Salt Rock: US/UK regulatory equivalence a challenge

Hedge fund managers need to get used to new compliance burden, says Salt Rock

Against a backdrop of a significant increase in regulation, costs and investor expectations, launching a successful hedge fund manager is more challenging than ever. One firm, Salt Rock Capital Partners, an eight-person discretionary global macro manager based in London, has shown how it is possible to launch with an institutional mind-set and infrastructure and attract institutional money – growing from launch assets under management (AUM) of $44m to over $300m in less than a year across its own flagship fund and managed accounts.

Mark Painting was previously a senior managing director and partner with Caxton Associates, where he worked for eight years and was responsible for managing a global macro portfolio ranging between $1 billion and $1.5 billion of AUM. Prior to this, Painting was head of money markets in Europe at Goldman Sachs where he worked for 12 years.

Painting’s co-founding partner and chief operating officer, Rowan Levy has 15 years’ experience and prior to Salt Rock was chief operating officer for Cayuga Capital Partners, a thematic macro manager. Levy has worked in the buy side since 2005 and is responsible for all aspects of Salt Rock’s day-to-day operations.

Salt Rock employs a discretionary global macro strategy that opportunistically invests across asset classes and time horizons to take advantage of the prevailing economic and political environment and policy action or inaction.

The typical holding period is six to 12 weeks, with some investments with a structural or thematic angle being realised over 12 months or more. Salt Rock studies the prevailing macroeconomic environment, policy-maker objectives and market prices to identify new and maturing macro trends, assessing whether current policy stances are consistent or subject to change.

Salt Rock invests in developed markets and the liquid emerging markets and implements its trade strategies across asset classes focusing on highly liquid assets – FX, fixed income, commodities and equities. Salt Rock targets superior risk-adjusted returns throughout the investment cycle.

There were three main decisions Salt Rock needed to make in structuring and setting up its business.

Seed capital: despite expressions of interest, Salt Rock says it decided to maintain its independence with Painting self-seeding the fund, because it felt the seed model emphasises growing AUM as opposed to generating returns, which is its focus.

Infrastructure: Salt Rock committed to an infrastructure that was sustainable in the event of lack of early investor traction, while not compromising on delivering to the high expectations of stakeholders and investors.

Systems and people: the key considerations were in selecting systems that met trading team, connectivity and operational control goals. At Salt Rock’s core, Tradar and RiskMetrics fulfil these needs.

In addition, commercially, being able to take managed accounts was an important decision, which gave the company additional investor traction.

There has been much talk about the increasing regulation which managers need to navigate and address. Salt Rock was approved in the UK by the Financial Conduct Authority’s (FCA’s) pre-alternative investment fund managers directive (AIFMD) regime. As the firm trades in interest rate swaps and futures it also needed approval from the US Commodity Futures Trading Commission (CFTC). If a manager wants to market in the US, to have a reasonable number of US clients and AUM, it also benefits to be registered with the Securities and Exchange Commission (SEC). As it happened, a US client required Salt Rock to be registered as a qualified professional asset manager.

Salt Rock says its biggest advantage was starting early, to ensure those who need exams have a plan that is consistent with the firm’s time frames. Also its work was staggered, in that the FCA application was rigorous and it wrote this first, following on with the more mechanistic CFTC and SEC application processes as it focused on getting the rest of the business up and running.

There is little regulatory equivalence between the US and UK, so managers need to get used to this and expect compliance to take up a significant amount of team time, according to Salt Rock.

Attracting institutional money
Painting says there is a strong demand in the space for nimbler macro investors like himself who have a proven track record over an investment cycle, plus he self-seeded the fund and so there is a clear alignment of interests with investors. He states: “We don’t plan to get too big. The best returns are typically seen from hedge funds with a smaller capital base. Staying in the game for the bigger opportunities and having success in dry patches is important for compounding returns in the long term, which is why Salt Rock will limit investor inflows to remain nimble and maintain the ability to compound, while being big enough to matter for prime brokerage relationships.”

Every team member has a proven track record in their area of expertise and is at least second-generation hedge fund. Painting adds: “This is married to the right portfolio management and risk control processes, plus a robust operational controls environment, which are clearly articulated. We think that together the investment and operational structure meet fiduciaries’ expectations.”

The first six months of 2013 presented good opportunities for macro funds and many managers posted meaningful returns; however, as trends matured opportunities became less obvious. The start to 2014 has seen a great deal of dispersion in returns. Salt Rock says it has weathered the choppy markets relatively well and has been preserving capital, ready for when opportunities re-present themselves.

With policy at the heart of today’s markets, global macro has seldom been more relevant as a space to invest in.

With a lot of consensus in macro trades, Painting says: “When the trade is the right one, we are happy to participate. We listen to markets and ensure we aren’t in crowded trades with poor positioning.”

Pari passu with its own flagship fund, Salt Rock runs a combination of managed accounts for investors demanding added transparency or building out new platforms for their underlying investors. Painting says: “Some wanted leverage and the certainty of knowing when trades went on within certain parameters. We’ve found this leads to a better understanding and dialogue, though in many ways we feel the transparency we give in our investor communications levels the playing field for all investors.”

In selecting software systems, connectivity and scalability were key. Tradar, its portfolio management system, connects to its prime brokers, numerous administrators and to its risk system. This means Salt Rock can internally build a modular approach to ensure the same controls operate across different clients, no matter who the client’s administrator is.

Levy says one consequence is that the company has added manpower but while this has added some costs to the business, it is worth it: “The three people in our operations team possess over 30 years of combined experience. This also makes it easier to respond to increasing regulatory demands.

“We did not set out to build our own managed accounts platform but in many ways we have, to support our clients accessing Salt Rock how they wanted.”

Effective partnering has also been key to building the business. Salt Rock selected Capital Support for its IT infrastructure, Quintillion as administrator and ACA Compliance as compliance consultant. Prime brokers Goldman Sachs and Morgan Stanley assist client on-boarding, support adding managed accounts and work closely on capital introductions. Levy says: “We selected primes based on quality of service, depth of relationships with our trading team and price, so we could ensure we meet our fiduciary duty to our investors.”

Biggest challenges
Over the next two years Levy expects heavily increased regulatory reporting to be a challenge; with shorter deadlines, more demanding calculations and wider-ranging requirement historic components than previous regimes. “This will be a particularly fierce year as we, like our peers, work out how to collect, present and calculate the answers to each particular regulator’s extensive reporting requirements,” he says.

“We have already been working to meet this as we perceived it one of the biggest immediate challenges – particularly Annex IV reporting under AIFMD – where we are partnering with ConceptOne and our depository-lite provider Indos Financial. We spent a considerable amount of time working out selection criteria then determining the best partners in this area.”

Medium-term challenges also abound over the next five years with a new Markets in Financial Instruments Directive (Mifid) and getting to grips with actual marketing in Europe under AIFMD.

Looking back, Painting says there are a few things Salt Rock might have done differently. An earlier concentration on process automation could have led to some operating improvements sooner, but the firm was busy in 2013 ensuring Central Bank of Ireland approval, SEC registration and that new managed accounts followed its launch.

Salt Rock’s first advice to other managers looking to launch over the next year would be to concentrate on getting the best people on board in every discipline, as there is massive value-add in applying previous experience to repeated start-up challenges – avoiding repeating mistakes saves time, cost and delivers what clients want more often the first time.

Also, plan at a high level, even if this is simply to identify potential dependencies early and to avoid log jams so all internal parties can be lined up at the right times. Critically, external parties, such as lawyers who have multiple client demands, need to clearly understand what a firm’s expectations are.

Doing one’s homework early is another essential – with regulators and with independent directors – as well as gathering external views and listening to as many industry veterans as possible.

Painting also offers one final piece of friendly advice: “Being a fiduciary starts and never quite finishes each day.”