I have several emails on my system from Bruce Love, editor in chief at Campden Publishing. “Just wondering if you would be interested in doing a quick comment piece for the next edition of the new Campden FO magazine?”; “Perhaps I can give you a ring to discuss a brief comment piece for next month’s magazine?”; “Where is the piece that you have promised me?” Notwithstanding that it has been the most extraordinary period for investors, I now feel sufficiently guilty to put pen to paper.
J Leon & Co is a fourth-generation family office based in Hampstead, London, with a diversified set of investments that has been constructed over the last few decades using the income stream from a portfolio of shops. It is this retail portfolio and other UK commercial properties that still form the majority of the group’s un-geared asset base.
Early in 2007, this diversification took the form of some hundred or so different managers across the group spread pretty evenly between UCITS III, private equity and hedge funds both in Europe and internationally. The group’s investment thesis has been that there are a handful of really excellent managers among the broad investment universe, and that we devote our energies into searching out these groups where we judge that we can find real value as well as asynchronous risk and return to the group’s property portfolio.
We have tended to be less concerned with the type of structure in which we were investing. Being a long-term investor, Leon has traditionally not placed any particular premium on liquidity and, over the past heady decade, we have long been reconciled to paying two-and-twenty in order to invest with those managers. We have particularly sought out managers in niche and asset-backed strategies and have therefore been investing for some time in hard asset classes such as pipelines, timber, infrastructure, energy plays and aircraft financing.
We have committed to such funds having done our best to satisfy ourselves that these managers are best-of-breed. We generally have three criteria: another family office or endowment in which we trust should first have invested in that manager; the passage of time to provide a useful smell-test (we will always insist upon a decent period between meeting the manager and finally committing to that manager to ensure that we reckon on the business model and that we are not investing reflexively); finally, others’ due diligence into the fund and a reliance on our existing fund-of-fund relationships to provide us with an overview of individual managers before signing up to that fund, and we invest small amounts in each manager.
This methodology has been the backbone to Leon’s investing for the past decade, but this started to change in the middle of 2007 when we were unexpectedly caught up in the Goldman Sachs Global Alpha debacle. We had been long-term investors in that particular fund having been persuaded that the manager’s seven strategies would provide real diversification and, as claimed on the can, that the strategies’ correlations would all move in very different directions in times of stress.
As that fund crashed in August last year, we started to understand what we did not understand before. We really had little clue about what we had invested in and were at a loss to explain the fund’s crippled performance. There has since followed a process of redeeming those funds where we have been invested because of a marquee name rather than because of a manager’s particular strategy that we clearly understood, thought attractive and which added to the rest of our activities.
For the same reason, we elected to stay clear of derivatives and other complications over the group’s property portfolio in an effort to remove additional layers of intricacy that we could otherwise avoid, and complexity to us comes in several forms. We like to understand the documentation into which we are entering, and expect to undertake the same level of due diligence into our counterparties as we would into the manager. We are obviously wary of exogenous events where we have no control, and we see ourselves as a long-term investor that prefers simple arrangements and have therefore avoided short-term structures that hold themselves out as forms of capital protection.
The Global Alpha episode also focused our minds on the matter of correlation in times of stress. The UK’s Institute for Family Business recently held its regular Strategy Forum under the prescient title of “Diversification, a panacea for troubled times?” Dr Robert Kosowski, director of Imperial College London’s Centre for Hedge Fund Research, gave the keynote address demonstrating (in case we needed the point to be demonstrated) that all asset correlations increase dramatically in times of crisis and diversification ultimately fails; a family office needs to do more in troubled times than simply invest in several baskets which, when trouble hits, are likely to all become unsafe; and that a family office must reallocate most of its assets as best it can to remaining safe baskets.
Notwithstanding some terrible manager performances, the emergence of hedge fund gates and the rise of the “side pocket” for particularly illiquid assets (why were these ever in supposedly liquid structures?), we continue to try and edge our portfolio towards areas where opportunity may lay in 2009.
In common with our peers, the current malaise has seen a new criterion emerge. If we are to carry on paying these fees, we definitely want to see the manager return our investment to us before taking performance fees and we are generally migrating away from hedge fund structures where this patently is not the case.
I mentioned that Leon was founded early last century. Leon’s management is unable under the group’s Articles to take on leverage on to the group’s balance sheet. For 9.99 years in any decade, it has been surprisingly difficult to articulate across the dinner table the wisdom of this conservative approach in what is essentially a property portfolio. We are now right in that 0.01 part of the decade and the past year has seen us further running to cash by redeeming from managers where we reckon opportunity sets have changed and where absolute return managers have failed provide absolute returns. Given the sea of red ink on manager reports across my desk, Leon’s earlier platform of 100 managers as measured in the heyday of 2006/7 has been whittled down to less than 70 since the start of the year.
Obviously, we should have whittled it down quicker and further and we will inevitably miss any rally in 2009 as we maintain our 40% cash allocation in the group’s authorised unit trust, but I do think that we better understand our asset allocation today than we did in the weeks before Goldman Sachs managed to lose half the value of our investment in its Global Alpha product, and we have really tried to re-learn the lessons of prudence, long-termism and simplicity that drove the group’s earlier generations and that we were in danger of forgetting in the wonderful bull-run we have all experienced.
But beyond the measures set out above, I do not foresee our fundamental investment model particularly changing. We will remain un-geared and will continue to have the majority of our assets in investment-grade real estate with the balance of our assets in small investments across a broad range of managers diversified by strategy, geography, vintage, structure, liquidity and currency.
While I remember, one of our subsidiaries has just won the “What House Sustainable Housebuilder of the Year” here in the UK. The market remains dead and we have finished products coming out of our ears. Any buyers? Otherwise our newly enforced long-termism may be sorely tested.