In an office block within sight of the Tower of London, rows of Hewlett-Packard (HPQ) computers whir away behind a locked door. The machines are the guts of a monster hedge-fund operation called AHL. Twenty-four hours a day they crunch prices in more than 100 markets, from foreign exchange to copper to pork bellies, spitting out buy and sell orders to teams of traders.
AHL doesn't look like much, but the futures-trading operation, which deploys some $10 billion, has been at the heart of a remarkable transformation that has taken place at Man Group PLC. Man was founded by an English cooper named James Man in the late 18th century. It started out as a sugar broker and is still based on Sugar Quay on the Thames. Over the past two decades, however, it has parlayed its expertise in the commodities business into a leading position in designing and marketing hedge funds for clients. Crucial to this shift was the gradual acquisition of AHL from its founders, beginning in 1989, for what now seems a bargain price of $34 million.
With AHL's help, Man Group has turned itself into the largest publicly traded hedge-fund manager in the world. In the three years ending Mar. 31, 2004, assets under management at Man soared sixfold, to nearly $40 billion. Profits before tax nearly tripled, to $872 million. "They've been innovative in their products, shrewd in their acquisitions, and they've recognized client requirements," says Robin Bowie, Director of London-based hedge-fund consultant Dexion Capital PLC.
CEO Stanley Fink, a former Citigroup buyout specialist, has designed this wondrous money machine. Man puts together hedge-fund products and sells them to well-heeled individuals, usually via a global network of 1,700 private banks and financial advisers. Like bond issues, these products run for a specified period, often 12 years, and typically include a guaranteed return of capital at the end. Man arranges a guarantee with a major bank and parcels the money out to several specialist managers in a blend designed to meet specific return and risk targets. A big chunk usually goes to Man's in-house managed-futures vehicle, AHL. Along the way, Man collects management fees of 3% per year and performance fees that are usually 20% of the profits. Man also puts together packages of investments, or funds-of-funds, for institutions at a lower fee. Operating margins regularly exceed 50%.
Now, Man -- and the 47-year old Fink -- have to figure out where to go from here. The firm is starting to feel the pull of gravity. AHL has had a poor year due to stagnant markets and the lack of clear direction in recent months in everything from interest rates to currencies to equity prices. AHL's annualized return over the last five years has been 11.6%, but it's down 5.4% for the year as of Sept. 27 and is off 12% from its high-water mark in January. Of about 90 other products listed on the Man Web site, all but one have negative returns for the year.
Poor performance has made it more difficult to pull in new money, especially from Man's key retail clients, analysts say. Assets under management took a rare fall between July 30 and Sept. 30. Although Man raised total new assets of $7 billion between April 1 and Sept. 30, 20% ahead of the same period a year earlier, that was the last leg of an industry boom. More significant: On Oct. 20, Man announced that its latest global product had raised just $215 million, down 60% from the previous fund-raising. "Private clients are clearly cheesed off with poor performance," says London-based Morgan Stanley analyst Huw van Steenis, who thinks sales may fall 40% in the second half. Meanwhile Man's stock price is down from its all-time high of $32.40 in late March to about $23.
It doesn't help that Fink, who has been CEO since 2000 and a guiding light since he joined the company in 1987, has been ill. After having a brain cyst removed in the summer, Fink said in an e-mail that he is recovering well and starting his return to work. But word of his illness, the decline in the stock price, and the growing appetite of established financial institutions to invest in hedge funds have fueled speculation that Man could be for sale -- although insiders say a buyer would have to pay a fat premium.
If Man does not get snapped up, Fink has to plot the company's next path. His goal all along has been to polish the slightly off-color image of hedge funds, making them no more threatening than, say, mutual funds were before the recent scandals. He often talks about Fidelity Investments as his model. And analysts expect the hedge-fund industry to shift from being a secretive, largely offshore business to one that operates with full regulatory oversight.
Fink has built up the critical mass -- and the legal staff and marketing machinery -- needed to operate in this newly regulated world. "Man Group in my view will be the kind of company that can channel products manufactured by small fund groups to investors," says Joanna Nader, an analyst at Lehman Brothers Inc. (LEH) in London. "Small firms are not going to be in a position to deal with things like regulation and tax."
Man is also using its heft to design products to sell in the U.S., where it has been traditionally weak, in part because, Fink says, U.S. regulation makes doing business there more expensive. Only about 10% of its sales have been in the Americas, compared with 64% in Europe and 20% in Asia. Man recently launched a fund-of-funds in the U.S. targeting individual retirement accounts and other tax-exempt investors. "This is a massive market largely untouched by hedge funds," says John Kelly, CEO of Man Investments Inc. North America. The price of entry is high: A customer must have $1 million in net assets and make a minimum investment of $25,000.
Man definitely needs new revenue streams. With close to a trillion dollars having flowed into hedge funds of late, earning top returns could get harder. As returns ebb, so will the flow of capital. In an interview last summer, Fink acknowledged that asset growth won't soon match the 40% annual gains that Man enjoyed in the past. "Our forecast is that we will grow just over 20% [a year] in the next 5 to 10 years," he said.
Of course, this year probably won't be so hot in terms of profitability. Analysts estimate that Man's overall profit before tax could fall by 12%, to $765 million. Undeterred, Fink and Man Chairman Harvey McGrath reported buying 100,000 and 50,000 shares respectively on Oct. 10.
BUILDING A BRAIN TRUST
Man's bread and butter is the capital-guaranteed fund, which gives clients the upside reward of a traditional hedge fund plus the assurance that they won't lose their money. One such product, Man AP Enhanced Ltd., should launch at the end of October. Man plans to place approximately 60% of the proceeds with Deutsche Bank (DB), which will guarantee return of capital after 12 years. Man will parcel out the remaining 40% to hedge-fund managers, including AHL. But by buying securities on margin, the firm more than triples the investing power of that capital. Man AP Enhanced will invest in arbitrage, directional investments, equity hedges, and long/short equities, according to its prospectus. Man is targeting 17% to 19% annual returns for the fund.
Finding managers who can make those returns is a challenge. To expand its brain trust, Man has acquired several fund outfits outright. Mike Lozowski, co-head of Man Global Strategies, says the company has also cut deals with some 35 managers in its quest for spots to place its funds.
Man even runs what Lozowski calls a "manager hotel" in its London headquarters. The idea is to nurture new managers, giving them office space and IT help and eventually raising money for them. One of those prospects is Keith Jordan, 35, of Man-Drake Capital Management Ltd., which he co-owns 50-50 with Man. Jordan specializes in long/short equities, such as trying to play the price swings of BP PLC (BP) against those of its crosstown rival Shell Transport & Trading Co. He is up 10% on the year, a good showing in a choppy market. Jordan is happy that Man takes care of all of his needs, even raising the $200 million he manages. But he says Fink & Co. drive a hard bargain. Because Man has put so much capital into his computer models, Jordan says, "I am trapped here for life."
Managers like Jordan are the future, but the present is dominated by AHL. The big question is whether the operation, which accounts for 45% of Man's management and performance fees in a good year, will recover. Lehman Brothers' Nader figures it will, noting that the trend spotter, which has a historical average annual return of around 17%, is volatile and has dipped before. If AHL snaps back to double-digit returns, profits will surge. If not, Man may need to rethink its model.
By Stanley Reed in London, with Mara Der Hovanesian in New York