For a man whose flagship hedge fund was down more than 50 percent at one point last year, Michael Hintze sounds surprisingly upbeat.
On a chilly winter afternoon, Hintze, 67, phones from London to talk about his firm’s reckoning this past spring, a time when the flagship fund’s structured credit instruments went terribly wrong and the firm’s positioning amid market turmoil sent that and one other fund plummeting to their worst-ever losses — wiping out billions of assets in mere weeks.
It was an exceedingly rare stumble for CQS, a London-based hedge fund that had reliably minted money for investors more or less uninterrupted since its founding in 1999. Its flagship Directional Opportunities Fund had averaged gains of nearly 14 percent per year since its inception in 2005.
That changed drastically in 2020, as the coronavirus ravaged global economies worldwide and bond markets gyrated wildly amid fears over liquidity. The fallout hit the assets CQS primarily invests in — structured and complex credits — particularly hard, as Hintze noted in a letter to investors in November. CQS’s Directional Opportunities, which accounts for 10 percent of the firm’s assets, lost 33 percent in March and a further 17 percent in April. The wretched performance, paired with upheaval in the executive ranks, took a toll on the firm, which cut some 50 jobs, scrapped a planned expansion into equities, and saw assets shrink by $3 billion in the short term, according to a June 2020 Bloomberg report.
But it also sparked a near-forensic appraisal of the entire firm’s operations, with Hintze and other executives meticulously combing through individual positions in every portfolio and reexamining all aspects of day-to-day decision-making. Ultimately, CQS reorganized teams, revamped portfolios, and put in place a new board executive committee and a senior partners’ group. Both groups were designed to help strengthen succession planning at the firm — a sore spot given the sudden resignation in January 2020 of Xavier Rolet, a longtime Hintze associate who had been hired to much fanfare to run the firm scarcely more than a year earlier.
Hintze announced these changes in the November letter and elaborated on them in the subsequent phone call with Institutional Investor.
“The world got turned upside down and inside out. This has actually allowed us to really think about stuff,” he says. “We needed to simplify and focus our strategy. We’ve got to get back to the core — it’s credit.”
Hintze says the firm has been able to accomplish this thanks to “a reenergized management committee and a reenergized investment process,” and as he lays out the firm’s transformation — and the “exciting” investment opportunities he sees ahead — his enthusiasm is palpable.
But is it founded in reality?
Judging by the firm’s performance since March, it appears to be. Directional Opportunities posted gains for five straight months through October, while the firm’s ABS Fund gained 37 percent over the same period. The firm’s Credit Multi-Asset Fund added 16 percent from the end of March through October, nearly erasing its drawdown for the year.
Still, Directional Opportunities finished 2020 down about 36 percent, according to a Financial Times report. And the severity of the sudden decline will inevitably raise tough — and fair — questions about how CQS manages risk.
Says Don Steinbrugge, founder of hedge fund consultancy Agecroft Partners, a drawdown of the magnitude CQS’s flagship fund sustained in March and April “is well above what is tolerable for most investors,” especially the type of institutional client that CQS favors.
That, he adds, “will make it very difficult for them to raise assets for their hedge fund strategy over the next couple of years.”
What’s more, though its assets have stabilized, the firm is now managing a smaller proportion of hedge fund assets. In fact, its non–hedge fund products attracted significant inflows last year, offsetting some of the losses and redemptions from its hedge funds. It is set to launch a total return credit UCITS strategy with $75 million in assets, and it recently won a €350 million ($421 million) mandate to manage a portfolio of convertible bonds. But those types of funds earn a fraction of the fees that hedge funds do.
It’s a point Hintze acknowledges. But he argues that his firm’s pivot toward non–hedge fund assets was intentional, and years in the making. “The world is talking about resilience” — in terms of supply chains, economies, and health care systems, for example. “For me resilience is building a firm that is able to go forward,” says Hintze. “It won’t help anybody if the hedge fund [industry] is going out of favor — and it is going out of favor, by the way. What isn’t is the ability to make money for people.”
That’s why Hintze began to build out CQS’s long-only business several years ago, a move he notes initially met with some resistance. Now, he says, those efforts have contributed to the very resilience that he believes has carried the firm through the test of early 2020.
All of which suggests that CQS will eventually move beyond the debacle of last year. But it will likely look very different than it did before.
“When I trained in the army, they trained us for stuff coming at us from the wackiest places,” Hintze says.
The ability to dodge danger and adapt quickly to new circumstances may be embedded in his DNA. Hintze’s grandparents fled the Russian Revolution and settled in China. But the Chinese Communist revolution forced the family to move again, and they settled in Australia.
Hintze took an interest in the financial markets as a child, according to the Bloomberg profile: As a young man he took earnings from odd jobs and Christmas gifts and poured them into Chrysler bonds, which earned a substantial premium to his savings account.
After his army stint, Hintze worked as an electrical design engineer in Australia. But finance beckoned. He earned an MBA from Harvard Business School and joined the trainee class at Salomon Brothers in New York in 1982, working on the fixed-income trading desk. He moved to Goldman Sachs in 1984, rising through those elite ranks to eventually become the head of U.K. equity trading in London, before joining Credit Suisse. There, Hintze built the firm’s convertible and quantitative strategies business and spun it out to form CQS in 1999.
Given his pedigree and successful investment record, Hintze didn’t take long to attract assets. Strong performance followed. During the financial crisis of 2008, perhaps the firm’s first major test, CQS pared losses in Directional Opportunities to the single digits and posted a 73 percent gain in its ABS fund — remarkable feats in a year when the average hedge fund lost 20 percent and global stock markets cratered by 40 percent. The following year, Directional Opportunities surged by 56 percent.
Hintze became known for making contrarian bets that panned out. In 2014 he predicted oil would fall, from $110 per barrel to as low as $40, according to the Bloomberg article. Prices passed that milestone and then fell further, hitting $26.20 in 2016. That year the fund returned 30.4 percent.
As it happens, oil prices are among the bets that went bad for the Directional Opportunities Fund this past March. CQS had sold short-dated credit default swaps protection — essentially a type of insurance against defaults — on two companies that filed for bankruptcy earlier in the pandemic: Chesapeake Energy Corp. and Whiting Petroleum Corp. (Both have since emerged from bankruptcy.)
The firm also bought credit protection on the debt of airline Deutsche Lufthansa — which, like other airlines, saw its business evaporate the instant governments around the world issued stay-at-home orders to combat the coronavirus pandemic. Suddenly, the cost of insuring the debt of these companies spiked, forcing CQS to unload a portfolio of European collateralized debt obligations at a fifth of their value to raise cash to meet collateral demands, Hintze explains in the Bloomberg profile.
CQS structured some deals as so-called first-loss investments. In this strategy, investment banks pool default protection contracts on individual companies and slice them up into tranches that range in risk; some investors agree to absorb the first losses that impact a portfolio. These tranches offer a bigger return in exchange for increased risk, and the strategy can be extremely lucrative, especially if the positions are not hedged — and CQS’s were not, according to the Financial Times.
But if an exogenous shock occurs, the losses can be devastating.
The coronavirus pandemic was arguably the mother of all exogenous shocks — and, in retrospect, CQS’s portfolio was uniquely vulnerable to the exact disaster scenarios that played out in March. One investor told the FT woefully that the firm’s hedges were a “disaster.” What’s more, Directional Opportunities wasn’t the only fund that fared poorly. The ABS trading team lost more than 43 percent in March.
Though no one could fault CQS for failing to predict the coronavirus crisis — nor, perhaps, is it reasonable to expect a firm to buy enough tail-risk protection to cover a meteor hitting the earth — investors were nonetheless taken aback by the speed and sheer depth of its March drawdowns. Even worse, the flagship fund’s double-digit drawdown in April happened at a time when global markets were bouncing back.
Amin Rajan, chief executive of investment consulting firm CREATE-Research, says the staggering numbers serve as a stark reminder to investors that hedge funds “can blow up spectacularly despite their implicit proposition of uncorrelated absolute returns in good times and bad. CQS was a case in point.”
It was all the more stunning given the sterling reputation CQS enjoyed among investors, Rajan adds.
Hintze acknowledges that the portfolio was not prepared for the damage wrought by the pandemic. But he says it’s not as if the fund didn’t do any risk analysis at all.
“Going into this whole thing, there was stimulus, there was global growth; [we were] able to think very clearly what this global growth meant for the corporates,” he notes. “We did a heck of a lot of work on that.”
The problem, Hintze says, was that “nowhere on earth did we think we’d be in a situation” where airlines would suddenly cease operations. Take American Airlines. “We looked at fuel costs going up, individual markets going down — no way did we look at [a scenario where] there would be a total global shutdown.”
In the midst of the carnage, “it was clear we had to start transitioning our portfolio,” says Hintze.
For the Directional Opportunities Fund, the research team, headed by Simon Tannett, reviewed every single credit in the portfolio. Ultimately, the firm reduced or cut several noncore strategies, allowing the fund to protect “the significant embedded value” in its core structured credit portfolio, according to Hintze’s November letter to clients.
Hintze consolidated the management team of the ABS fund under a single CIO: Jason Walker, a ten-year veteran of the firm who had been co-CIO of the fund since 2016. Walker lightened the fund’s hedges after the crisis hit, positioning it well to take advantage of the recovery.
Meanwhile, the multiasset credit team, headed by Craig Scordellis, reviewed the firm’s investment process and all of its holdings at the time of the crisis. Ultimately, CQS concluded that it made sense to keep the positions it had held through the crisis, and it even hired four new investment professionals to the team. The moves appear to have paid off, given the gains in the ABS fund and the Credit Multi-Asset Fund for the rest of the year.
In the November letter, Hintze also points to strong performance by other CQS funds — although those funds are much smaller.
The $340 million CQS Global Relative Value Fund, managed by Prakash Narayanan, launched in January and had gained 39.4 percent through November. The CQS Asian Macro Fund gained 8.9 percent and the long-only CQS Global Convertible Fund returned 8.1 percent through November, according to the letter.
At the same time, the firm revealed that its long-only investment trust business has performed well — particularly the CQS Golden Prospect Precious Metals fund, which gained 67.7 percent through November.
Of course, the long-only funds, given their lower fees, are a much smaller contributor to CQS’s bottom line. But Hintze asserts that these funds are an increasingly important part of the firm’s future.
“People like to talk about my fund — and it’s important, but it’s 10 percent of our assets. The GRV fund has done really well. We are about to get another €350 million for a convertibles mandate,” he says. “The fees aren’t 2 and 20, but let’s be clear, it pays the bills, it allows us to employ people, it allows us to offer ten to 12 traineeships. That is real resilience.”
Getting the performance of the main funds back on track was challenging enough. But at the same time the firm was busy reviewing and shoring up its portfolios, it also had a business problem on its hands.
“Xavier and I have known each other for 35 years, having worked together early in our careers in finance,” Hintze said in a statement announcing Rolet’s hire. “There is mutual trust and respect. Xavier is a man of great integrity and one of the best CEOs I know.”
But barely more than a year later, Rolet was gone.
CQS announced the news in January 2020 in a terse statement, saying he was stepping down to serve in an advisory role “for reasons unconnected with CQS” but not giving those reasons. Rolet, who now serves as an independent non–executive director on several corporate boards, declined to comment, citing a confidentiality agreement.
When Rolet left, several of his key hires went with him, including deputy CEO Serge Harry and head of data science and CRO Ahmad Deek. CQS scrapped a planned long-short equity strategy and opted instead to spin out the team and take an equity stake in the new firm, Landseer Capital, as well as to invest in its funds. But that deal also fell through, according to a Bloomberg report. (Paul Graham, CEO of Landseer and the former head of equities at CQS, did not respond to a request for comment.) Meanwhile, another senior investment staffer, Nick Pappas, left in December to start a distressed-debt fund with a former CQS head of special situations investing, Ivelina Green.
Press reports suggest that the moves came as CQS had decided to abandon an ambitious expansion plan, choosing instead to retrench and return to its core credit focus after it hit turbulence. Other reports hinted at tension between Rolet and some longtime CQS staffers. A Bloomberg editorial headline crowed: “Drifting Hedge Fund Star Could Do With a New Co-Pilot.”
Hintze wouldn’t be drawn in on the rumors, but acknowledges that in spite of his long and friendly relationship with Rolet, having two people at the top did not work out as well as he’d hoped.
“That was probably my biggest mistake,” he says. “I corrected that to make sure there was one person responsible — that’s the big thing.”
The timing of Rolet’s departure nearly ran headlong into the crater of the firm’s performance. But it also forced Hintze to reckon with how he wanted the firm to operate in the future — and what he wanted its management team to look like. Hintze says that in the midst of the chaos, two people stood out in rising to the challenge: Soraya Chabarek, the firm’s global head of distribution, and board chairman Michael Peat.
“I want to work with people who are energizing and helpful,” Hintze says. “As we reshaped the teams, these folks stepped up. So why should I not give them a shot?”
To that end, he promoted Chabarek to serve as a member of the firm’s board executive committee alongside Hintze and Peat. The group is responsible for forming CQS’s strategy and determining the overall direction of the business. Hintze also established a senior partners’ group to tackle the future of the firm (read: succession planning) “with enhanced senior partner equity participation,” according to the firm’s November letter to clients. In addition to Hintze, the group members are Chabarek, Peat, Narayanan, Scordellis, and Walker. Hintze also stepped up the firm’s graduate recruitment program to help ensure a strong talent pipeline for the future.
And he proudly points out that half of the firm’s recent hires have been women. Though he hastens to add that they were hired on their merits, Hintze says they have increased the diversity of thought, which has had a material positive impact on the firm.
“I want businesses resilient,” he says. “The only way I can get that is through diversity of thinking, people, and effort. There is a whole group of people who want to take this to the next level.”
Rajan at CREATE-Research notes that it’s not out of the question that the firm could retain clients and even attract new ones. Some current investors may chalk up the losses to a black-swan event that the firm couldn’t have planned for, he says, and give CQS another chance given its longevity and historical performance before the brutal drawdowns.
“The speed and scale of the Covid crash [were] absolutely unprecedented,” he says. “By the time people woke up to realize what was happening, it was too late to sell and too early to buy.”
And although some may cash out as soon as their investments are made whole again, prospective investors may be willing to bet on the firm, if only because many are facing their own crises in terms of earning enough assets to fund their liabilities and are desperate to get any kind of yield in this lower-for-longer interest rate environment.
“If a fund manager had a good record, came a cropper last year, and then recovered, they will be willing to give CQS the benefit of the doubt” because they need to find higher-yielding assets one way or another, Rajan says. And if CQS bounces back, he adds, “that recovery will not go unnoticed. They stood out among their peers. They’ll get the benefit of the doubt where others [may not].”
He also thinks investors have been pleased with the firm’s organizational changes.
“One of the things they have been worried about is key-person risk. Hintze has been very much the center of gravity,” he says. “These changes that have been announced have been welcomed, because people do worry about the key-person risk. It’s time CQS had proper structures.”
But if the firm wants to attract new customers, it will likely have to focus on the long-only business, which wasn’t as adversely affected by the recent losses, Rajan notes. “CQS needs to attract new customers on the back of the long-only funds and raise the comfort level about the deep level of skill and talent” at the firm, he says. “That has to be done through example and achievement, rather than put in a prospectus.”
Given the challenges actively managed long-only funds in particular have faced, that won’t be an easy task. But Hintze is not only undaunted — he’s excited, in no small part thanks to the investment opportunities that have sprung up as a result of the crisis.
“Once you have mandated an economy doesn’t exist anymore, you have to start stimulating like all heck,” he says. “The really cool thing is you have a world where you now have tools to push money into the system that you didn’t always have. This quantitative easing that you saw in 2008 allows us to do a Japan-type structure across the world, where central banks can keep buying debt from the Treasury.”
Hintze is also excited about the new committees and how the firm weathered the turmoil earlier last year. As he points out, the firm raised €3.5 billion for a long-only fund in the middle of the crisis, and CQS now manages $18.7 billion in assets — slightly more than a year ago and 35 percent more than three years ago.
And for all the talk of an abandoned expansion plan, Hintze says the firm is not focused on growing assets to a particular level.
“Forget about size — I want a firm that serves our clients,” he explains. “We’ve got a resilient platform that allows us to do that. These markets transform on a dime. We need to have people who are able to pivot. Markets change. You’ve got to change with them, make sure your clients are with you, make sure you are humble enough, make sure your operations are sound.”
Hintze insists the firm has now accomplished all of those things — and he is, for perhaps the first time in months, enthusiastic about its future. That goes not just for the business, but for the funds themselves.
“Now we’ve turned it around, and we’re going for it,” he says. “This is just so cool, what’s going on here. There is so much going on! I’ve got another 50 percent year in me.”
