [FCAM]. FPM have profitably held the London-listed asset manager in our wealth management portfolio. Significantly, F&C traces its history to 1868 with the founding of “Foreign and Colonial Investment Trust”, the world’s first publicly listed investment pool. 

FMT Proposal Bullseye was evidenced when in January 2014, BMO Financial Group [BMO], the parent company announced the acquisition of F&C for £708 mn / US$1.2 bn. Notice that BMO (short for Bank of Montreal) is Canada’s oldest bank, established in 1817 and operating in Britain since 1870. The bank employs about 45,000 staff globally and has divisions focusing on retail banking, wealth management and investment banking services.

Other reviews of FPM activities and transactions available on request to Kristian via kks@FundPortfolioManagement.com. FPM does not represent itself on websites other than this blog site. Please email us for further information.

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