Joel Katzman clearly and fondly remembers the early days — 10 years ago — when it was possible for two people to oversee the investment management of J.P. Morgan's hedge fund-of-funds business. Today, Mr. Katzman's team numbers 70 and allocates $6 billion to a wide range of hedge fund managers, while keeping tabs on a much wider universe. Based on the market's insatiable appetite for hedge funds, Mr. Katzman anticipates it won't be long before J.P. Morgan Alternative Asset Management Inc. will be managing $10 billion of client assets in hedge funds of funds. Born, bred and still living on Long Island, Mr. Katzman is an avid collector of Asian antiquities and would someday love to have more time to spend indulging his interest in art such as Buddha statues, jade carvings and other Asian sculpture. He spoke to Senior Reporter Christine Williamson about the triumphs and tribulations of heading a growing hedge funds-of-funds operation.
A I started off looking to become an accountant and going to undergraduate school for accountancy. I was always very good with numbers, so that was my proclivity. As I started taking business classes, I started getting more and more interested in finance and less and less interested in accounting. I switched my major, and from then on it was finance and business school. When I started working at (what was) at that time Chase, I started in a financial function and, over time, shifted from analyzing results for the board to strategic planning to treasury. At the point I was in treasury, I started blending the finance with the investment management. That was when I started getting interested in the investment world. … Then I switched over, in 1988, to my first job on the investment side.
A Not really. I always felt that my skill was in assessing others' ability to manage portfolios and then putting that together. I'm a fund-of-funds manager. I often joke that we have the easy job. The hard job is that of the individual hedge funds that have to pick the individual stocks and bonds and securities.
A If you look at the assets overall of J.P. Morgan Fleming, we are 1% maybe. And the individual hedge fund business also is at that level, less maybe. As a percentage of assets, the business is very, very small. However … in the last few years, there's been a significant increase in clients' questions about the asset class in terms of education. Now we're beginning to see more implementation. I would say the importance of the business is in excess of the amount of assets it currently represents.
A I think it's probable that some time during the next three to four years we will be in the $10 billion range. … By the way, there probably will be 15 other firms of that size, as well.
A I think over the next few years, the real challenge is focused on one item: institutionalization.
That has several aspects, one being capacity.
If you have a significant amount of money being placed into your business, you have a limited number of managers to place that capacity. If you want to maintain a certain quality or profile of the managers you allocate to, you're going to run into capacity problems.
So, you have to pace your growth. The capacity problems are not only related to the availability of investments, they also are related to the availability of investment staff. You have to continue to add people not only on the investment side, but also in risk management, client servicing, operational areas, compliance, legal, product structuring.
A It changes as your ability to deploy money changes. I remember in the fall of 1997, we were managing somewhere in the range of $400 million. We had to close our funds temporarily because we needed to have some managers in certain strategies, which if we didn't find them, would limit our ability to have balanced portfolios. Then we reopened several months later for $150 million and were able to attract double that and had to turn half of it away. In those days, that was big.
Now we look at our current size and believe that we can add another $1 billion or $1.5 billion this year, given our current views of the world. Maybe even $2 billion, if there are opportunities.
A No. We're exclusively on the buy side. There's a separate group within J.P. Morgan that focuses on incubating new funds. We would not invest in any fund that was incubated (by a J.P. Morgan Fleming entity), just as we would not invest in any in-house fund.
But we do have an internal fund of funds that is kind of like a farm team. We had a commitment of 2% from each of our fund-of-funds vehicles and among our large separate accounts that want to participate in something that is known around the office as the "2% Solution." That pool of approximately $100 million is used to hand out $5 million and $10 million allocations to managers that we watch over time. As we gain more comfort with them, we … increase their allocations and move them into the (fund-of-funds) portfolios.
A We're looking for capacity and favored status in terms of transparency and things like that. What I believe is that if you invest in new managers, you can get more favorable capacity arrangements going forward.
One of the things we're strict about is that we don't let outside investors invest directly into this vehicle. It is only for our own managed (hedge fund-of-funds) vehicles and separate accounts, because we want to make sure that the people who are investing in these managers are getting the right to bid on the capacity of the manager (in the future).
A Actually, the returns in that particular portfolio — which is partially due to the mix of managers that happened to be in there — were the highest in our suite. Having said that, I haven't seen any conclusive evidence that leads me to believe that new managers inherently have better skills or higher returns than existing managers.
Q What is your prediction for the future of hedge fund investing?
A I'll make a bold prediction. Sometime in the next 15 years, you're going to see more money in hedge funds than you will in traditional long-only active management. I think indexation will attract more assets than anything else, but after indexation, you are going to see more people running money in hedged styles than you will long only.