When Benedikt von Michel was asked to return to JMH Capital Management, the parent company of JMH Asset Management, in 2009 after a four-year hiatus that saw him work for activist fund Principle Capital Advisors, he realised that the company had no clear division between the investment and non-investment functions.
“JMH Capital did not have anything that could really be called a family office in the traditional sense, having changed from being a corporate finance firm in the early years to taking on some investment responsibilities and concierge activities for the Hay family instead. It comprised just a couple of guys combining both functions and hoping to be all things to all men,” says von Michel.
JMH Capital Management is the family office of principals Dr. and Mrs. James Hay, whose fortune arose from buying Fosroc, a BP subsidiary, and turning it into the most profitable company in its peer group. Having worked with von Michel between 2003 and 2005, Hay was keen for him to return to build a single family office and enhance the firm’s investment capabilities.
Von Michel says that splitting the two functions made perfect sense, given that the non-investment side of the business tends usually to be the most urgent and pressing for a family and that investment management was not receiving the full attention
it deserved. The decision was taken to create two separate teams. JMH Capital and its regulated subsidiary JMH Asset Management would focus on managing investments for the family, whilst a newly-created “private office” oversees the family’s private affairs.These latter activities encompass tax, trust structures, the management of properties, and overseeing a couple of direct investments in the luxury sector, such as Ray Ward, a gun shop in Knightsbridge, two pheasant shoots in the UK
and a wild boar shoot called Parc de Launay located in France’s Loire Valley.
Investment growth
The investment team now comprises von Michel, who also acts as chief investment officer and compliance officer, fund manager Johann Ropers and risk manager Wiebke Baehr. Von Michel and Ropers are responsible for running the portfolio. Von Michel decided not to hire sector specialists, preferring to stock the team with “generalists, because that means that everyone is involved in every part of the process”. Additionally,
the resourcing of the investment unit was based on trust and established connections.
“Trust and forming strong stable working relationships are vitally important for a family office. With just one exception, every single person within JMH Capital and the private office was hired through our own network of contacts,” he states.
Before 2009, the portfolio had a scattergun investment approach with an amalgam of many different instruments. In addition, the firm had relationships with 11 private banks, which, as von Michel notes, seemed to be offering very similar products. “Banks would serenade us with impressive pitches and polished teams of managers, but it was amazing how homogenous and correlated their product offerings were,” he says.
A change in tack was required and so von Michel and Ropers reshuffled the investment portfolio and started focusing solely on strategies that were uncorrelated to equity and bond markets, and therefore with the Hay family’s other investments.
This repositioning led them to invest in niche strategies which typically fell under the radar of the traditional private banks.
The immense scale of global markets and having to sift through scores of strategies and thousands of companies and funds was challenging. Hence, von Michel and Ropers drew experience from their equity backgrounds by employing similar screening methods to the ones they had used when focusing their research efforts and running equity portfolios earlier in their careers.
“There are almost 20,000 funds in our investable universe, but most of them are directional and correlated to the broader markets. We only want to focus on the top 5% which are totally relevant to us. Having a systematic process to deselect the majority of bad apples early on can save us an enormous amount of time and enable us to concentrate on meeting the higher quality managers and conducting our due diligence process on a small subset of these,” von Michel explains.
The process is working well and the portfolio is forecast to return 8% for the year. “The strategy is very different from more traditional portfolios, isn’t taking much in the way of directional risk and the returns have proven themselves to be genuinely uncorrelated to the broader markets. We should end up the year just above our 8% annual target, so we are pretty encouraged by the result,” he states.
Von Michel observes that hedge funds are typically 70-80% correlated to the MSCI World index. “Our portfolio is less than 30% correlated to the MSCI World. The lack of correlation which is embedded in the design of our strategy is about as low as you can possibly get and we believe it to be something genuinely unique,” he declares.
Niche strategies
The fund manager’s strategy of achieving superior risk-adjusted returns is predominantly based on filling the gaps left in the market by banks. The investment team targets opportunities with asymmetric expected returns and focuses on medium-sized, non-brand name managers with a proven track record of alpha generation.
Disintermediation of the financial system and taking advantage of global regulatory changes that are adversely affecting financial institutions is the key driver of the strategy. Basel III and the Asset Quality Review in Europe are forcing banks to offload risky assets from their balance sheets while the Dodd-Frank Act’s Volcker Rule in the US has led to the closing down of most of the banks’ proprietary trading units.
“This has opened up a wealth of opportunities as specialist managers set themselves up to invest in a range of niche markets, such as direct lending, trade finance, litigation finance or commodities arbitrage,” he says.
Von Michel explains that the team looks at investment themes in clusters to leverage the specialist knowledge in certain areas. Once the team is comfortable investing in a certain strategy, for example an arbitrage fund focussed on soft commodities, then they would to try to tap into that same opportunity if it is applicable in other commodities markets, such as metals or energies too.
The fund manager began investing in a US structured credit strategy nine months ago and he adds that there are plans to implement a similar strategy in Europe. With a number of loans trading at 70-75 cents on the dollar, he views the pull to par of over 8% (the annual target) as very attractive.
Another appealing characteristic is that self-amortising mortgage loans provide principal payments throughout the term of the transaction and there is no big balloon payment at maturity as is the case with corporate or sovereign bonds. “The risk/return profile progressively improves throughout the length of the investment because at maturity there is hardly any risk left at all,” he says.
Von Michel divides the strategies into three categories: specialty finance, proprietary desk and portfolio protection strategies.
Specialty finance forms the bulk of the investment opportunities, generates a very steady income and focuses on profiting from the disintermediation within the bank lending space. For instance, JMH has invested in a $200 million litigation fund in the US along with two other family offices and three endowments.
A number of global banks, such as Bank of America, were heavily involved in litigation finance, but regulatory changes are limiting the size of their book. “There are very few litigation funds out there simply because the level of incredibly specialist knowledge you need to research and make investments is too much for most firms,” he says.
“Not many people have the specialist legal know-how whilst also benefiting from many years experience in making investments, and quantifying and taking calculated investment risks.”
The second biggest strategy is proprietary desk strategies. In this space, JMH mostly focuses on arbitrage strategies, for example post-announcement merger arbitrage where, once again, directional market risk is reduced to a minimum.
Von Michel explains that opportunities are growing due to the Volker Rule, which has forced the closure of many prop desks to stop commercial banks using customer deposits to trade the bank’s own accounts, sometimes investing in more speculative instruments.
“As teams are shed, this is resulting in the formation of more independent investment firms, which have good track records and are less constrained and also more highly focused and driven than working for the large global banks. Their strategies have been shown to work, in fact they work better now, because there are less players and the market has become less competitive,” he says.
The third investment bucket deals with portfolio protection and includes a number of CTAs and a portfolio of deep-out-of-the-money put options. Although the core of JMH’s portfolio is designed to retain its value in a 2008-type scenario on account of being largely uncorrelated to such market dislocations, other funds that claimed to be uncorrelated have been caught out in the past, and JMH is acutely focused on avoiding such pitfalls.
“We have adopted a belt-and-braces approach to capital preservation,” von Michel explains. “If we are indeed wrong and correlations spike – even in the very differentiated niches in which we are invested – our long volatility positioning within the third investment bucket will protect us against potential shocks and defaults that, as night follows day, you know will keep coming round to haunt the markets.”
Structural change
In a strange twist, the scenario of investing in funds led to JMH Asset Management seeking to be regulated 18 months ago by the UK’s Financial Conduct Authority and the Luxembourg regulator Commission de Surveillance du Secteur Financier.
“The Hay family did not feel comfortable with giving details of their entire trust structure to the funds they were investing in, as the managers undertook their KYC checks on JMH. A trust is something that is very personal and private, and the family rightly wanted to keep it that way.”
The most sensible and cost effective way to protect the privacy of the family was actually to be “public”. Therefore in 2014 JMH Capital set up the JMH Absolute Return SICAV SIF, a Luxembourg-regulated specialised investment fund, and rolled the family’s portfolio into this new structure.
“The whole process was driven entirely by protecting the privacy of the family; that was the end goal,” he says. “Although receiving authorisation was an arduous task, having this institutional approach is an additional comfort to the family.”
Furthermore, by setting up a robust infrastructure with custody and administration functions handled by Pictet in Luxembourg and Switzerland, the Hay family could feel secure in the knowledge that their assets were safe, correctly accounted for and checked by external auditors. The investment team receives weekly and monthly valuations from most of its investments and the Pictet Connect platform provides full visibility of all the fund’s positions.
The regulated structure of the fund now means that staff members of the family office, as well as “friends and family” supporters, can co-invest alongside the Hay family. The fund launched two months ago with a two-year track record.
“It is important that managers eat their own cooking and the new structure means we are completely aligned with the family’s interests. Opening up the fund gives us an opportunity to build a business. However, we have time on our side and the family remains extremely supportive of the strategy,” says von Michel. “The true focus will always be on running the family’s money and continuing to drive the 8% uncorrelated returns. If other parties want to join us as partners, then that’s fine. But this isn’t a priority for us at the moment.”
