Chapter 2
Man versus Machine
I love what I do. I love finding investments that people have missed. I love the whole discussion and arguing cases with bright people, or reviewing an obscure company, or discovering the best way to play that macro thematic on demand in that country. And I just hate to take no for an answer.
—Pierre Lagrange, Founding Partner of GLG, May 6, 2011, interview
Observing the peerless dance duo Fred Astaire and Ginger Rogers glide across the screen, the actress Katherine Hepburn reportedly decoded the duo’s brilliant chemistry, saying, “He gives her class and she gives him sex appeal.”
Those may not be the precise adjectives that come to mind when thinking about the Man Group’s 2010 blockbuster acquisition of GLG Partners, but they’re not far off; in creating one of the world’s largest hedge fund organization, with $69 billion in assets, each partner brought unique characteristics. In the Man Group, a company so old school it’s where the old school went to school, shareholders get the hardnosed quants who note every price fluctuation in every trend in order to patiently profit from the long-term trends. In GLG Partners, they get a star culture of investment gurus whose collective reputation for success attracted $30 billion in assets. Not class and sex appeal exactly; more like grit and glamour, patience and spark.
Opened as a sugar brokerage by barrel maker James Man in 1783, the company’s first break came a year later when Man won the contract to provide rum to the Royal Navy (the service’s tradition, by which each sailor received a tot of rum daily, was observed until 1970, with Man holding the contract for the entire time). Over the years, the company evolved into the commodities trading firm ED&F Man (which continues in business as a separate entity), and then, through astute acquisition of managed-futures traders and fund-of-funds operations, celebrated its bicentennial with its first acquisition of a hedge fund, New York’s Mint Investment Management Co. By the end of the decade, the company had a billion dollars in assets.
The flagship of Man’s operation, with $23.6 billion in assets, is AHL. This unit was founded by Michael Adam, David Harding, and Martin Lueck, three analysts who studied physics at Oxford and Cambridge Universities, who eventually sold the firm to Man in 1994. Rigorous in its study of long-term trends, AHL has achieved an annualized return of 16.7 percent from its inception in March 1996 through September 2010. But as Man Group CEO Peter Clarke told Institutional Investor in 2011, “clients, especially those in Asia, wanted exposure to a discretionary single manager.”
Enter GLG, which has single managers by the score. Established in September 1995 by Noam Gottesman, Pierre Lagrange, and Jonathan Green, a trio of erstwhile Goldman Sachs private-client executives, GLG quickly became home to nearly 200 elite fund managers, each of whom is free to pursue his or her own strategy. Though enormously successful—along with substantial growth and profits, the firm has won numerous accolades and awards—a system so dependent on star power has proven to be unstable; the departure of the highly successful trader Greg Coffey a couple of years ago triggered an outflow of several billion dollars.
With their needs and assets so obviously complementing one another, Man and GLG began exploring a merger in 2008. Those talks were abandoned amid the turbulence of the financial crisis, and were resumed with a new urgency in the aftermath. AHL was up in 2008 but was down 17 percent in 2009, and in 2010 was still 3.7 percent below its high-water mark. Man’s fees suffered accordingly; in March 2010, fees amounted to $97 million, down from $358 million the year before. In addition, RMF, Man’s fund-of-funds business, lost $360 million in the collapse of Bernard Madoff’s Ponzi scheme, and others strategies suffered significant losses as well.
In the face of these losses, Man’s CEO Peter Clarke began the search for new assets. GLG was the first place he turned, and he found receptive listeners. Between the market turmoil of 2008 and Coffey’s departure, GLG’s stock price tanked, and the amount of assets under management fell to $17.3 billion, reportedly threatening to put GLG in breach of a covenant on a $570 million loan from Citigroup. Although the company rebounded rapidly, Clarke’s call came when the smell of disaster was still fresh in the air. Suddenly, each side saw itself looking at a partner who not only addressed its problems but promised attractive synergies. The allure of becoming among the first $100 billion hedge funds on the planet was too attractive to pass up, and the acquisition was announced.
Still, no marriage is without its bumpy patches, and, in this case, the partners are not without the sort of habits, traits, and idiosyncrasies that often prove quite bothersome. We have the Man Group (from 1783, a buttoned-down, corporate, systems-driven, black-box operation based in a venerable Sugar Quay building in the city of London) and GLG (from 1995, an individualistic, personality-driven, entrepreneurial, blue jeans–wearing, star system–driven operation based in fashionable Mayfair). No wonder Institutional Investor called them the “Odd Couple.”
But no Felix and Oscar combo has ever enjoyed such expectations. Observers fully expect the new Man Group, with the quants designing new products for the gurus, to become not only one of the first hedge funds to surpass $100 billion in assets, but suggest that—if hedge fund growth continues as analysts predict and if big successful funds continue to take advantage of their scale to keep attracting new assets—the Man Group could reach the $200 billion mark in the not too distant future.
Two of the Man Group’s key executives, Tim Wong, the CEO of AHL, and Pierre Lagrange, one of the three founding partners of GLG, each had very different paths they took to the Man Group, but now work hand in hand to run one of Europe’s biggest, and most complex, hedge funds.
Looking back, Tim Wong realizes that while his upbringing in Hong Kong was not steeped in the disciplines of finance, a great many of the people that he knew in his family and his neighborhood were involved in playing odds one way or the other. “My father probably had more success with horse-racing than trading in the stock market,” he laughs. Either way, such concepts as trends, odds, risk, winning, and losing were introduced at an early age, and must have taken hold. When the intellectually gifted Wong left Hong Kong to study engineering at Oxford University, he had not decided to which branch he would devote his skills, but, as an undergraduate, he became increasingly interested in finance.
As he neared graduation, he saw an advertisement in the newspaper. “It was probably about an inch and a half by an inch and a half, something like that, very small,” he says, “and it didn’t say which company it was from. But it said something like ‘If you want to join a dynamic business and if you have some science background and like market value, please apply.’ I guess there must have been other ads out there, but that was the one that actually caught my eye. So I applied, and it turned out to be from AHL. And once I started interviewing with them, I never looked back.”
Wong, who became the company’s CEO in 2001, says he was not daunted by the fact that he had no background or education in the stock market. “AHL was all about using systems, which is what I had studied and what I knew. I knew how to write programs and how to analyze data and how to build models. The rest I could learn. So, it was a good way, actually, to enter into financial sector.” Today, Wong says he is very grateful that he studied engineering. “They don’t actually teach you how to build anything in school,” he says with a chuckle. “But they teach you how to think.”
Wong’s experiences during his first few years at AHL were hands-on, writing programs that would deliver data and trading signals to markets more quickly (every few minutes, which used to be fast). Wong says he learned two lessons from these early experiences, which he continues to emphasize.
The first is teamwork. “We were a very tight-knit group that shared ideas and tried to help each other. It wasn’t a big group—the research team was probably 10 people, and the whole company had fewer than 30. But we were extremely helpful to one another, and that culture is still here today. People are always ready to help.”
The second lesson, says Wong, “is that, for some reason, and I don’t know why—we had no fear. We all somehow just believed that we could do whatever needed to be done. Deadlines? No problem. We were super optimistic. And as a result, we didn’t care if we failed. You would try and fail, and try and fail, and try and fail again. But everyone was so optimistic, and believed that it just was a matter of time until you discover something.” And it was okay, Wong says, if after three years, the only thing you had discovered was that the thing you were trying to do just couldn’t be done; you still learned something. “It was extremely good to have done that because that really drew into your head what was possible and what was not. I was very lucky to have started out in a place where we could be unbelievably optimistic about our own ability.” He admits that it is not so easy to have that kind of attitude in a company like AHL today.
Although he is CEO of a trading company, Wong says he still sees himself as an engineer. “I’m very practical,” he says. “If we’re looking at a model, I’m not interested in the underlying theories behind why this model is so successful. I’m interested in the outcome, and I’m interested in how to bring the outcome to life. The purely intellectual pursuit of alpha? It’s absolutely not what I do. And I know I drive the people who come from a pure math background crazy. There have been times when we’ve had to put a risk factor in an equation, and the math people have been going back and forth over whether to make it 2.3 or 2.4. And I say, come on, just make it three. I just want something that works.”
Wong says that the one thing most people don’t understand about systematic trading is the trade-off between profit potential in the long term and the potential for short-term fluctuation and losses. “We are all about the long run,” he says. “It’s why I say, over and over, the trend is your friend.”
“If you’re a macro trader and you basically have 20 positions, you better make sure that no more than two or three are wrong. But we base our positions on statistical models, and we take hundreds of positions. At any given time, a lot of them are going to be wrong, and we have to accept that. But in the long run, we’ll be more right than wrong.” Evidently—since 1990, AHL’s total returns have exceeded 1,000 percent.
Still, AHL is hardly invulnerable. The financial crisis brought on a sharp reversal, and the firm remains vulnerable to the Fed-induced drop in market volatility. In response, says Wong, the company has developed “a number of computerized trading models designed to respond better in the current macro environment.” The fund’s 15 percent rebound last year substantiates this view, and Wong anticipates further growth” beyond its 2010 size of $22.6 billion.
“I think that it is quite important to really understand the risk of your business and not overreact,” says Wong. “Quite a lot of people have gone out of business because either they couldn’t explain to the investors why the market behaves as it does or they fundamentally change what they do, and then cannot recover and make back the losses. So I think that’s what we do very well—that is, we really understand the performance that we’ve generated, and we really understand the volatility and the risk.”
Wong recalls that when he started at AHL, he worked under then research head David Huyton. One day, Wong expressed surprise that between 1991 and 1999, AHL’s positions on the S&P had lost money every year. Huyton shrugged. “When you have a hundred different markets in your portfolio, the finding that one market has consistently lost money for many years is not that surprising.” The key is to identify the long-term trends. “This business is about accumulating your odds over a long period of time.” Wong says he recalls that when AHL first began selling its funds in Hong Kong, investors were not very patient with the markets. “They all wanted a fund that would make them 40 percent during the first year,” Wong says. “They were skeptical about letting us hold their money for three to five years, and make a 16 or 17 percent average return, even when they saw proof of our performance. It took us three, four years of really very persistent effort before people began to give us a chance.” Today, Hong Kong is one of AHL’s our most successful investment markets.
“Most traders want to be very good gamblers and beat the roulette table,” says Wong. “I would rather be the house and own the roulette table. Every day, somebody is going to bet against us and win, and, from time to time, lots of people may bet against us and win. We’ll have losing nights and losing weeks. But if we play the game over and over again, eventually we’ll win because of the statistical advantage that we have.” Pushing this advantage is the most important job of a hedge fund, says Wong.
“My boss used to tell me that to win at either gambling or investing, you have to bet. And in order to do that, you have to have some chips left. If you lost all your chips, then, game over. So, risk management is actually the most important part of what we do. In our business, you don’t have to lose 100 percent. Even if you lose 40 or 50 percent, you could be out of the game. Protecting your chips is the trick.”
Though Wong does admit to having been worried about a culture clash emerging from the union with GLG, his fears have been dispelled. “I talked to the people and found out that we have very similar outlooks. We are all very result focused, and we all want to deliver the performance.” Wong believes any preconceptions GLG had about the old Man Group stalwarts have disappeared as well. “Many people talk about AHL as a systematic black box, very formulaic, like we’re all robots. But ultimately there’s a bunch of human beings here.”
Wong says he has seen many changes since he began at AHL. “Back then, we traded about 50 markets. Now we trade over 200. In those days,” he recalls, “you had less integration between Europe and the United States. And nowadays, if you look at the correlation between the developed markets or G-7 market, it’s much tighter. So in order to really have this less correlated position, we have to look elsewhere.” They were one of the first to trade in Korea, Taiwan, Singapore, Brazil, and South Africa. Particularly in the early days, this was expensive and difficult to do, but it was worth it to AHL. “These markets have been much less correlated to the developed world, so they kind of diversify us.”
One of Wong’s key objectives has been to develop close ties between the company and the academic community. “Having a firmer link with an academic institution would help us in terms of hiring people and getting to know the latest advances in academics and research, and might even give us some of new ideas that we could actually capitalize on,” says Wong.
After some exploration, AHL focused on Oxford, mostly because the university had a clear vision for the collaboration. The result is the Oxford Man Institute of Quantitative Finance. “They offered us an entire department within the school,” says Wong. “We have an office there with a partner who is physically on site, and about another dozen of our people are there interacting with about 50 academics on a daily basis. And that’s a great match: academics love to solve problems, and we love to ask people to solve our problems.” The Man Group has contributed 13 million pounds to the venture, and Wong believes the investment has been definitely worth it. “The financial service sector and banks and hedge funds have a bad image,” he says. “This shows Man giving back to the society. It works on many different levels.”
Pierre Lagrange: The Money Maker
At the age of 50, Pierre Lagrange, a native Belgian who is one of the richest men in England, has the long hair and casual wardrobe of a classic rocker about to uncase his guitar and unleash a few choice power chords from the stage of the Hammersmith Ballroom. Instead, he is a successful leader of hedge fund operators, and a man whose fortune and influence may yet be decades from their peak.
“I love what I do,” he says. “I love finding investments that people have missed. I love the whole discussion and arguing cases with bright people, or reviewing an obscure company, or discovering the best way to play that macro thematic on demand in that country. And I just hate to take no for an answer.”
Coincidentally, like Wong, Lagrange began his professional career studying engineering—in his case, environmental engineering at Solvay University at the Universite Libre de Bruxelles. Like many young people, Lagrange didn’t know what he wanted to do with his degree, and when J. P. Morgan invited him to join its six-month training program in New York, he jumped at the opportunity.
It was at Morgan that Lagrange had his first exposure to investing, and he took to it with enthusiasm. “It was a fantastic bank with an extraordinary training program,” he recalls. He started on the currency side and was one of the few people with a university degree to join the treasury side of the business. After the initial program, Lagrange remained with Morgan, although in time, he began to look for other opportunities. “I wanted to be in London,” he says, “and I wanted to get into equity trading.”
He joined Goldman Sachs, and found his métier. His next move came in 1995, when he and Gottseman and Green opened their own hedge fund. “Our whole philosophy of how to invest was based on getting people with different backgrounds and different views to work together so we can see something that someone else is not seeing,” he says. Few philosophies are ever practiced so perfectly. By the time of the merger, GLG had recruited a roster of elite traders from big investment banks, and built a roster of multistrategy funds with more than $30 billion under management.
As Lagrange sees it, “Man was very intelligent in looking for an active asset management business for company managed or existing products. Man had tried and failed to do this, so finding GLG, which actually needs distribution, was the perfect fit.” In the same way, GLG, which had tried and failed to build a strong business presence in the United States, benefits from Man’s expertise. “When we get that working,” Lagrange says, “that should be a killer.”
Lagrange says Man understands and respects his business: “They really understand what it takes to build what we’ve got. We both want exactly the same thing.” As opposed to other acquiring companies, Man adopted the view that it would select the people best-equipped to bring the business forward, no matter where they come from. “It’s very brave to do that,” says Lagrange, who adds that he is one of those affected. “There are many of people here who are running more money than I do, and that’s as it should be. They’re better at what they do than I will ever be.”
Lagrange believes the merger has freed GLG’s fund managers to focus on managing money. “We are good at investment management,” he says, “but we are perhaps not the best people at running a business, and we haven’t focused enough on distribution. To do so would have taken up a great deal of capital.”
Lagrange himself is an example of the new arrangement. Although he sits on Man’s executive committee, he is there to give his views, and not to run the business, which frees him to manage his $2 billion fund centered on European strategies. With its energies properly focused, GLG, which had been described as “a collection of 40 relatively small funds that are closed when they reach capacity,” could, as part of the Man Group, have $50 billion under management within the next few years. “It’s really working,” says Lagrange.
GLG built its reputation by fostering “a star culture,” one that attracted the very best proprietary traders from leading investment banks by offering them the freedom to follow their own strategies. “There’s a lot of different ways to get to the right answer,” Lagrange says. “We have a lot of people who are really smart. We don’t want to normalize their processes; we want to normalize the output. It doesn’t really matter how they arrive at the right output.”
But having a star system doesn’t mean that teamwork and process are forgotten concepts. Lagrange stresses that while autonomy is initially attractive, the deeper opportunity GLG offers a trader is to work with other elites of proven stature. Somehow, being a superstar among superstars undercuts the internecine competition. “The ability for people to take from and give to other people is massive,” says Lagrange. Once this spirit is recognized, everything becomes much easier. “People share resources, as opposed to fighting for resources,” Lagrange says. “We try to support the strengths of our managers and compensate for their weaknesses. What they are not really good at gets done by somebody else. Because it’s all about a return on capital employed. We manage the people here based on return on human capital.”
Process is also hugely important. Although portfolio managers have a lot of latitude, their results are subjected to two systems of review. First, GLG spends time analyzing companies, asking questions, and challenging managers on their convictions. When you do that, Lagrange says, “You can see who’s really looking at it from the right way.” Second, GLG places a lot of focus on the portfolio itself. Every two weeks, Lagrange and his risk managers review where they made and lost money. Each trader has a risk budget and is free to use it as he or she sees fit, but the review puts attention on why and how effectively it is being used. “Quite often, people spend 80 percent of their risk where they’re going to get 20 percent of the return, and vice versa. So, that’s where we work with them to push them toward doing very well.”
GLG also emphasizes keeping the whole portfolio in perspective. “What does the idea bring to the overall portfolio? It’s very tempting to be excited about an individual opportunity, but you have to look at things overall, at how this will change the portfolio level. Will it affect profitability? Does it create more volatility? Does it get us closer to the Holy Grail Company where you’ve got top line gross, margin improvement and multiple expansion, and balance sheet optimization policy? When you’ve got a company where you’ve got all these green lights, that’s what you look for.”
Looking ahead, GLG is long on Chinese banks, and aims to increase its position on automakers. The two strategies are connected.
First, Lagrange dismisses the concerns many observers have about Chinese banks. “Our view is that it is very easy to be scared at the level of provisioning,” he says. “In most emerging markets, the level of provisioning for back debt is much higher. But it’s also probably very myopic to really focus on that absolute level of provision without looking at the loan book that these guys have. You have to focus on the economic growth we see in this area. And really, growth is going to continue.”
Lagrange is pleased that many investors have grown bearish on China, and have begun to doubt whether the population and economic growth will match the amount of construction that is happening there. “It’s natural to have doubts,” he says, “and actually, I quite enjoy that people are doubting, because otherwise everybody’s going to be happy and long and complacent, and that would be horribly dangerous.”
GLG had begun developing a bigger presence in Asia even before the merger. Now Lagrange visits China every six weeks or so, looking for new opportunities and meeting with management and clients. He feels it’s important to be present on the ground to have information and control. The Man Group now has a hundred people in the region, and an established trading capability. He believes this gives the company an enormous edge. “You can’t underestimate the value of infrastructure in this business,” he says. “And you can’t underestimate China from an economic growth point of view. We might be a bit too big from a cyclical point of view, but from a structural point of view, you can see that we’re just looking at a kid, at an adolescent. He’s going to grow and grow. You can’t say that about the western markets. The western markets are already an older person.”
As an example, Lagrange points to automobiles. “Our research shows that in order for a household to buy a car, it must have $3,000 in disposable income after taxes. In China, the number of people reaching this level is doubling. The amount of disposable income a household needs before it starts purchasing goods at the luxury level is $10,000. The number of people who will reach that level will triple over the next five years. It’s that kind of analysis that can lead you to detect the opportunity.”
“It is not a crime to make a mistake in the investment business,” Lagrange says, “but you have to recognize your mistakes early and take decisive action to reverse the decision.” As an example, at one point a GLG fund was long on some young oil companies, making the incorrect assumption that because they had low levels of debt, they were somehow immune to financing pressures. “But implicitly these companies needed to come to the stock-market to raise equity because they were involved in long term projects that did not generate any cash in the short term. When the market essentially shut down in October 2008, it became clear just how risky these investments were. We had to get the hell out of them as quickly as possible.”
Lagrange sidesteps the prediction made by CEO Clarke that the combined Man-GLG team will become the first $100 billion hedge fund. “We’re definitely not targeting a number,” he says, without quite dismissing the possibility. He prefers to stress that the Man Group is “not one hedge fund with $150 billion or $70 billion or wherever. It’s 50 different funds including long only.” For Lagrange, the company’s underlying identity is that of a group of elite, autonomous managers, and at the moment, the group is nowhere near a capacity.
In the meantime, any conflict between whether the Man-GLG team will have offices in Sugar Quay or Mayfair was neatly resolved in July 2011, when the Man Group moved its international headquarters to 2 Swan Lane on the banks of the Thames in London. In the spirit of thinking long-term, the company signed a 20-year lease.