In the Forbes List of Australia’s 50 Richest, the names in the top 20 are probably well-known to most business people. Packer, Lowy, Triguboff, Rinehart, Forrest. At number 16 with an estimated US$1.55 billion is Sir Michael Hintze. The main reason for Hintze’s relatively low profile in Australia is not only because he lives in the UK and is active in their arts, politics and media rather than ours, but he has made his money in the rarefied atmosphere of alternative investments.
In this world, he is a hedge fund legend, with a life story that should be made into a movie. At the recent Alternative Investment Management Association (AIMA) conference in Sydney, Sir Michael Hintze gave some fascinating insights into the mind of a successful hedge fund manager. His firm, Convertible Quantitative Strategies (CQS), is a global multi strategy asset manager, and Bloomberg recently ranked the CQS Directional Opportunities Fund third in its list of 100 Top-Performing Hedge Funds. Hintze invests in non-traditional opportunities that 99% of investors never see, as shown by some of his funds:
- long short relative value asset backed securities fund
- global convertible bond arbitrage fund
- long short credit fund
- rig finance fund (for the construction of rigs and other oil and gas infrastructure)
- long only European loan fund investing in senior, mezzanine and second lien loans.
What type of background does it take to run a leading hedge fund with US$12.5 billion under management and over 250 staff around the world? A remarkable one. Hintze was born in China in 1953 to Russian parents, who made their way to Sydney, where he was raised and educated. He considers himself an Australian. He holds a BSc in Physics and Pure Mathematics and a BEng in Electrical Engineering, both from the University of Sydney. He also holds an MSc in Acoustics from the University of New South Wales and an MBA from Harvard Business School. Hintze told his Sydney audience that he borrowed most of the money to finance his Harvard MBA. He worked at Salomon Bros, Goldman Sachs and CSFB before moving to London and setting up CQS in 1999.
And for good measure, before he started his finance career, he served for three years in the Australian Regular Army as a Captain in the Royal Australian Electrical and Mechanical Engineers. Hintze was knighted in June 2013 in recognition of his philanthropic work for charities and the arts, and he is a major supporter of the Conservative Party in the UK.
The types of funds CQS manages requires it to monitor global trends in everything imagineable, especially geopolitical, monetary and fiscal risks. The CQS website would win no awards for simple English, but when he says his strategy is a “collaborative multi-disciplinary approach seeking adjacencies across all areas in which we invest” (ouch, my head hurts!), you gain insights into the arbitrage and risk management process which has driven his success.
In fact, Hintze says he has invested $20 million “of my own money” on his risk management systems, and claims this has created a competitive advantage in liquidity management, execution and nimbleness. No doubt major competitors have invested far more in their systems, but it does show how the game has changed over recent years, creating problems for the small hedge fund manager who wants to compete by outsourcing administrative, settlement, trading and risk measurement functions to third parties.
Here are some of the insights Hintze gave in Sydney:
- He is paid to take credit and arbitrage risks but he soon realised that massive operational risk must also be managed. A hedge fund must be operationally resilient.
- His major successes have come from ”bespoke alpha-generating products”. Institutional investors are looking for different sources of alpha, and their use of hedge funds will grow.
- The biggest trading risk is when correlations between markets go to 1, as this makes it more difficult to hedge risk.
- Increasing regulation is the most significant change he's seen in the industry, followed by the availability of liquid derivatives. Regulators have long viewed hedge funds with suspicion, and have encouraged far greater disclosure.
- There is massive moral hazard from expecting central banks to bailout the financial system every time there’s a major problem. Central bank intervention has been so heavy that there are fewer normal signals in the market now - what is the risk-free rate on government bonds when there’s massive intervention? It should be much higher.
- China’s leaders are smart and well-educated and benefit from a 10 year political cycle, but the country is still sorting out problems with corruption, shadow banking, pollution and clean water.
- There are 17 members of the Eurozone (those countries which have adopted the Euro), which gives many opportunities for credit trading on the short side.
- Europe’s biggest problem is not the small countries like Greece and Cyprus, but France. It has fiscal and taxation problems it does not want to face.
- He is optimistic on US prospects, driven by a good housing recovery, low-priced energy due to shale gas and strong demographics. The United States does not have high standards of building for homes in many places, and 300,000 houses a year fall apart. This creates a lot of ongoing employment for less skilled workers.
- One million Australians are working overseas, and there are two reasons many do well: Aussies are willing to have a go, and they have a global perspective. It’s surprising how often he encounters Australians in senior positions in overseas countries.
- There is also some advantage working and living in Australia, because you are outside of the daily noise and chatter, able to think about things more.
- Philanthropy is a big deal. There is an obligation on those who have done well to give back. “To whom much has been given, much is expected.” Make a difference.
- The main things that worry him are the long tail risks (a technical definition of long tail risk is the risk that an asset or portfolio of assets will move more than three standard deviations from its current price, potentially compromising the best risk management techniques).
- To date, we have had little inflation because labour costs have not risen, and the velocity of money is down. But the massive growth in central bank balance sheets increases inflationary risks, and his risk management tries to remove rate risk from their portfolios.
- Government spending has been good for equities and bonds, but what about our children?
Sir Michael Hintze probably has a perspective on every major geopolitical event in the world, with close sources making many of them uniquely well-informed. Although Hintze is personally fascinated by global politics, society and business, the type of funds he runs means that every major event is a potential trade. Without in any way making a moral judgement on him, he cannot help but see every conflict, every natural disaster, every border skirmish and every political battle in the context of the positions in his funds.
A few examples snuck out as the conversation turned to world events. Both India and Pakistan have tactical nuclear weapons, as opposed to strategic. All it needs is for some crazy lieutenant to take matters into his own hands, even if there is no central policy desire to do so. Oh, that would destroy a major food basket, what are the implications for agricultural commodities? Or if the Syrian crisis extends to Israel, what will happen to that very successful country? There’s an opportunity to trade Israeli Credit Default Swaps.
And that’s what’s required to run a global credit arbitrage fund. Have a global view, watch every part of the world, know what is happening everywhere. There is a potential trading opportunity in every major event, in the same way there’s a potential personal obligation in every worthy cause.
At the end of his keynote interview, Sir Michael was invited to stay for lunch. He agreed, then added, “But I won’t be able to stay long. I’ve got things to do.” Nobody in the room doubted it.