Deepak B. Gurnani is one of those money managers whose face lights up when he talks about the art and science of managing hedge fund portfolios. He is a man with strongly held convictions about the hedge fund industry, particularly the portfolio that he and his team manage from New York for Investcorp International Inc.
That conviction might stem to some extent from Mr. Gurnani’s 16-year tenure at Investcorp, which has a unique history among alternatives managers. The firm was incorporated as a public company in 1982 in Bahrain, with nearly 80% of its initial $50 million capitalization provided by 355 Persian Gulf state shareholders. In the early days, Investcorp’s focus was on private equity and real estate, with hedge funds being added in 1996 and the more esoteric Gulf growth capital and technology investment strategies added later. Today, the company manages its portfolios from London, Bahrain and New York for both strategic investment partners and external institutional investors.
While Mr. Gurnani acknowledged that hedge fund investment was difficult last year and remains challenging in 2009, he is optimistic about hedge fund managers’ ability to generate alpha over a one- to three-year horizon, particularly in strategies that exploit liquidity-driven dislocations like relative value arbitrage and convertible arbitrage.
What lured you into money management from engineering? Engineering was in my family’s background and what I studied in school. I started to get interested in finance while completing my MBA and added courses in the area to my degree program. I started to think about a career in finance or money management. After graduate school, I worked at Citi (Citicorp Overseas Software Ltd. Mumbai, India), and got introduced to money management indirectly while there. When I moved to Investcorp in 1993, I initially started as the risk manager and that was my first direct involvement in money management.
Why hedge funds? In 1996, Ibrahim Gharghour, then the treasurer (now co-head of hedge funds) and I … started the hedge fund business. The objective was to come up with a source of revenue for Investcorp (that is) uncorrelated with its other business lines. Both (have) very good profitability, but (are) transaction-oriented. We looked at other asset classes, like the more traditional equities and bonds, but quickly zeroed in on hedge funds because they fit in very well with Investcorp’s specialized focus on alternatives.
What was it like to start a hedge funds-of-funds program back in the mid-1990s? The industry was still fairly new at that time. Although we didn’t have much direct hedge fund experience, we did have a fair bit of investment experience with the kinds of strategies hedge funds are involved with. …
At that point in time, there was a finite group of managers that could be taken seriously. We were based in Bahrain at the time and I still remember our very first visit to hedge fund managers. We spent five weeks in New York and a week or two in London and during that period, we met everybody, every single hedge fund that was serious and that would fit into our portfolio. Some things were clear to us even in those days. We wanted to be invested in funds that were institutional quality. The genesis of hedge funds was in the high-net-worth investor community, and many of these funds were very successful. There was only a small subset of managers then who fit on an institutional-quality investment platform. It took about eight or nine months to meet managers, perform due diligence and talk to other industry professionals. In the end we came up with a small subset of managers, a group of between 15 and 18 hedge fund managers that we (initially invested in).
What’s different today? One thing that still is the same is the quality of investment talent. Back when we started, it was clear to see that hedge funds attracted the best investment talent. I think we continue to see that today. If you’re talking about estimates of the number of hedge funds, it has increased significantly, whether it’s 5,000 or 10,000 funds. I don’t know what the real number is. But even if you assume that the top 300 or 400 are serious managers, (ones) that you would look at, that’s still a much larger number than we had (to choose from) earlier. The number and breadth of hedge fund strategies has increased significantly across the board. And I think given that the asset base has become significantly more institutional, especially among the hedge fund managers that we work with, transparency, risk management and open communication with clients has greatly improved.
I remember that when we first started, when you asked for transparency, you would get this sort of look on the face of the manager as though he had never been asked for that before and suspicion about what you would do with that information if he gave it to you. That’s no longer the case now. Investors have been asking for more transparency so they can run their own risk analytics and are getting it. Managers do expect that to attract institutional investors, they will have to offer more information. It’s rare that managers will not give you some level of transparency and while there are exceptions, they are becoming fewer and fewer.
When we first started, we found that there was much more consistent absolute and relative performance among the managers that we saw. What has happened as the number of managers increased, there’s no question that some mediocrity has crept in and that performance is less consistent. The industry has been successful and has attracted a lot more people.
What investment opportunities are you looking at now? We’re looking at alpha opportunities where stock or credit selection is critical. Securities have been sold without much differentiation between securities with good fundamentals and those with bad fundamentals. We believe that we’re entering a phase where the market will differentiate more — whether for equities or credit. We believe that alpha plays are a medium-term opportunity and over the next one to three years should provide very strong returns.
Another area we like is liquidity-driven dislocation, essentially relative arbitrage strategies. Because of deleveraging and forced selling, a lot of historical relationships have gone completely out of sync and offer tremendous opportunities.
How are you assessing managers within a hedge fund universe that is rapidly downsizing? You can’t use your old measures for evaluating managers. You need to make a fresh assessment to see how managers can withstand the current crisis and look ahead to opportunities once things stabilize. But I think we are beginning to see a clearer picture as far as opportunities and managers are concerned. I think there will be differentiation between the managers who can withstand redemption pressures and can apply their strategies to a changed investment landscape. ...
There is a difference between the performance of the bigger funds; some have held up well, but some are under a lot of performance pressure. On the other hand, some of the smaller funds with experienced managers that we have on our investment platform have done very well and have actually outperformed their peers very significantly. ... We’re seeing real differentiation between managers and it isn’t related to size. It’s related to investment process.
