Michael Hintze of CQS: Hedge funds should talk

Michael Hintze founded global hedge fund CQS, where he remains chief executive and chief investment officer. During a recent visit to Hong Kong, he invited AsianInvestor to be the only publication to have a one-on-one interview with him.

Is it fair and reasonable that a Wall Street bank can undertake the same kind of trading strategies as a hedge fund via its prop-trading desks, while also benefitting from an implicit government guarantee that hedge funds do not have?
This is one of the issues that caused such excesses. It is due to the leverage factor, because banks could leverage themselves to an extreme level and use their balance sheets with, say, 50 times or more leverage. Bank proprietary trading desks were our major competitors, and while fairness does not come into it, it was not a level playing field.

As these prop desks were so highly leveraged, in a strategy like convertible arbitrage, for example, the resulting sell-offs were significant due to the need to get balance sheets down. They really slammed down exposures, which hit hedge-fund positions that were not highly leveraged -- and then of course there were collateral calls. To make it worse, those Wall Street firms then used hedge funds to some extent as an ATM for their balance sheets.

If we approach a man in the street and ask him what he thinks of convertible-arbitrage strategies and hedge funds, he'll probably say he hasn't a clue what the former is, but hedge fund managers are evil. Given that hedge-fund managers haven't caused any systemic risk, none has asked for a bailout and it's generally accepted that shorting isn't economically harmful, why is this?
The short answer is fear of the unknown. It's hard to verbalise what a hedge fund's strategy is -- it is more a style of investment, encompassing many strategies such as long/short, arbitrage or directional.

Also, there is the lack of transparency and engagement. That is one reason why we do make an effort to engage with the media. It is a long journey to explain the role of hedge funds, and that's why we're doing what we're doing now, instead of staying in bed another hour this morning (note to the reader: this was a pre-breakfast meeting).

Hedge funds have been vilified since Soros pushed sterling out of the ERM [Europe's exchange-rate mechanism]. Now, hedge-fund managers are reluctant to speak, perhaps because they don't have the infrastructure or people to do it or the experience and training in speaking up for the industry. It has to be approached systematically -- that's why we employ communications staff, so that you don't phone me up when I'm right in the middle of a trade and I give the impression I don't want to speak to you.

You have built a large hedge-fund business. Is it possible for a hedge-fund manager to create a legacy business that endures after he retires?
Yes, you would hope so. That's what we're trying to do. There are funds that if you invest in them, you are buying 'me'. With the others, you are buying the investment process, and the latter will endure. Look at Goldman Sachs -- arguably the world's biggest hedge fund -- there you have a process which continues.

You yourself remain the portfolio manager on one of your funds.
Yes, and I am the senior investment officer across the platform.

And your fund did best out of the CQS portfolio last year (the CQS Directional Opportunities fund, a multi-strategy fund that was up 56.3%), suggesting you're still a central figure on the portfolio-management side.
I did best because the Directional Opportunities Fund has a less constrained mandate than the other funds. Meaning that there is still discipline in the process, but in an opportunistic fund, riskier positions can be reasonably taken. I enjoy the portfolio-management side of my job, but the business-building side is also rewarding.

Last year we witnessed a hedge fund, Old Lane, being sold to Citi for a large sum, $800 million, and its boss subsequently getting the top job at Citi. Do you think we will ever see anything like this again in our careers? 
Yes, it was quite a headhunting fee wasn't it? That fund has now closed down. At the time I did look at it closely, but it felt a bit like watching your neighbour doing something weird over the garden fence.

Will it happen again? It won't be any time soon, as it will have all to do with regulatory capital. I think a purchase like that by a bank will be hard to accomplish under the Volcker rule.

How complicated is it to risk-manage the CQS portfolio of funds? What can be learned from the failures of the bank's risk management?
It's difficult and has to be done under 'parental supervision', so to speak. We don't just look at value-at-risk, but one has to look at a wide array of risk elements, such as liquidity. It was obvious that a major problem in the crisis was a failure of liquidity risk management.

You also have to look at the long tail risks and see just how bad they can be. Banks also forgot about their notional balance sheets. If you look at the world of derivatives, where you have a nominal $600 trillion out there, some of those derivatives are back-to-backed, but are still sitting notionally on people's balance sheets. The cash value is less, of course, but the leverage there is absolutely enormous. Judgment here should not be underestimated.

An extended version of this interview will be published in the Alternative Q&A section of next month's AsianInvestor magazine, in which Michael Hintze gives his views on other issues, including capital raising, how financial markets have reformed, and regulation in Europe and the US.