Gregg Groechel joined Minneapolis, MN based American Express Asset Management at age 22, in 1988
Gregg Groechel joined Minneapolis, MN based American Express Asset Management at age 22, in 1988. He served as a fundamental research analyst in equities, fixed income and convertibles. His work with convertibles led to work with derivatives and various risk management practices employed across a variety of products. In 1994, Gregg's team began investigating the feasibility of American Express launching hedge fund products. The first such product, an opportunistic long/short U.S. equity fund was started in December 1996 with Gregg and William P. Miller as portfolio managers. In January 1999, the company set up a second product managed by the same team, a long/short market neutral equity fund with a parallel offshore fund launched in October 1999. The hedge fund group has grown to $1.3 billion in assets under management, and in its three and a half year life, the first opportunistic long/short hedge fund has achieved an annual compounded net return of 52%, with strong performance during the most turbulent market environments. It recently closed to new capital. While representing only a fraction of American Express' $240 billion in assets under management (including life insurance and mutual funds assets), or even the $56 billion American Express Asset Management subsidiary which it is part of, American Express' hedge fund group is a very visible and successful example of how large financial organizations are venturing into hedge funds. Gregg Groechel spoke to HFN publisher, Antoine Bernheim, in mid-July 2000.
Profile of Gregg D.Groechel
Born: January 17, 1966 in Kansas City, MS
Education: BSB in Finance and Marketing, University of Minnesota; MBA, University of Minnesota; CFA
Last book read: A Brief History of Time by Stephen Hawking
Hobbies: golfing and boating
How he best describes himself: "entrepreneurial, energetic and focused."
Q. Where do hedge funds fit into American Express Asset Management?
A. Every long-only portfolio can be broken down into its constituent parts, which involves a set of systematic risks (beta) and a long/short portfolio which comprises the alpha. Our hedge funds are positioned as absolute return oriented, skill-based products with an intense focus on risk-management. As a company, we want to offer very strong products to meet both ends, beta and alpha, and our hedge funds are focused on the alpha end. We began looking at the business in 1994. Many of our institutional clients were starting to show an interest in alternative assets. We also looked at the competitive landscape in hiring and retaining the best people in our organization. It became quite evident that a successful hedge fund business was a key hiring tool. Thirdly, we looked at the hedge fund business as attractive from a financial point of view. We set up our compensation system so as to make those involved truly partners in the product. We realized the importance of having the right structure/culture and compensation system, so we set it up ahead of time, and our American Express senior management team realized the value of the system.
Q. Could you describe how you use the research and execution resources of American Express Asset Management?
A. What has worked well in our hedge fund group is that we really found the right mix between individuals dedicated to the hedge fund product and people who have a strong incentive to help the hedge fund but also support other people within the organization. I am personally the only portfolio manager dedicated to the hedge fund product. The other portfolio managers in the hedge fund group spend a good portion of their time on the hedge funds, but have other responsibilities. Likewise, we have twenty-nine equity research analysts who are industry experts within their field and service all equity portfolio managers. That is a very effective way to leverage the resources of our organization because most of our products can only use long ideas and our analysts are constantly coming up with short ideas as they do their fundamental research. However, we have also realized that to build a strong short portfolio, we needed dedicated short analysts. So we have two dedicated short analysts who only focus on the hedge fund products. On the trading side, we have a dedicated trader who trades both our cash and our derivative instruments and he has the back-up of nine others. Finally, the other really important infrastructure is shared technology which is key to manage risk appropriately and to maximize both internal and external communication.
Q. Could you describe your own investment style in managing your hedge fund?
A. We live by the precept that fundamentals rule stock prices until liquidity overwhelms fundamentals. We use a combination of bottom up and top down factors. Every day, I speak to people throughout our organization, looking at what is happening to spreads in different asset classes and different global economies as all of these factors impact our US companies. In addition, our twenty nine analysts are constantly coming up with bottom up ideas and we try to put those two together in a very solid, risk-managed, long and short equity portfolio. Our process is to take a fundamental idea, be it a long or a short, and implement it with the appropriate risk profile. That may mean being long stock/short call/long put, or setting up a pair trade, whichever is most appropriate to isolate the alpha we want and get rid of the risk that we don't want. For instance, we have had a long term position in Safeway, the supermarket company, which has been a strong absolute and relative performer over the past four years. They have a tremendous management team, they have a strong earnings history and projected earnings growth which is not very economically sensitive. We were very early on in understanding what can happen to the supermarket industry if you apply good technology to it, whether it is scanners or better inventory management systems and we also understood the impact of greater buying power that comes from consolidation within the industry. This has helped some of the companies in this group have very strong earnings growth and multiple expansion. Within the group, however, there are some companies which are not taking advantage of all the different attributes that a Safeway is and whose stock is likely to under perform Safeway. So we go long one supermarket and short another and try to lock in the excess alpha of the Safeway position over the short. This is a type of trade that is replicated many times, particularly in our market neutral portfolio.
Q. Could you describe your research process?
A. Approximately half of our ideas come from our internal research group and half come from external sources such as Wall Street, consulting firms we deal with and our industry and company contacts. Many of our analysts travel constantly to visit companies and we have structured our research sector teams to make sure they all work and communicate together and share enough information across different industries to hopefully have it all be additive. In addition, we have a constant flow of companies coming through our shop, which allows the portfolio managers to keep up with management teams, without constant travel.
Q. How do you manage risk and portfolio structure?
A. We manage risk starting bottom up at the position level, at the sector level and at the overall portfolio level. The reason we start bottom up is that we do use a lot of options to manage the overall risk in the portfolio, whether it be collars, spreads or just being long calls or puts. We think that the derivative allows us to capture the portion of the risk in the idea that we want. We emphasize the risk position of a particular security rather than the size of the position itself. Typically our long/short opportunistic fund runs approximately 45 longs and about 40 shorts with 120% gross long and 50% to 80% gross short, including the delta equivalent positions for the options. However, the manner in which we end up being 40% to 70% net long may be very different from other hedge funds with similar net exposure because of our optionality. The option premiums represent typically 5% to 10% of capital and we usually run 5 to 10 basis points per day of time decay in the long/short opportunistic and 1 to 2 basis points of time decay in our market neutral fund. As a result of the optionality in our portfolio, our exposure can change as the market is changing. The reason the long/short opportunistic product has preserved capital and in many cases has had positive returns in down equity markets is that we are using our optionality appropriately to make sure that we are winning by not losing in the tough markets. The risk profile of our long/short opportunistic fund looks much more like a call option risk profile which truncates downside losses and gets the upside when it's there. In the market neutral strategy, we have 50 to 60 longs and the same number of shorts and we use less of our balance sheet (on average, we have been 70% gross long and 70% gross short). We focus on how our balance sheet and the volatility of our portfolio mix together. For example, when volatilities are low, or options are less expensive, we can construct a similar risk profile on a larger balance compared to when volatility or options are expensive. In that portfolio, we balance specifically market capitalization risk, sector risk, beta risk and style risk.
Q. What are your goals for the future?
A. From a performance perspective, in the long/short opportunistic fund, the objective is threefold: in markets down 15% or more, our goal is to be down less than 5%; in 8% to 12% return markets (i.e. more normal markets), our goal is 15% to 25% return; in bull markets of 25% plus, our goal is to keep up with the market. To date, we have exceeded our goals in the long/short opportunistic predominantly by doing a good job in preserving capital in tough times and getting things right on the upside through both long and shorts. Our market neutral strategy has much more linear objectives: Treasuries plus 6% to 9% net of fees irrespective of the market environment. In that strategy, we aim for three or fewer drawdowns per year with a maximum drawdown of 2%. Over the last eighteen months, we have not had one losing month in the market neutral strategy. From a group perspective, Scott Nelson, who leads our new product development effort, is working on launching new skill-based products, using core strengths of our organization. These new products will be based on fundamental security selection, in equity and fixed income, where we can find within our organization a special team with the ability to generate a lot of alpha while putting a very strong risk management wrapper around it. u