BH Global (BHGG) aims to deliver strong risk-adjusted NAV returns in all market conditions. It aims to achieve this by investing in the range of trading strategies offered by Brevan Howard through its Multi-Strategy Master Fund.
As we discuss in the Performance section, strong performance during 2020 has prompted renewed interest in Brevan Howard as a firm, with AUM rising from $7.5bn to c. $11.4bn so far this year. With a new CEO, Brevan Howard has been hiring trading talent and its number of traders has risen from c. 40 to around 55. In time, this will likely filter through to BHGG, which can be more exposed to a wider range of asset classes than the BH Master Fund (or BH Macro).
This wider exposure to asset classes allowed BHGG to outperform BH Macro during Q2, and has contributed to the strong returns made year to date (+17.1% as at 06/11/2020). BHGG has only experienced one down year over the 12-plus years since launch (-1.32% GBP NAV in 2015). This is illustrative of Brevan Howard’s strong risk controls which, as discussed in the Portfolio section, are built into the organisation’s DNA. The managers aim to control downside through strict risk limits on an underlying trader basis, but also at a portfolio level.
During 2020 the investment committee made some significant changes to the allocation of the underlying funds. The percentage invested in the BH Master Fund was reduced from 43.5% (as at 31/12/2019) to 20%. An increase was made to the ‘single-manager portfolio’ (from 40% to 59.5%, back towards its previous peak of over 60% in 2018).
The chairman of BHGG describes the fund as “structurally uncorrelated” (2020 interims), and in our view the key attraction of BHGG is its ability to generate returns irrespective of the direction of markets. Historically, the best NAV returns have been generated in periods of poor equity returns and heightened volatility. During the first half of 2020, the fund delivered its highest six-monthly performance (+14.5% for the GBP share class in NAV terms). With equity markets once again elevated, and political risks heightened, BHGG’s portfolio diversification attributes are increasingly relevant.
These attractions have not eluded investors, and BHGG’s discount has narrowed. As a result, both BHGG’s NAV and share price have outperformed equity markets significantly so far this year. The current premium to NAV for the GBP shares of 1.3% compares to an average discount over the last three years of 4.3%. However, BHGG continues to trade at a significant discount to sister BH Macro, which trades on a premium of 13.5%. This differential has rarely been wider, and in our view means that BHGG currently offers a better-value access point to Brevan Howard’s traders and strategies.
In our view BHGG remains a useful tool from a portfolio-construction perspective. BHGG is a strong candidate for more sophisticated investors to own when balancing their portfolios. With Brevan Howard having further deepened its pool of trading talent, we believe the future for BHGG – by offering a broad exposure to these traders – looks bright.
|Strong performance in 2020 when equity markets have struggled, reinforcing the historical low correlation to equities and bonds||Hard for investors to get a timely understanding of current exposure|
|Shares trade at a small premium to NAV, but are significantly cheaper (in terms of premium) than BH Macro’s
||Discount volatility: NAV moves are not always reflected by the share price
|Multi-strategy nature of underlying fund means BHGG can be used as a diversifier for equity portfolios
||Shares can be relatively illiquid at times (reflected in spreads between buying and selling price)|
BH Global (BHGG) aims to deliver strong risk-adjusted NAV returns in all market conditions. It aims to achieve this by investing in the range of trading strategies offered by Brevan Howard through the Brevan Howard Multi-Strategy Master Fund, and by managing risks. Over time, the allocations to different strategies, traders and asset classes are managed by Brevan Howard’s investment committee. As we discuss in the Performance section, returns generated during 2020 have catalysed renewed investor interest in Brevan Howard as a manager, and the firm has seen AUM rise from $7.5bn to c. $11.4bn over the calendar year so far.
With a new CEO (former chief risk officer Aron Landy), Brevan Howard has been hiring trading talent aggressively. So far in 2020, its number of traders has risen from around 40 to c. 55. In time this activity will likely filter through to BHGG, which is exposed to a wider range of traders and asset classes than the BH Master Fund (or BH Macro). Over time the overlap between the two funds is expected to vary depending on the opportunity set identified by the underlying traders. In mid-2017, for example, the overlap was only 50%. At the start of 2020, reflecting the opportunities that Brevan Howard saw, the overlap was c. 80%. Since then, the overlap has declined to around 70%. Whilst the two funds will always have a certain degree of overlap thanks to their respective exposures to Brevan Howard’s most experienced traders, the hiring of what Brevan Howard calls the third generation of traders bodes well for the future returns of BHGG in our view.
The latest announced exposure of the fund can be seen below. It is the relatively significant exposure to interest rates, volatility and FX that drove returns during the crisis. During Q2 these areas saw modest losses, whilst a positive contribution came predominantly from credit markets, but also from equities and commodities. It was this wider exposure to asset classes that allowed BHGG to outperform BH Macro during Q2.
BHGG, through the Multi-Strategy Master Fund, achieves its exposures through allocations to Brevan Howard funds and the single-manager portfolio (SMP) as decided by the investment committee, which uses a variety of quantitative and qualitative factors including historical returns and correlations in making allocation decisions. The most recently published allocations (as at the end of September 2020) can be seen in the chart below. It is important to recognise that BHGG’s sister investment company – BH Macro – offers exposure to just the BH Master Fund (currently representing around 26% of BHGG). All of the traders and strategies in BHGG are found in BH Macro and/or BH Master Fund, but in different proportions. Within the SMP, the investment committee can make direct allocations to individual traders’ books as well as funds. In this way, the investment committee can have an oversized exposure to specific traders compared to the exposure that these traders might represent (for example) within the BH Master Fund. We understand that (as at 30 September 2020) the SMP constituted 59.5% of assets, and had exposures to nine underlying traders.
COMPONENT PARTS OF FUND
Looking through the various funds that BHGG holds, investors have exposure to around 50 traders currently. That said, the weight of exposure is to a few key senior traders who have their own funds. Brevan Howard provides visibility on some of these funds, but it is also worth remembering that investors also have exposure through other funds (such as the Master Fund). As much as we are able, through publicly available information, we estimate the look-through exposure to specific traders in the chart below..
lOOK-THROUGH FUND EXPOSURES
During 2020, and likely reflecting the very strong returns and changing opportunity sets between Q1 and subsequently, the investment committee made some significant changes to the allocation of the underlying funds. The percentage invested in the Master Fund was reduced from 43.5% (as at 31/12/2019) to 20%, and the SMP percentage increased from 40% to 59.5%, taking it back towards its previous peak of over 60% in 2018. BHGG’s allocations continue to evolve, reflecting both the opportunity set and the trading talent available. As well as aiming to access traders who will generate strong absolute returns, the SMP is also expected to provide diversification to the other parts of the portfolio. The SMP (or ‘direct investment portfolio’, as it was called at the time) was one of the key drivers of returns during 2017, which was a more difficult time for the BH Master Fund and therefore served to provide a smoother return for BHGG (in NAV terms) during that period. It is this pattern of returns that makes BHGG a useful tool from a portfolio-construction perspective, given its tendency to deliver consistently positive returns on an annual basis and its lack of correlation to equities in particular, but also to bonds.
The chairman describes BHGG as “structurally uncorrelated” in his statement in the 2020 interims. In our view, one of the attractions of BHGG is its ability to generate returns irrespective of the direction of markets. Macro traders typically take a nuanced view on the direction of markets. For example, by taking a probabilistic view on how the economy and markets may evolve, and by comparing that to what the market is currently pricing, they seek to position a range of attractive trades with convex (or asymmetric) pay-offs. Thanks largely to the widespread use of options, traders are often able to create these asymmetric trades at a low cost (with no further downside other than the price paid) but which offer potential upside of many times the amount paid. As we illustrated in detail in our previous note on BHGG, the best NAV returns have typically been generated in periods of poor stock market returns. Our analysis below illustrates that in periods where VIX (or market volatility) is high (two standard deviations above average), trailing three-month NAV returns have been significantly higher.
Historical NAV returns during periods of volatility
|‘Extended’ volatility: VIX higher than 31.8 (two standard deviations above average)
||‘Dampened’ volatility: VIX below 31.8
|BHGG NAV average returns over three months (%)
Brevan Howard aims to generate the highest returns possible, but pays particular attention to downside losses and risk management. Brevan Howard has an internal aim to limit losses to a maximum of 5% of NAV in any one month. The highly resourced risk team police the traders and ensure that losses are minimised both at a trader level and at a fund level. Traders run their own books within defined mandates and risk tolerances, and there is no house view, so theoretically traders could be positioned in opposite directions (although we understand that this is rare in practice). However, if the risk team observe a concentration of risk in the overall portfolio towards any particular exposure, they have authority to neutralise some of the risk or to bring it down to within acceptable limits.
Looking at monthly data since inception, it has been rare to see a month in which the NAV falls by more than 2%. This reflects the fact that the risk-management team tend to dial down risk exposure after significant falls from a peak. Brevan Howard emphasises that it aims to control the risk it is taking in terms of loss of capital, and not volatility of returns. Overall, the managers believe risk is defined as permanent loss of capital, and this thinking forms the backbone of their approach.
In terms of outlook, the managers observe that financial assets are expensive by many standard metrics. So long as a V-shaped recovery in risk assets fails to create a V-shaped recovery in economic activity, this tension is a recipe for increased volatility. They note that since interest rates are constrained by the zero lower bound and credit spreads have been explicitly underwritten by major central banks, volatility will have to show up in other asset classes. As we have shown above, volatility usually presents Brevan Howard’s traders with opportunities – and this outlook should benefit BHGG, given its broader exposure to different asset classes.
BHGG does not employ gearing in a traditional sense. However, Brevan Howard’s traders try to exploit pricing anomalies and provide investors with asymmetric pay-off profiles over defined periods in the future. These trades are often structured using options which can be considered leveraged (using margin). However, whilst these options might typically generate proportionately high (geared) returns if the trade works out, if it doesn’t the maximum loss might be the cost of putting the trade on (or the option cost). As such, while such trades offer geared upside, they are not necessarily the same as traditional gearing, which also exacerbates the downside.
BHGG’s investment objective is to generate consistent long-term capital appreciation. Historically, we have observed that it has achieved returns with lower volatility than its sister fund, BH Macro. BHGG has also had a tendency to perform strongly when equity markets are struggling. 2020 so far has been a case in point, with the fund generating its highest six-monthly period of performance during the first half of the year (+14.5% for the GBP share class in NAV terms). As the graph below shows, the impact of the discount narrowing over this time means that the GBP share price returns have been even stronger. Both NAV and share price have outperformed equity markets by quite a margin so far this year.
Also observable from the graph above is the performance of sister fund BH Macro, which has performed even more strongly, it having a narrower focus on interest rate and foreign exchange markets and, as a result, typically a higher NAV volatility. From the outset, this pattern of lower volatility from BHGG has been maintained. According to data from Morningstar, over the ten years to 30 September 2020 BHGG has delivered compounded NAV returns for investors of 4.5% per annum. It has achieved this with annualised volatility of 6.2% and a maximum drawdown (peak to trough) of 4.6%. This compares with BH Macro, which has achieved 6% returns per annum, with volatility of 8.4% and a maximum drawdown of 7.8%. In other words, with lower risk and commensurately lower returns, BHGG has a broadly similar Sharpe ratio of 0.2 for BHGG as compared to 0.3 for BH Macro over ten years (Source: Morningstar).
BHGG has only experienced one down year over the 12-plus years since launch (-1.32% GBP NAV in 2015). This is illustrative of Brevan Howard’s strong risk controls which, as we discuss in the Portfolio section, are built into the DNA of the organisation. The managers aim to control downside through strict risk limits on an underlying trader basis, but also at a portfolio level.
The years from 2016 onwards have seen returns perk up from the relatively fallow period after the global financial crisis, which reflected the difficult environment for Brevan Howard’s traders with interest rates grounded at zero and volatility depressed across most asset classes. As central banks, led by the US Federal Reserve, started to slow or reverse balance sheet expansion (and even in the Fed’s case to raise interest rates), so the opportunity set started to open up. Over five years, the NAV total return has been c. 37% (to 06/11/2020), against the MSCI ACWI return of 82.3%. This underperformance against an overall strong equity market over the period might be expected, particularly when taking into account the volatility of 7.9% against the equity market volatility over the same period of 12%. Looking forward, we think it likely that interest rates will stay close to zero for a period of time but volatility across asset classes is likely to be significant, which should be good for Brevan Howard’s opportunity set.
CALENDAR-YEAR NAV RETURNS SINCE INCEPTION
Ultimately, we believe Brevan Howard is in a strong position to benefit from policy missteps from central banks and heightened financial market volatility. However, BHGG tends to provide a smoother return stream than BH Macro. We believe that it is this pattern of returns that makes BHGG a potentially useful tool from a portfolio-construction perspective, given its tendency to deliver consistently positive returns on an annual basis. Perhaps more importantly, it is BHGG’s low NAV correlation to equities (an average of 0.1 on a rolling 12-month basis since IPO) and to bonds (an average of -0.02) that makes it a good addition to a portfolio from a diversification perspective. In fact, the correlation over time is relatively dynamic, as illustrated in the graph below. Within the context of elevated equity markets, it is noteworthy that BHGG is currently negatively correlated to equities (as measured on a rolling 12-month basis). In our previous note (accessible here) we illustrate the protective properties of BHGG’s NAV during periods where the equity market has fallen. These characteristics mean BHGG will in our opinion likely improve a portfolio’s overall risk-adjusted returns, and can be considered as a highly attractive portfolio diversifier.
ROLLING ONE-YEAR NAV CORRELATION
The strategy employed by BHGG and the BH Multi-Strategy Master Fund does not generate income, and we understand that at the current time dividends are not on the agenda. However, BHGG’s board does have a facility to make an annual partial capital return in respect of the NAV growth in each calendar year, but has chosen not to make use of this feature since 2016. If returns continue to improve, then the board will have discretion to determine whether BHGG makes an offer of a partial return of capital of up to 100% of the previous calendar year’s return. It remains to be seen whether this is a feature that the board makes use of in the future.
Founded in 2002, Brevan Howard is one of the world’s leading global macro hedge fund managers. At points in the past, Brevan Howard was considered one of the largest macro hedge fund managers in the world, with assets in excess of $40bn in 2013. Since then, the firm has downsized following redemptions from investors. The strong performance this year has seen AUM rise once again from $7.5bn to c. $11.4bn (as at the end of October 2020). Founder Alan Howard has stepped aside from the CEO role as of December 2019 in order to focus entirely on trading, with Aron Landy, formerly chief risk officer, becoming CEO.
Structurally, the firm has modified the way that it does business over time. Key staff are now tied in with their own funds (as well having allocations from other multi-PM funds such as the Master Fund). Latterly, we understand that Brevan Howard has been hiring trading talent aggressively, which has taken its number of traders to around 55 (a rise from c. 40 at the beginning of the year). Overall Brevan Howard has 180 employees with offices in London, New York, Geneva, Jersey, Hong Kong, Washington and Singapore.
For BHGG, the increased number of traders is highly relevant. The BH Multi-Strategy Master Fund, of which BHGG is a feeder fund, aims to provide a broader exposure to trading opportunities relative to the BH Master Fund (of which BH Macro is a feeder), which focusses on G7 interest rates and foreign exchange markets. With an increased range of traders, over time BHGG should be exposed to a wider pool of talent and opportunities. BHGG remains a relatively large percentage of the BH Multi-Strategy Master Fund (over 80%), although we understand that it has latterly seen some inflows, and Brevan Howard is hopeful of further inflows as time goes on.
Another noteworthy event specific to BHGG is that Magnus Olsson, who was chair of the investment committee responsible for asset allocation of the multi-strategy fund, has left Brevan Howard to pursue a career change. Ryan Kennelly, who previously worked with Magnus, has rejoined Brevan Howard and has stepped into the role. We understand that this change is likely to have no practical impact on the way that the fund is run.
BHGG has largely traded on a discount to NAV, although since the market volatility of H1 2020 the shares have traded on a significantly tighter discount than historically. In our view, this reflects wider awareness of the attractiveness of BHGG’s portfolio diversification properties as well as the strong returns delivered this year. The current premium to NAV for the GBP shares is 1.3%, compared to the average discount over the last three years of 4.3%. The graph below illustrates that BHGG continues to trade at a significant discount to sister BH Macro, which currently trades on a premium to NAV of 13.5% for the GBP shares.
discount to nav
Historically the board has enthusiastically repurchased shares, with a stated aim to use buybacks opportunistically in seeking to reduce discount volatility. The last buybacks of shares by the board were completed in June 2018, when the shares were on a persistent discount of c. 5%. Since then, whilst the shares have occasionally traded wider than this, buybacks have not been used and natural demand has led the discount to remain relatively tight. The board has an annual buyback allowance of 5% of the shares in issue, beyond which a 2%-of-NAV fee will be payable to the manager for the amount bought back. BHGG has a longer-term discount control mechanism for each share class, which offers shareholders a share class discontinuation vote if the average discount on each month-end NAV is wider than 10% over a calendar year. The same protections exist if the company falls below net assets of $300m.
Anecdotally, strong absolute performance typically leads to the discount narrowing. Conversely, in periods of less notable performance the discount tends to widen out. In contrast to this pattern, BHGG’s discount widened dramatically during and immediately after the COVID-19-related equity market crash. In our view, as was the case with most investment trusts, a lack of liquidity in stock markets generally meant spreads widened dramatically, but also led to wild swings in prices in the LSE ‘closing auction’ (which represents the official closing price, and doesn’t necessarily reflect the average price over the day). Whilst BHGG’s discount did widen over this period, we believe the reality wasn’t as bad as the graph above suggests. Certainly, with more normal market conditions having been re-established, the discount has narrowed convincingly.
Relative to BH Macro, the difference in the share price rating between the two companies has rarely been starker. Since IPO, BHGG has traded on a discount which on average has been four percentage points wider than BH Macro’s. However, since the start of April 2020 (following the sharp equity market drawdown of Q1 2020) the average differential has widened to ten percentage points. In our view, despite the stronger performance of BH Macro through the crisis, the current differential means that BHGG offers a better-value access point to Brevan Howard’s traders and strategies. In any event, the risk of a de-rating is arguably less for BHGG, with the board having previously bought shares back if the discount becomes persistently wider than a 5% discount. At any rate, BHGG a discount control mechanism designed to keep the discount narrower than 10%. By contrast, BH Macro’s shares could de-rate by 10% and still be trading on a small premium to NAV.
With effect from 1 April 2017, the board negotiated a reduced management fee with Brevan Howard of 1% of adjusted net assets, which was fixed at that point based on the net assets of the company as at October 2016, but adjusted for certain changes in shares in issue. Any capital growth from that point on will not attract management fees. Given NAV performance, this means that the effective management fee is now less than 1% of net assets.
In addition to the management fee, shareholders pay a performance fee of 20% of NAV appreciation, subject to a high-water mark. The report and accounts do not disclose an OCF based on the AIC guidelines, but from the KID document; the ongoing charges are quoted as 1.34%. The full KID RIY cost is 2.36%, including 0.68% of performance fees.
Trading and equity investing are very different investment activities. In this context, we understand that Brevan Howard regularly assesses the trading activity of the investment funds it manages to ascertain whether environmental, social and governance (ESG) factors are appropriate or applicable to such funds. Brevan Howard observes that most ESG principles have been envisaged in the context of equity or corporate fixed-income investment and therefore are not readily applicable to most types of instruments traded by the majority of funds it manages.
Nonetheless, we understand that Brevan Howard applies ESG principles to its activity where appropriate, and considers the structure of its relevant funds and the applicable trading universe. Brevan Howard reports that it continues to monitor developments in this area and will seek to implement industry best practice where applicable.