PCAM Blue Chip: Prime Capital: Prime Capital (Cayman)/Prime Capital

Winner: Best sub-$250 million fund of hedge funds

PCAM Blue Chip is Prime Capital's answer to the problems traditional funds of hedge funds (FoHFs) face. Although the fund was launched in 2007 just before the financial crisis hit, Prime Capital had already spotted the shortfalls of traditional FoHFs. These included such things as the emphasis on asset gathering, trying to be macro managers rather than focusing on manager selection, and a bias towards excessive fees for little work.

"The major difference is that we are striving to find the best managers within the respective strategies. We have a relatively concentrated basket," says Ivo Zonev, portfolio manager of PCAM Blue Chip.

PCAM Blue Chip also aims to be a low-cost investment vehicle for investors. The management fees range from 0%-0.5% depending on the share class with performance fees  set at 0%-10%.

The portfolio is made up of 11 underlying funds with a focus on the largest and most well-known hedge fund managers. This again bucks the current trend to access smaller and lesser-known managers. But for Prime Capital, the combination has been a winning formula.

To be included in the fund, a manager needs minimum assets under management (AUM) of $5 billion, although the average for managers in the portfolio is actually $10 billion. A manager must also have at least a three-year track record. The average period, however, is five years.

Identifying the biggest names in the hedge funds industry might be a no-brainer and something investors may balk at paying for, but Prime Capital believes it adds value. "There are different categories within [large managers]. We think there are some big managers who are just asset gatherers or hangers-on and then there are some of them who have the capabilities to have a leading edge in some of their respective areas. Maybe not all of them but at least in some of them," says Zonev.

"This has been our focus – to have some of the best managers within strategies. Additionally we have noticed that some of the large managers have independent risk management teams and have much stricter adherence to risk guidelines, risk limits and stop losses, which we find very important."

Because Prime Capital builds good relationships with managers, it is able to gain access to funds that are closed or have restricted capacity. It also has the capital to invest in managers that require a high minimum investment, something smaller investors will value.

Manager selection is based on a qualitative analysis backed up by quantitative data. "We try not to be too influenced by the quantitative factors and to focus on the quality of team, on quality of investment process and risk management, which we find very important," says Zonev.

"Quantitative factors are used to hint at various potential hidden risks and are also used in the portfolio construction to achieve better diversification and to balance the tail risk of the portfolio," he adds.

From Prime Capital's extensive hedge funds database, more than 30,000 data series are tracked to select 6,500 active funds. That is narrowed through detailed investment analysis, due diligence and manager meetings to identify a universe of approved hedge fund managers. There are currently around 30 managers on this list.

During due diligence alarm bells will be triggered if there are thought to be hidden tail risks in a strategy. Sometimes these are factors that even the manager is not aware of, according to Zonev.

Other factors that cause concerns include a lack of a robust risk management or style drift. "We avoid managers who have a mismatch in their liquidity terms with regard to their strategies. If the strategy is illiquid, the manager cannot afford to have liquid investment terms and also the other way around. If the strategy is quite liquid, we avoid managers having illiquid terms," says Zonev.

Risk analysis pre-investment takes into account systematic exposures. This means looking at which markets the fund has exposure to, the level of that exposure and how this will change with market movements and in extreme market environments. "We try to avoid managers who have existing excessive systematic risk exposures or excessive tail risks," says Zonev. "We monitor for concentrations of risk factors and we proactively reduce them if we think they are not attractive anymore."

Almost 40% of the portfolio is allocated to multi-strategy funds. "Multi-strategy managers quite often offer big, independent risk management teams who strictly follow their risk management guidelines. We see better results and risk management as a result of that," says Zonev.

That is one reason why they are preferred. Another is the ability of multi-strategy managers to change allocations swiftly in response to market events. Such managers also provide diverse sources of alpha. "At the end we find some of the best market neutral relative value quantitative teams are within multi-strategy," concludes Zonev.

The fund's second-largest allocation (35%) is to event driven managers with a preference to those investing in distressed opportunities in the credit market. "Event driven managers specialising in the distressed space have some structural advantages," explains Zonev. "They have access to structural alpha because there are some forced sales in the space and there is some market segmentation."

He also thinks the risk/return offered by credit markets is more attractive than that offered by equity markets. In addition, Zonev believes further restructuring in the European banking sector will provide more opportunities for this strategy. "We expect there will still be an attractive pipeline of opportunities in the credit distress space."

Other strategies include global macro and managed futures. The fund's allocation to these two areas was increased in early 2011 in expectation of the end of QEII in the US, which was expected to cause market volatility. They now make up around 23% of the fund's portfolio.

For each strategy, allocations are made to between two to four managers.

On average one manager is added to and redeemed from the fund each year. The main reason to remove a manager is the view that there is no longer an attractive opportunity set for the fund it runs. Other reasons for removal include a failure to adhere to risk management guidelines, style drift or changes to the team that are seen as weakening the fund.

Returns continue to be strong for the fund. Although many managed futures funds have had poor performance over the last couple of years, PCAM Blue Chip's allocation has outperformed the market average, according to Zonev. Relative value and market neutral managers have also performed well in 2012, although they make up only 2.5% of the total portfolio allocation.

Going into 2013, Zonev expects a similar environment as 2012 with policy-makers continuing to intervene in markets. The fund is in the process of trimming credit exposure and increasing allocations to managed futures and market neutral managers in order to protect the fund in this macro environment. Zonev believes there will continue to be attractive opportunities in these strategies.

Although the current market climate is unlikely to change soon, when it does, the fund will be ready to respond.

Fund facts
Full name of fund: PCAM Blue Chip
Name of portfolio manager: Werner Goricki, Ivo Zonev
Name of investment/management company: Prime Capital (Cayman)/Prime Capital AG
Contact information: Werner Humpert, Bockenheimer Landstrasse 51-53, 60325 Frankfurt am Main ([phone]; [e-mail])
Launch date: October 1, 2007
Assets under management: $230 million (at November 30, 2012)
Net cumulative performance since inception: 35.71% (at June 30, 2012)
Annualised return: 6.64% (at June 30, 2012)
Annualised volatility: 6.66% (at June 30, 2012)
Sharpe ratio: 0.70 at risk-free rate of 2.0% (at June 30, 2012)
Strategy: multi-strategy
Share classes: euro, US dollar, Swiss franc
Administrator: Citco Fund Services
Auditor: Ernst & Young
Custodian: Citco Global Custody
Prime broker: Citco Bank
Legal counsel: Maples and Calder
Domicile: Cayman Islands
Management fee: 0.5% or no management fee
Performance fee: none or where there is no management fee, 10% with high water mark
Minimum investment: $1.5 million
Lock-in: none
Redemption/liquidity terms: quarterly, 95 days' notice

2011
Winner: Best performing diversified FoHF over one year; Best performing diversified FoHF over three years
Shortlist: Hedge Funds Review FoHF of the Year