By Claire Makin
Post-crisis, a new breed of asset managers has sprung up, with
new ideas and ways of implementing them. One of these is
London-based Falcon Money Management, which has a clear sense
of its own identity and where it fits into the evolving fund of
hedge fund space.
Michael Perotti, Falcon’s founder and chief
investment officer, says that much of the funds of funds
industry became the victim of its own success, commoditised and
beta-dependent, and on those grounds recent criticism of the
industry is warranted.
But Falcon has moved beyond this business model to view
hedge fund strategies as a way of delivering defined return
streams in a mixed-asset portfolio – no magic and no
mystique. "It starts with our not being a hedge fund shop. We
start off being an asset manager trying to achieve certain
objectives," Perotti points out.
Falcon applies these views to $4.2 billion in portfolios
that it manages across a range of asset classes, including a
$475 million hedge fund allocation currently outsourced to
about 25 managers. All of these are alpha-seeking funds that
are largely uncorrelated with each other and with mainstream
assets; and many are small, early-stage managers employing
"I think there is an important role for people like us to
play, particularly in niche strategies where you want to go off
the beaten track to find funds doing different things to your
mainstream managers," Perotti says.
Conspicuously absent in the uncorrelated alpha strategies
approach that Falcon is looking to offer to other investors are
many core hedge fund strategies: no long/short equity, and very
little credit, distressed, event-driven or anything with a long
bias. Instead, Falcon prefers relative value and
market-neutral-type strategies that are also highly liquid.
This is because Falcon has followed a distinct
low-volatility approach since it was founded in January 2009.
Until recently, Falcon managed assets exclusively for Beazley,
a major Lloyd’s of London insurer that has a 25%
ownership interest in the firm. The risks inherent in
Beazley’s insurance business required its assets
to be run with a high degree of liquidity and minimum
volatility – in other words, to avoid draw-downs,
particularly year on year.
Falcon’s low-volatility strategy has so far
done just that, with positive returns in each year since
January 2010, and in 80% of months including May 2011, which
was a catastrophic month for many hedge funds. The
strategy’s maximum drawdown was -0.78% in July
The agreement was for Falcon to manage money exclusively for
its strategic partner for three years, to focus on performance.
Now, with a three-year track record behind it, Falcon is
actively courting additional clients, and Perotti and his team
are working on new products for institutions with different
risk and return requirements.
Before founding Falcon, Perotti spent 11 years with Swiss
asset manager Union Bancaire Privée, becoming CIO for
UBP’s London operation where he oversaw a
40-strong team that he had helped build. He resigned in 2007.
"I wanted to build up something from scratch, something
entrepreneurial that would meet the demands of an institutional
client base," he says.
At the same time, Beazley was looking to boost its internal
asset management capabilities, conscious that attracting
talented people for an in-house team is much easier than
retaining them. The solution was Falcon Money Management, which
is located in Beazley’s headquarters near the
Tower of London.
Thanks in part to Beazley, the operational and risk
infrastructure that Falcon has in place, as well as its
18-person team, are more suited to a large public organisation
than a niche asset manager. "We had to make sure our standards
were up to theirs from day one," Perotti notes.
Besides Perotti, senior members of the alternatives team
include Ermenegildo Schettino, who is head of external manager
allocations including hedge fund strategies, and responsible
for Falcon’s alternative investments in foreign
exchange and fixed income, commodities and volatility, as well
as other relative value strategies. Schettino was previously
head of European hedge fund strategy research at UBP, and
before this, worked at Tarchon Capital Management for seven
Edoardo Rulli, formerly with UBS Alternative Investment
Solutions, oversees Falcon’s alternative
investments in equities and credit, while Antonello Russo,
Falcon’s head of risk management, joined after an
11-year career at Deutsche Bank, where he worked mainly on
hedge fund prime brokerage and risk monitoring and
Anchored in fixed income
Falcon’s investment strategy has so far been
shaped by an ultra-conservative approach that mixes traditional
asset classes with hedge fund type strategies. The
'anchor’ for its main port-folio is fixed income,
which has a relatively short duration of around two years and
is close to the duration of liabilities.
Half of the portfolio is managed directly by
Falcon’s team, and about a third is invested in
non triple-A fixed income, outsourced to traditional
fixed-income managers. A further 12% to 15% is allocated to
capital growth strategies with a higher target return,
including uncorrelated alpha strategies.
This allocation targets a return of T-bills plus 400 basis
points with a tight risk budget, and is invested in liquid
strategies with a low beta element, meaning that they are
largely not exposed to equity market or interest rate risk, or
dependent on economic growth scenarios.
However, this does not restrict Falcon from investing across
the whole spectrum of strategies, including commodities,
credit, equities, forex and fixed income and volatility.
Typically, the focus falls on relative value and arbitrage
strategies with a non-cyclical bias that are uncorrelated to
major asset class indices.
"One of the main principles I believe in, particularly for
this portfolio, is to have different drivers of return,"
Perotti says. In fact, diversification is the key
differentiator in Falcon’s investment approach, he
Proof that the strategy works is its -0.12 correlation with
the MSCI World index. Managers also have a low correlation with
each other. Over time, only two pairs of managers have a higher
than 0.6 correlation and most have correlations ranging from -1
By diversification, Perotti says he means not just three to
four drivers of return but more than 15 different drivers in a
portfolio. He and his team achieve this by looking for managers
with original strategies but "that’s not to say we
won’t end up with one or two global macro
managers" for protection, he adds.
Commodity trading advisers perform a similar function,
although Falcon chooses specialists and not the large,
traditional managers whose strategies held up well in 2008.
"You have to be pretty granular in what you expect from
different strategies, and indeed, from different hedge fund
managers within those strategies," Perotti points out.
In general, Falcon looks for strategies where there are high
barriers to new entrants for various reasons. They may require
long experience in a particular region, a high degree of
technical or legal expertise, as in commodity arbitrage, or a
large capital investment, such as high frequency trading.
Such strategies may have limited scalability, so Falcon
often invests with small or early-stage managers. Investing
early also brings the benefits of added transparency and better
access to key people. There is no size limit and Falcon has
even seeded one manager. "What’s important for us
is a robust infrastructure, also that the strategy is liquid
and there is no asset liability mismatch," Perotti says.
Around half of Falcon’s managers are located in
New York or London, with the rest in various locations around
the world. About 20% of the hedge fund allocation is invested
with Asia-based managers, who have outperformed the rest of the
portfolio, according to Perotti.
"Traditionally, allocating to Asia was very much an
equity-based hold-onto-your-seat type of investment. We are now
seeing relative value and market-neutral strategies appear to
take advantage of inefficiencies in newer markets," he says.
Obviously this comes with extra risks, he adds. One is that
liquidity in Asia is lower, so managers have to be sized
Looking for alpha in complex strategies requires constant
vigilance, and not only in Asia. "We embrace complexity as a
way of adding return. However, you do have to be very careful
about the risks involved in these strategies," Perotti
To monitor and manage risk, Falcon employs all the usual
metrics, as well as some unusual ones. More importantly, the
team relies on its own judgement and experience to understand
how a strategy will behave in different market conditions. "Our
main defence is knowing the strategies and the risks involved
very well," Perotti says.
Falcon has two lines of defence. First, its front-line
investment professionals are very experienced in recognising
the risks and warning signs in the strategies they oversee. The
second line of defence is Falcon’s independent
risk management team, headed by former Deutsche prime broker
Perotti says that when he built his team, one of his
priorities was to hire a head of risk who was familiar with
prime brokerage agreements and the counterparty risks involved
in complex hedge fund strategies. "That’s not to
say we are immune to risks. You can do all the due diligence
you want, and at the end of the day you will always be exposed
to risks," he notes.
Perotti’s greatest concern is a
liquidity-driven crisis when normal market relationships tend
not to work. "The key is to limit volatility, to make sure
managers are not taken out by volatility, or by investors or
counterparties who call in their lines," he says.
As for attracting new clients, Falcon is ideally looking to
develop new relationships with sophisticated global
institutions, "including those who are curious to expand beyond
the realms of the usual". Prime candidates are investors in the
UK, Nordic markets and the Far East, in particular Japan, where
Falcon has a Tokyo office.
Falcon is conscious that capacity in its uncorrelated alpha
strategy is not limitless, and so has set no targets for asset
growth. However, growth will be capped before it requires any
change in the underlying strategy, Perotti says.
Falcon also sees itself as a solutions-based provider and is
developing other strategies with different return streams in
response to client requests. One is an equity-based approach
that aims to deliver some of the upside of global equity
performance while limiting downside losses. Another is a higher
return-seeking, higher risk allocation that aims to profit from
the illiquidity premium in strategies such as distressed and
Perotti acknowledges that the strategies Falcon has followed
so far are sophisticated and costly to implement, but says
there is no question about the value added.
"I would say it is absolutely worth it. If you can generate
a 5% return in this interest rate environment with low
correlation to major asset classes, those returns will be worth
their weight in gold," he notes.