The world’s biggest hedge fund company evolved from the British Navy’s rum supplier into a profitable purveyor of alternative investments. Are its heady growth and fat margins sustainable?
By Andrew Capon
December 2002
A prominent U.S. fund-of-hedge-funds executive recently boasted to Stanley Fink, CEO of London-based Man Group, that if he moved in on Europe, he could undercut Man’s business by a third, selling alternative investments to wealthy individuals and institutions. But the American added that he wouldn’t do that until the European Union adopted a single tax, regulatory and legal regime for all its members.
“My response,” says Fink, laughing, “was, ‘See you in 20 years.’”
He has a right to feel secure. By structuring products for onshore investors that meet the diverse requirements of Europe’s still-fragmented markets, Man has climbed to the top of the fund-of-hedge-funds heap. The company is more than twice the size of its nearest peer (see “The Fund of Hedge Funds 50"). Unlike its smaller rivals, which are mostly privately held and intensely secretive, the firm has been publicly traded since 1994; it joined the FTSE 100 index of the U.K.'s largest companies in 2001 and thus is subject to the kind of scrutiny that hedge funds usually abhor.
Man markets its products aggressively, distributing them through more than 1,000 independent financial advisers, banks and asset management partners, to whom it pays some of the richest fees in the business. It sells 33 percent of its funds in the Asia-Pacific region, 43 percent in Europe, 16 percent in the Middle East and 8 percent in the Americas. It has seven offices worldwide, but the 85 people who represent the bulk of its sales force work from a tiny village in Switzerland.
Culturally, Man resembles an ordinary money manager more than a hedge fund operation. It doesn’t keep a stable of high-profile investment stars. Indeed, Man is largely untouched by the cult of personality that makes many such funds synonymous with their founding partners -- Julian Robertson and Tiger Management Corp., Paul Tudor Jones and Tudor Investment Corp., George Soros and the urhedge fund that bears his name. CEO Fink is a lawyer who worked for Arthur Andersen, candy maker Mars and Citibank before joining Man in 1987.
Yet compared with other plain-vanilla fund managers, Man is wildly profitable (see table at the end of story). For the firm’s first fiscal half, which ended on September 30, it reported pretax profits of £138 million ($216 million), 36 percent higher than in the year-earlier period. Assets under management have swelled to $23 billion, up 19 percent since March even when two acquisitions are netted out. Operating margin for the fiscal year ended in March was 44 percent, compared with an industry average of 23 percent.
Shareholders clearly approve, and the result is Man’s $4.6 billion capitalization -- 20 percent of assets, versus 3 percent for Amvescap and 1 percent for Schroders, the only other money management companies in the FTSE 100. After soaring by 94 percent in 2001, Man shares were trading at about 10 in late November, a 28 percent decline from their 52-week high. That performance was in line with the U.K. market but better than average for the money management sector.
Inflows into European equities are at their lowest levels since 1995. But while mainstream fund managers are hurting, Man keeps raking in assets. Its latest product launch, a capital-guaranteed fund introduced in October, raised $686 million, a record for the firm. “I think people have been theoretically aware of the dangers of being long-only in equity markets, but three years of losses have really brought this home,” says Fink. “Private client investors and, increasingly, institutions want the diversification that hedge funds can offer.”
At least some analysts think his upbeat attitude is warranted. Says Bill Barnard, speciality finance analyst at Dresdner Kleinwort Wasserstein: “Stanley Fink is an ebullient cheerleader for the entire hedge fund industry. But so far Man has lived up to his optimistic assessments for the future of the business.”
Now Fink has what he describes as a “high-quality problem” -- namely, how to maintain Man’s rapid growth. The company has two core businesses. Man Investment Products, the asset management division, sells more than 200 different alternative-investment products, mostly to individuals, and accounts for 80 percent of revenues. The remainder comes from Man Financial, the world’s sixth-largest futures brokerage.
Fink has shored up both divisions this year. In May he acquired Swiss fund-of-funds manager RMF Investment Group for $833 million -- doubling Man’s assets under management in one stroke. And he bought GNI Holdings, a London-based derivatives brokerage, from South Africa’s Old Mutual in early November for $100 million. Even before the acquisitions, the group showed robust organic growth. In the first six months of fiscal 2002, earnings at Man IP were up 41 percent, and Man Financial’s rose by 8 percent.
Observers wonder what the 45-year-old Fink, who became CEO in 2000, can do for an encore. For one thing, Man’s ascent has coincided with the kind of market slump that hedge funds were born to beat. For another, the industry shows signs of maturing. The global market for alternative investments has been growing at more than 25 percent a year for the past ten years; Merrill Lynch & Co. and Cap Gemini Ernst & Young estimate its total size at $563 billion, up from $300 billion just two years ago. Meanwhile, the number of hedge funds has ballooned, from 880 in 1991 to about 3,000 in 2000 and 6,000 last year. And astute analysts like Barton Biggs, global strategist at Morgan Stanley Investment Management, have warned that the hedge fund mania gripping the U.S. and Europe “is rapidly assuming all the characteristics of a classic bubble.”
Most hedge fund strategies are, to a greater or lesser extent, limited by how much money can be put to work while still delivering market-beating returns. And 90 percent of Man’s assets are in hedge funds. Nevertheless, Fink’s business model is concentrated on asset gathering, and he wants to make sure Man’s supply can keep up with demand. Bringing new products into the fold was part of the rationale behind the RMF acquisition. Man came under fire for the purchase price, which was the highest ever paid for a hedge fund. But Fink figures that acquiring RMF added $8 billion to $10 billion worth of capacity. “It would be a tragedy if this business could gather assets but didn’t have enough product,” he says. “We have to make sure that doesn’t happen.”
RMF also allows Man to target European institutions after years of focusing on retail. Of RMF’s $8.5 billion in assets, $400 million is in private equity funds of funds and more than $2 billion is in European high-yield bonds and collateralized debt obligations -- all new areas for Man, and all likely to appeal to institutions.
Man’s most profitable investment strategy, a computer-driven, trend-following managed-futures program called AHL, with $5.6 billion in assets, is targeted mainly at private clients in Europe, the Middle East and Asia. It has returned close to 20 percent (annualized and net of fees) for 19 years -- a long track record in the hedge fund universe. But a managed-futures fund is by definition size-constrained, governed by liquidity in the underlying markets. And Man has relied too heavily on AHL, which five years ago contributed nearly 90 percent of its fund management revenues.
Nevertheless, until recently, Fink was reluctant to push too hard into the institutional market, citing, among other things, institutions’ unwillingness to fork over the high fees to which Man is accustomed. AHL customers pay an annual management fee of 3 to 4 percent and performance fees of at least 20 percent, according to Bloomberg financial data. But RMF reshapes the group, changing Man’s asset mix to 50-50 retail and institutional. Swiss Life and Credit Suisse Group, both RMF clients, together brought Man $5.2 billion of new money to manage. In five years, Fink projects, AHL will account for just 10 to 15 percent of Man’s assets under management and 20 to 25 percent of group profits.
Besides reaching out to European institutions, Fink is looking for future growth in the U.S. Although it represents half of the world market for hedge funds, the country now accounts for just 8 percent of Man’s assets. Man has a toehold there through Chicago-based fund-of-funds manager Glenwood Group, which it acquired in 2000. Glenwood now has about $5.7 billion under management, mostly for institutions. In January 2001 Fink dispatched global sales chief John Kelly from Man’s European distribution center in Pfäffikon, Switzerland, to Chicago. Kelly’s brief is to get regulatory clearance to sell Man-Glenwood alternative investments to private clients in the States; a product should be ready for launch by the end of this month. “The goal is to get 20 percent of assets under management sourced from the U.S. in the next few years,” says Fink.
Despite the new initiatives, Man will have to struggle to maintain its past growth rate and profitability. The increasing popularity of hedge funds has heightened competition among providers. The likes of Goldman Sachs Asset Management and Deutsche Asset Management now have multibillion-dollar fund-of-funds businesses. Mainstream companies eager to boost their margins by offering alternative investments are already beginning to drive fees down. Fink himself has admitted that deriving more revenues from institutions will narrow Man’s margins.
Also, managing a far-flung network of hedge funds while maintaining the transparency that shareholders demand may get increasingly difficult. Analysts were frustrated this summer when a New Yorkbased equity option fund that Man-Glenwood helped set up in the early 1990s, Livingston International, made a bad call on volatility and lost more than 70 percent of its value. Its collapse contributed to a 4 percent return for the Man-Glenwood Multi-Strategy Fund in the six months ended in September, way below its long-term record of 11 percent annualized returns net of fees. Some investors are annoyed at what they see as a lack of disclosure. (In another example, ousted Swiss Life CEO Roland Chlapowski and other executives are under investigation for selling off a large stake in RMF held in a secret fund. The scandal had no impact on Man shares.)
Conversely, the spotlight that comes with working for a publicly traded company may scare away cutting-edge money managers who want to be left alone to do their own thing. Says David Harding, a Man veteran who now runs his own hedge fund, $300 million Winton Capital Management, “Their corporate culture may put off some talented individuals in the hedge fund world, and that may impede their growth.”
Yet despite Man’s hybrid nature, analysts increasingly benchmark it against other asset managers, not other hedge funds, and they think it measures up well. “What gives me confidence is when I forget the products,” says Merrill Lynch, Pierce, Fenner & Smith specialty finance analyst Philip Middleton. “Divorce the business plan from the exotic underlying products, and you’ll see that all Man is trying to do is what the best fund management businesses have succeeded in doing over the past decade.”
Middleton is referring specifically to the art of pushing product through an efficient pipeline. But others says there’s more to Man than sales. “People often sum Man up as a marketing machine,” says Winton Capital’s Harding. “That is true, but it also understates Man’s virtues. Man has brought a corporate discipline to bear on a business that has been characterized by amateurism.”
MAN GROUP’S ORIGINS STRETCH BACK 219 years. Its headquarters on the Thames’s Sugar Quay, near the old Port of London and the Customs House, attests to its roots: The firm’s founder, James Man, started out as an apprentice barrel maker for the sugar trade, launched his own sugar brokerage in 1783 and then branched into other commodities. Within a year he had won an exclusive contract to supply the Royal Navy with rum. The deal was not only lucrative but long-lived: Despite sporadic opposition, the daily rum ration for British sailors survived until 1970.
When James Man died in 1823, his firm had become one of London’s leading commodities traders. For more than 130 years, it was named ED&F Man, after the founder’s two grandsons. In fact, the company, which grew into the world’s largest trader of cocoa and sugar, would have been recognizable to James until recently.
But the turning point in Man’s evolution came during the 1980s. Under then-chairman Michael Stone, who had been a partner since the late 1970s, the firm moved into futures. Man had built expertise in hedging its own books and had developed a treasury operation, and executives felt the next logical step was brokering the instruments Man used. So in 1980 David Anderson, who held a number of top positions at Man over 20 years and went on to chair the London Commodities Exchange, founded Anderson Man, a commodity futures brokerage. At about the same time, the firm set up Mantrad, a money brokerage and trader in financial futures and gold -- the precursor of today’s futures brokerage business, Man Financial.
After a couple of years, Man executives noticed that some of its biggest futures clients were neither commodities buyers nor other brokerages but offshore limited investment partnerships, most of them based in the U.S. In 1983 treasury chief Harvey McGrath (who joined Man from Chase Manhattan Bank in 1980, became its first CEO not to have come from the commodities division in 1990 and is now group chairman) brought in college chum Colin Barrow as assistant treasurer. He packed Barrow off to New York to investigate the so-called commodity trading advisers that fed Man a significant chunk of its futures business.
There Barrow discovered Mint Investment Management, a two-year-old CTA run by Larry Hite and Michael Delman. Hite had published a book in 1972, Game Theory Applications, that suggested game theory could be used in trading futures, and Delman, a computer scientist from St. Louis, had written a program to implement Hite’s ideas. In its first two years in business, Mint had returned more than 20 percent annually.
Barrow decided that managed futures was a business Man had to be in, and in 1983 the firm bought a 50 percent stake in Mint for an undisclosed sum. It was a runaway success. By the end of the 1980s, Mint was managing $900 million -- most of it for Man -- and boasting a compound annual return of 24 percent since its inception. (In 1987, the year of the stock market crash, Mint made headlines by delivering a 60 percent return.) Nevertheless, Barrow didn’t want all his investment eggs in one basket. In 1989 Man bought a 60 percent stake in a fledgling, London-based managed-futures business called AHL. Like Mint, AHL specialized in computer-generated managed-futures trading. But it soon began outperforming Mint. (Man bought out the majority of AHL in 1994 and gradually reduced its exposure to Mint.)
By the early 1990s fund management accounted for half of ED&F Man’s revenues but was growing far faster than the commodities side of the business. One reason was that Barrow in 1989 moved the distribution center for Mint and AHL products to the sleepy Swiss hamlet of Pfäffikon, on the shores of Lake Zurich, where he recognized a far larger market for managed-futures products than existed back in London. It was a canny move: Switzerland’s banking secrecy laws and favorable tax climate are a magnet for wealthy investors.
In Pfäffikon Barrow and global sales chief Kelly turned Man into a marketing powerhouse. They peddled its products mainly through a network of independent financial advisers and exclusive private banks. Barrow believed that the best way to nurture distributors was to pay them an up-front sales fee. Although the firm won’t comment, that fee is generally said to be 4 percent -- between two and three times the level for most mainstream fund management products. Man meets these costs rather than passing them on to investors, but it charges a hefty redemption fee that ensures that it is not out-of-pocket if an investor sells out early.
Sales compensation is based in part on performance and in part on salary and is paid according to overall team results in a region. And Man believes in postsale follow-up. Service staff sometimes accompany intermediaries on client visits, and Man holds regular seminars for distributors to update them on performance and new products. (According to Christoph Möller, current head of the Pfäffikon sales operation, Man’s typical client has between $250,000 and $1 million to invest.)
Fink, meanwhile, had joined Man in 1987 to oversee mergers and acquisitions. He is widely credited with boosting Man’s product-structuring ability and expanding its intermediary network. He was appointed finance director in 1992 and took over as head of Man Investment Products in 1996, when Barrow left to start his own hedge fund business -- London-based equity fund Sabre, with $500 million in assets. When ED&F Man went public in 1994, floating for £400 million, McGrath and Fink made some £14 million apiece. Stone, who had been with the firm for 37 years, made £40 million.
McGrath and Fink, eager to diversify the fund management business further, went on reshaping Man. In 1996 the firm entered the fund-of-funds business through a joint venture with Glenwood, which specializes in multistrategy and multiadviser portfolios. (Glenwood was one of the first investors in Chicago’s Citadel Investment Group, the convertible bond and risk arbitrage house that under Ken Griffin has grown into one of the world’s most successful hedge fund organizations.)
“As we got to learn more about hedge funds, it became clear to us that managed futures were just a subset of a much bigger universe of managers,” explains McGrath. “We decided to diversify the business further by buying into Glenwood.”
Ultimately, McGrath and Fink decided that Man had outstripped its origins. The fund management business had been growing by 25 percent a year for more than a decade -- in some years by more than 30 percent -- while revenues from commodities were volatile and cyclical, dragging down earnings. So in March 2000 Man sold off the commodities division in a private management buyout, for £569 million. The commodities business is now under the leadership of former chairman Stone and trades under the old ED&F Man name. “It was a tough decision, but we knew it was the right one,” recalls Fink.
McGrath became chairman, and Fink rose to CEO of the renamed Man Group. The split soon turned Man into a virtually pure play on hedge funds: Later that same year the group bought out Glenwood, paying $110 million for majority control.
Man now sells its Man IP and Man-Glenwood products through a range of regional and national institutions, including ABN Amro, Barclays, Crédit Européen and Nomura Securities. Its network of intermediaries has exploded from 80 in 1996 to more than 1,000 today. The firm also sells co-branded funds through distributors with regional clout, such as Société Générale in Europe, National Bank of Bahrain and BankMuscat in the Middle East and Mitsui & Co. and Westpac Banking Corp. in Australasia. Before the RMF acquisition such arrangements accounted for some 30 percent of Man’s sales.
Man has typically launched four funds a year, including Glenwood and AHL products. Now it’s beginning to introduce emerging managers from small alternative-investment firms under a new brand, Man AP. For example, in 1999 Man launched a joint venture with Marin Capital Partners, a U.S.-based convertible arbitrage specialist that manages $1.4 billion for Man. It has another joint venture with London-based Concordia Capital, a market-neutral equity strategy run by Jason Hathorn, formerly of London-based hedge fund pioneer Buchanan Partners. And it has an equity stake in London-based managed-futures fund Vector. Of Man’s total assets, more than $3 billion is now in the hands of 12 emerging managers. In March Man launched Man AP Strategic Series 1, a product blending AHL, Marin and Concordia management, raising a modest but respectable $280 million.
But AHL remains Man’s signature investment strategy and cash cow. AHL trades more than 100 underlying futures contracts -- broadly, one third are invested in capital markets products such as interest rate and stock index derivatives, one third in foreign exchange and one third in commodities. As its computer algorithms spot trends, it adds positions, but when volatility in the underlying contracts ticks up, AHL cuts back again. In 2001, as global interest rates tumbled, AHL returned 64 percent through November. This year it’s on track to return a bit more than 20 percent, its long-term performance average.
Man’s new strategic push, into the European institutional market, centers on RMF. Fink sees an increasing appetite for diversified fund-of-hedge-funds products among pension managers and insurers as returns from traditional asset classes keep falling. He also notes that RMF’s capability in structuring products for a wide range of regulatory, tax and legal systems for institutions complements Man’s ability to do the same for retail. “In terms of what institutions can do in hedge funds, it is largely uncharted waters,” Fink says. “RMF is ahead of the pack.”
Man’s second major growth effort is in the U.S. For years Fink was put off the U.S. market by its complex solicitation regulations and frequent litigation. But Kelly sees huge potential there. U.S. pension funds’ share of hedge fund investment increased by 76 percent between 1996 and 2000, according to a recent BarraHennessee Group report, and is still growing. Glenwood chalked up one high-profile institutional client last year: General Motors Pension Fund invested $200 million.
A growing portion of new money will supposedly come from private clients, to whom sales chief Kelly will pitch products that blend AHL and Glenwood strategies. Fink thinks Man’s guaranteed products will give it an advantage in this market. These are typically funds with ten-year maturities in which investors are guaranteed to get their principal back regardless of what happens to the fund. Man puts half the capital in a ten-year zero-coupon bond and the other half in a trading account. Man then lends its own capital to the trading account, so that it has the same investment exposure it would have without the bond holding. For Man, the risks are more reputational than financial, since banks are guaranteeing the product. So far the firm has avoided taking a financial hit by sticking to ten-year maturities, giving itself time to trade its way out of declines.
The big question for Man, in both the institutional and individual markets, is whether investors’ appetite for alternative investments can remain as keen as it has been for the past few years. Fink and his crew clearly think hedge funds have gone mainstream. Sums up Glenwood chairman Frank Meyer: “To the extent that there is a free lunch anywhere in the investment world, diversification provides it. That’s what hedge funds offer, and I think we have only scratched the surface of investor interest.”
At the top of the food chain
Man beats other European asset managers in profitability.
Firm* Operating margin (2003)**
Man Group 53%
Crédit Lyonnais 42
HSBC 36
Société Générale 33
Barclays 27
Amvescap 25
ABN Amro 22
Lloyds TSB 21
HVB Group 17
Schroders 14
Deutsche Bank 12
Commerzbank 5
*Margins are for asset management division only. ** Estimated.
Sources: Oliver, Wyman & Co.; UBS Warburg.
For additional stories in our extensive hedge fund coverage, please go to www.institutionalinvestor .com/hedgefunds.
