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Man Investments AHL Update - April 2011

18th April 2011
31mins 37secs


Presenter: Good morning, and welcome to another of our AHL quarterly web conferences. I'm joined today by Mike De Groot, Senior Client Portfolio Manager at AHL. Mike is going to spend ten or fifteen minutes reviewing performance and issues relating to AHL during the first quarter of this calendar year. We will then open this to questions. To remind you, you may submit questions at any point either during the formal presentation or thereafter. We hope, as always, to have a lively active discussion, and with that I pass over to Mike to review Q1 2011.

Michael De Groot: Good morning everyone. My name's Mike De Groot. The purpose of this call is to give an update on performance for this year so far in terms of looking at the performance of AHL Diversified plc.

So, if you'd like to turn to slide 3 please, we show the track record here of Man AHL Diversified plc since inception through to 31st March 2011. So you can see in terms of performance, the fund has annualised, or generated net annualised return of 15.9% per annum for an annualised volatility of 17.7%. So in terms of dissecting performance of this year compared to last year, so looking at last year we returned a positive 14.8% net return for the year, so very very strong performance for 2010. But moving into 2011, it's been a bit of a difficult year for AHL and also for other PTAs and trend-following managers as well. So looking at performance over the last three months, in particular January, February and March, we've seen quite a difference in market activity over the three months.

So if you'd like to turn to slide 6, here we show the attribution of Man AHL Diversified plc from the last valuation point, or the last Monday in 2010, up until the last available official valuation point, which is 11th April 2011. So covering that period of performance, the net return of Man AHL Diversified plc was -2.8%, but you can see in terms of the attribution where that performance actually came from. So on the negative side, for example, so bonds have been a negative contributor to performance, contributing broadly around about -2.3%, -2.4%. Looking at stock indices, that follows bonds so -1.8%. Following from there, currencies about -3.45%. And then on the positive end we have, for example, metals, energies and agriculturals contributing positively to performance.

So in terms of dissecting the performance over the period, looking at January, that was a negative month for AHL, and I believe for other trend-following managers as well. So looking at where the performance came from, on the negative side was mainly from currency trading, so we saw a few reversals in the currency market for the month of January. In particular, our short US dollar positions, their performance on the back of the fact that the US dollar surged about 1.6% on the month on the back of positive economic data releases. Short euro positions also outperformed as well, again on the back of the fact that the euro rallied about 1.5% for the month, again in response to easing of Eurozone sovereign debt issues.

Also looking at other sectors for the month of January, bonds also contributed negatively to performance, and here long positions suffered as euro bonds fell largely in diminished sovereign debt yields. Looking at metals, for the month of January, overall was a negative return but it was a bit of a mixed return for the month. So precious metals fell for us, but on the flipside long positions of base metals actually contributed positively to performance.

On the positive side of the equation, for the month of January, good profits came from trading agricultural markets, so things like long lean hog positions performed well for AHL, and also things like long cotton and also long wheat trades for the month of January also did well for the performance of AHL for the month of January.

Looking at February, so that was a positive month for AHL, so according to official valuations for Diversified plc we made 1.3% on the month. So where that performance came from; mainly came from long exposure to precious metals markets, so long gold and long silver positions performed well, and in fact gold rallied about 5.9% on the month and silver about 20.8% respectively on the back of continued unrest in North Africa and also the Middle East.

Looking out to other sectors, energies also performed well for the month of February, really driven here by short natural gas positions, and natural gas prices fell about 8.7% following a forecast warmer than expected US weather which lowered expectations for demand. Looking at other sectors for the month of February, so agricultural also contributed positively to performance for the month of February, and in particular long positions in coffee, cotton and corn accounted for the majority of the gains.

Looking out to the month of March, and here unfortunately, given the circumstances in Japan that we saw, the earthquake and the resulting radiation fears throughout Japan, it was quite a negative month for trend-following managers, not just AHL but other [TDAs?] we have served within the market as well. So really in terms of our positioning before the earthquake unfortunately hit in Fukushima, we very much had a long risk position. So very much short US dollar, long commodities for example, long equities, long in the precious metal markets and base metal markets. So obviously when this unfolding crisis emerged and people realised the gravity of the situation, very much having a risk-on trade across the portfolio hit performance.

So in terms of where the majority of the losses came from in March, it was really from trading in stocks, so we had a long Japanese equity and long other equity exposures within the portfolio, so the resulting sell-off within the equity markets hurt performance. The metals sector also ended the month down, and here the majority of the negative return came from long positions in industrial metals such as nickel and copper.

Looking out to other sectors; agriculturals also performed on a negative basis for AHL for the month, and here overall long positioning in the agricultural complex hurt performance, as I explained earlier, because it was very much a risk, we went from a risk-on to a risk-off environment and everyone was selling commodities, for example.

Looking out to where we actually did make money for the month, so energy trading did post a profit, in particular our long crude oil positions, so we sort of continued uncertainty within Libya and the Middle East and that had an upward pressure on oil prices for the month of March and we made money from that trade. And also trading interest rates as well fared well for the portfolio, and this was mainly due to short Euribor contracts and the prices of these contracts moved lower on expectations of an interest rate increase by the ECB in April.

Moving out into April, we have seen some quite good performance over the last couple of weeks, and in particular it's been very much a risk, kind of a return of the risk-on environment. So if you look at the return from 28th March to 4th April the portfolio made 2.2% and then from 4th April to 11th April we made another 2.2% on the week. So very strong performance over the first two weeks of April, and really it's because risk appetite has rebounded as investors are focusing their attention on improvement in the US labour market and also improving confidence in the global economic recovery. So, for example, things like long crude has been a good trade for us, and very much some of the commodity-linked currencies as well, so long Aussie dollar, trade has been good also things like long silver and long gold reaching multi-year highs have also been good for the portfolio.

Looking at where we're currently positioned within AHL, so in terms of our sector positioning. So within agriculturals we have a net long position, in terms of bonds we have a net short position, within energy a net long position, interest rates net short, metals net long and stock indices are net long as well. So basically I've talked about performance so far for this year, and I think it's very important to view AHL as a medium to long term investment.

So if you go back to slide 3, you can really see the benefits of holding these products over the medium to long term, in particular comparing to the performance of world stocks. And that's really shown by improvement of equity market weakness that we saw in 2008, and similar periods between 2000 and 2003. But, as I did mention before, this is - it is, I'm not lying to you, a volatile product. You can see the annualised volatility of Diversified plc is 17.7% versus world stocks which is 15.3%.

So in the short term you can expect periods where we do generate a negative return. I wish we always generated a positive return but unfortunately that's not the case, but what you have to keep in mind is that holding onto Diversified plc is a medium to long term investment and you can really see that compared to stocks over that period of time, and also for bonds as well. You can also see the benefits of holding Man AHL Diversified plc versus a portfolio of very traditional investment and also alternative investments as well, and this is really observed by the correlation of Diversified plc versus other traditional investment and hedge fund strategies as well.

So you can see over that 15 year period that Man AHL Diversified plc's correlation to world stocks of -0.14, bonds 0.31, and you can also see as well that the correlation of Diversified plc to other strategies as well, so for example to fund of funds the correlation is about 0.03, so it has diversification benefits compared to traditional investments and also to alternative investments as well.

Looking at the medium to long term, so I mentioned before we have very much a risk-on kind of positioning on at the moment. Looking out to other measures, so in terms of margin, the current margin to equity ratio of AHL Diversified plc is about 14.3%, the current growth leverage of the portfolio is 5.2% and the current say a risk measure for AHL Diversified plc is 1.1%.

So, that wraps up performance for AHL Diversified plc for the year, for year to date so far this year. So in terms of looking at performance up until 11th April the fund is down only slightly, -2.8%, which is really typically quite a volatile quarter for in particular trend-following managers, not just for AHL but other participants that we're seeing trading in terms of our direct competitors as well, and that's really due to unforeseen circumstances that we saw, in particular in Japan in March of this year. But as I emphasised before, AHL really should be viewed as a medium to long term investment with at least a three to five year holding period for AHL Diversified plc.

That wraps up the performance review of AHL for this quarter. I'd like to open up now to questions, to anyone who would like to ask me anything about AHL in terms of performance over this year, and also other developments especially in the research of other things as well.

Presenter: Good, Mike, thank you very much. Clearly not the easiest of quarters for AHL, we have one or two questions about how you expect to perform in the future, we won't ask those given that that is not something that AHL likes to opine on. However, perhaps we could start, someone's asked how many markets AHL actually trades with. We've seen the attribution across sectors but how many underlying markets do you trade at the moment?

Michael De Groot: A very good question. So I think one AHL's key strengths is the fact that we have over 82 research analysts, which is one of the largest research teams within the managed futures space, and part of that is, well AHL's research ethic is to continually improve its systems and its diversification of our programme. I mean certainly since we started trading in 1987, I think back then we only traded about 40 or 50 markets, now we're trading around about 300 across over 36 global exchanges, so a high degree of diversification trading both exchange traded futures and also other instruments that we trade as well to add further diversification to the portfolio. So an example of that would be trading things like cash bonds, cash equities, and also things like credit default swap swaps where we trade …[unclear]. So a highly diversified portfolio, and I dare say one of the most diversified portfolios within the managed futures space.

Presenter: Good, thank you for that. Looking forward, could you talk a little bit about some of the expected developments for AHL during 2011? Clearly research is a key to success in managed futures and I think it would be helpful for people to hear just what do you think the calendar looks like?

Michael De Groot: Yes, definitely. I mean just to give you a bit of backdrop, AHL has been undergoing quite an extensive kind of research effort over the last year and a half, two years, and that resulted in the introduction of a new way of trend following which we call internally here the predict optimiser, which is a more dynamic way of trading the markets that we trade on the trend-following side of things. And also a lot of work was done in terms of improving our existing systems. And this has been AHL's approach since 1987 is the continual improvement of the existing models and the development of complementary ones as well that improve the risk/return profile of AHL's programme. And certainly in terms of looking at the research pathway in 2011, it's very rich, and it's very rich in the sense that, as I mentioned earlier, we have a team of over 82 research analysts which is one of the largest research teams within the managed futures space. So having that many people gives you the ability to work on a lot of different projects simultaneously in order to better the performance of AHL.

The one project we're currently working on is looking at kind of electronic trading, in terms of electronic trade institution, that's really being spearheaded by both our team here in London and also our research team at our Man research laboratory at Oxford University. And here it's really developing a second generation of electronic trade institution algorithms that are more intelligent in the sense that when the main trading system identifies a trend and wants to trade a particular market, before it does that it looks a variety of factors. So things like the microstructure of the order book, the speed at which the price is moving away from the sample price and then cross-reference all those unique factors with prior trading history. And then it comes up with the most efficient way of trading that particular market. And so far that's been rolled out to about just over 80 different futures contracts and so far we've seen, on the basis of introducing this second generation of electronic trade institution algorithms a further 20% reduction in slippage across those markets. So you can see from that perspective that's quite significant, even though AHL's managing over US$20bn, it's still finding avenues to reduce our transaction costs in the market.

Other projects we're also looking at is things like, for example, yield curve trading which is a more mean reversion system whereby we're looking at the curvature of the yield curve and the changes of that. An example would be trading over two, five and ten year US treasuries, and looking at the changes in the curvature and taking positions based on those identified changes. And what we find is that has a very correlation to our existing trend-following systems and it's an instant portfolio diversifier and also improves risk/return profile of our trading system.

Other things we're also looking at that we're looking to introduce into our portfolios earlier this year, for example, is also things like volatility trading. So where we're trading a number of FX options that, again a bit more of a mean reversion kind of aspect to the trading style where we're looking at the relationship between implied and historical volatility in the option markets, but it also has a directional component as well. And here, similar to what we see with the yield curve trading, it has a very low correlation to our existing trend-following strategy, so when you add that to your existing portfolio it actually increases the risk/return profile of the portfolio because of that correlation.

So that's some of the research projects we're looking at. Obviously there are other things we're looking at as well which I really can't tell you about because it's very much blue sky, but that gives you an idea and a flavour of exactly some of the things we're working at this point of time.

Presenter: Good, that's very helpful Mike, and I know that our audience is very keen to hear about ongoing developments, so we should keep that coming in these quarterly web conferences. Questions that have come, two or three very much related, which is during periods of stress and crisis such as we had in Japan, AHL's taking steps to reduce risk temporarily in the portfolio, but several questions around could we talk a little bit more about the type of intervention that you practise, is it qualitative, is it quantitative, how does AHL reach these decisions very key for a systematic manager that makes a change to a portfolio given a market event.

Michael De Groot: Okay. AHL, as you know, is a purely systematic manager; 100% systematic. In our normal day-to-day operations we are analysing the risks very closely across all the markets we trade, not only risk but also looking at things like the volume interest of markets as well to ensure the fact there is enough liquidity in the market we're trading. So in terms of our normal risk measures, we use a variety of risk measures. Firstly, when we generate a trade in the market, if we're looking at our trend-following systems we're sounding prices in real time. That'll potentially generate a trade to buy or sell off a particular futures contract. On top of that we also use that price sample to calculate the historical volatility of that price period, and that's used to volatility scale all the positions in our portfolio. And this comes back to the way AHL manages our money for our clients, that we target a specific level of risk, so we target 14% volatility for the diversified programme.

So volatility increases in a market we're trading, we scale that position systematically, and if volatility decreases then we'll increase the size of exposure to that market as well systematically. On top of that we also have a variety of risk measures that our chief risk officer's monitoring on a daily basis. This includes things like day of risk, and we stress test our portfolios by both sector and also the portfolio level, and also have things like implied volatility to give us more of an expectational day of risk in the markets, because historical volatility doesn't capture that.

So, broadly speaking, the systematic volatility scanning process is done systematically, the risk measures that we use are monitored by our chief risk officer, and if we breach any of those then we manually decrease the risk in the portfolio. But, on top of that, events like we saw in Japan was unforeseen. You know, when you have a systematic trading process they can't predict that an event like this is going to happen, especially an earthquake and resulting radiation fears and contamination fears within the Japanese markets. And even, for that matter seismologists would even have the mathematical models to actually predict an earthquake to start with let alone AHL which is trading the financial markets.

So in these unforeseen circumstances unfortunately that we observed in Japan, the models are not designed to react in a kind of normal fashion to really what we observed which is a non-normal event, this is a natural catastrophe. And what we actually saw unfolding within Japan very much over the course of the weekend was the kind of fears of contamination or radiation contamination throughout the financial markets.

What potential problems kind of emerged from that is that if the radiation spread to Tokyo what would happen to the exchanges. Would the Tokyo authorities decide to close down the exchanges? What's going to happen to liquidity in the markets, in particular there's the on exchange, well the onshore Japanese futures exchanges, you know, is that going to dry up? So based on all these fears and factoring in all these kind of different scenarios here we made the call to actually reduce our exposure to Japanese exchange traded futures contracts within the portfolio.

Admittedly, in terms of the number of markets we trade, there aren't that many markets that we trade in Japan compared to other market trading globally, so it didn't affect a large number of markets in the portfolio. But having said that, we actually reduce the risk by a factor of about 90% to those Japanese exchange traded futures markets. And we were very much, very confident that in terms of that decision that was the right decision to make, because if the exchange did close down you'd have an open exposure over a certain amount of days that again is unknown before you resume trading again.

So in terms of our approach, we are sticking to being as systematic as possible at all times, but when you have an event like this which no mathematical model can actually forecast and you don't know in terms of what's going to happen in terms of the future in terms of the exchange is going to shut down, is liquidity going to dry up in the market, then the most sensible thing to do is actually reduce risk within your portfolio to those particular markets and then increase the risk back on again when you see the circumstances normalise. And that's certainly what we did throughout the Japanese crisis and we feel that that was the best decision to make given those exceptional circumstances.

Presenter: So you have resumed taking risk on the Japanese market once again?

Michael De Groot: That's correct, yes.

Presenter: And for the benefit of our audience, could you just tell us who, which person or committee decides on such interventions?

Michael De Groot: Ultimately the decision stands with our chief risk officer. He is independent from both our trading team and our research team, and he reports directly to Tim Wong who's our CEO. So the decision lies with him based on careful analysis and also interactions with our research analysts, and in particular our traders who have very good knowledge of dealing with our brokers in Japan and other counterparties elsewhere, they can gauge the amount of liquidity in terms of the volume in each of these markets. Using all those factors and information combined to come up with a final decision to actually reduce exposure to those markets.

Presenter: Excellent. Thank you for that, that's very clear. We have a question which relates back to something you said earlier, that AHL should be held as a mid to long term investment, which I think we'd all agree with. It is clear to one of our audience here that AHL has been in a period of drawdown for some time, although we keep on moving towards high watermarks we haven't yet broken it of late, and the question would like to know at what point does one throw in the towel, how long is long term? And I suspect a bit of reassurance would be very helpful.

Michael De Groot: Well AHL are certainly not going to throw in the towel. We have been operating since 1987, you can see our performance of a variety of different market conditions, and you can see in terms of our drawdown profile as well, drawdown length does vary. And I think the industry as a whole, CTAs have been very, have kind of I'd say more so lucky in the past, normally drawdowns do not last very long and the recovery has been very quick. But if you look at it from a purely mathematical and statistical perspective, there is absolutely no reason why we couldn't have a longer drawdown, if you look at the normal distribution of drawdowns for example.

So certainly in terms of the drawdown we're currently experiencing at the moment, it is within our internal kind of statistical expectations and, you know, it has lasted since the end of December 2008, but having said that, as I mentioned before, this is a medium to long term investment, you should really be holding on to AHL for at least three to five years in order to increase the chances of probability of achieving a strong absolute return. And you can certainly, I mean investors that have invested with us since 2005 or 2006, over that period of time, certainly are very happy with AHL's continuing performance they've actually realised over that five to six year period.

So the message here is we are definitely not throwing in the towel. We are making a lot of progress towards improving our model, improving our execution, increasing the size of the research team and also interacting with Oxford to even bring more benefits to the research side of AHL, and hopefully if we see environments favouring AHL in terms of kind of strong trends in the markets then by all means there should be no reason why we can't reach that high watermark.

Presenter: Excellent. I think we have time for one more question. This really turns the last question on its head and says assuming we enter into a more benign period for managed futures, how does the capacity of AHL look? How will you be able to cope with significant new inflows?

Michael De Groot: That's a question we get I think every month or every quarter is about the capacity of AHL. So I mean in terms of AHL, if we look at just the historical numbers, the cold hard facts, back in 2008 we returned 33.2% net of fees, and in that year we were managing just over US$28bn. So the current AUM is just below US$23bn, the simple maths there means that we've managed an extra US$5bn in the past and that's generated very good returns and we have US$28bn, so there's no immediate capacity concerns there whatsoever. And then going into the future, we do not believe we have any immediate capacity concerns as well. And that's a function of a focus one is the organic growth of futures markets that we're seeing, and have observed certainly over the last five to ten years. Also the organic growth of the FX markets as well, and they're growing at an even greater rate compared to the futures markets.

On top of that it's also about the research, and the research is really the critical element here, and we've done a lot of research into executing in the markets very efficiently, in particular, as I mentioned before, introducing a second generation of electronic execution algorithms, that's helped us now across the just over 80 futures markets that we've applied them to, reduced slippage by a further 20%, so we're able to trade very efficiently in the market, and also in terms of diversification as well. So now, I mentioned before we're trading just around about 300 markets globally, when we first started in 1987 we were trading about 50. So increasing that level of diversification by opening up more innovative markets and things like, for example, the ...[unclear] locked unlocked in terms of the market we trade versus other competitors and have been ahead of other competitors in things like trend-following credit default swaps in the form of iTraxx and CDX indices, also opening up Korea as well and trading the Korean property index and Korean 3-year bonds.

So also doing active research in both increasing the diversifiers, or diversification of the portfolio also allows you to manage more money. And certainly having a team of over 82 research analysts, we have the capability to both improve our models, improve our execution and also spend a lot of time actively researching new markets to increase the diversification of the portfolio as well. So in terms of from our perspective, we don't have any immediate capacity concerns whatsoever.

Presenter: Well that's very good to hear, very encouraging for the audience. Well we have reached our allotted time. We had a few questions over, for anyone who asked a question where it wasn't answered we will get back to you directly. It just remains for me to thank Mike very much for a great review of the quarter and we wish you enormous success through the balance of 2011. Thank you very much, and goodbye to everybody.

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