[P19]Pain During Early Pregnancy

Set up in 2000 as a convertible and credit specialist by former Morgan Stanley men Jonathan Lourie and Stuart Fiertz, who have worked together for some 17 years, the firm has built a reputation as an innovative and opportunistic multiple-strategy asset manager - with a history of reacting to periods of market upheaval by positioning itself strategically to take advantage of subsequent recovery.

With assets under management of some $11 billion, a staff of over 200 people and a wide array of some 34 separate investment products, funds and strategies, the firm has established a broad and ever-expanding platform across a range of different asset classes.

It occupies a market-leading position in investment-grade credit (with a team of some 22 people managing around $3 billion of net assets in long/short and long-only products) and in sub-investment grade credit/event-driven strategies (with a further 25 people and around $3.6 billion of assets).

Through its offices in New York and Hong Kong as well as its main London base, the firm is also active in European and global equity, as well as in equity-related instruments, and runs a suite of six equityfocused strategies - four of which produced returns of more than 20% in 2007, with the other two posting returns in excess of 10%. And, in tune with the firm's philosophy of always seeking to push into areas of new opportunity, Cheyne is also developing a strong platform in what the firm describes as "new alternatives".

These include selected areas of specialised finance like asset-based financing and direct lending where it sees an opportunity to profit from the recent market dislocations, the problems in the banking sector and the increasing disintermediation of banks - at a time when many traditional bank lenders are focused on shrinking their balance sheets.

Few firms can boast as diverse or as multistrategy a hedge fund business as Cheyne. But the firm found itself in the eye of the credit storm last autumn on account of deciding to cut its losses early on two of its smaller specialised credit vehicles - neither of which is a hedge fund and which together represent less than 4% of the firm's AUM.

Compared to the rather more dramatic credit-related events - including massive writedowns by most of the world's major banks and other big players in the market, along with a number of credit funds disappearing altogether - the problems at the listed Queen's Walk investment company and with an asset-backed SIV structured credit financing vehicle were hardly headline-deserving material.

The fall in Queen's Walk's NAV - which, after taking into account the dividends that have been paid out, was ultimately just 13% to the end of March this year - was actually triggered by Lourie and Fiertz identifying the extent of the problems in the US sub-prime mortgage market before most of their peers.

As for the SIV, the winding down of the Cheyne vehicle was the first of numerous similar episodes at other firms where structured financing products are being restructured or liquidated as a result of the problems in the ABS and CDO markets and the systemic crisis in the asset-backed commercial paper markets.

The impact on equity investors in the Cheyne SIV itself - many of whom rolled over into other and more profitable investments within the firm - was limited. And its impact on other and bigger parts of the firm's business, and on its long-standing and traditionally very loyal investor base, has been minimal. Indeed, despite the challenges of 2007, Cheyne's net assets under management still grew by some 7% last year.

"We were early into the credit crisis and we believe we are going to be early out of it," says Lourie. "The lifeblood of our business has been in responding opportunistically to inflection points in the markets and we think this is another of those opportunities."

He adds: "Our philosophy has always been to take the pain early, fight your way through it, protect yourself when you are in the eye of the storm and ensure that you are in the best and strongest position possible to take advantage of the rebound."

Already the evidence is emerging that Cheyne is again doing just that - and that the firm's big investment-grade credit team, in particular, is already starting to profit from the dislocations that have struck the global credit markets and laid low a number of its peers over the last year.

Led by John Weiss, the group's flagship Cheyne Long/Short Credit fund is already up by some 5.5% this year - at a time when several of its big rivals are continuing to ship water - and the team is finding a range of relative-value trading opportunities to exploit the widespread stress in the higherquality credit markets.

The group has steered clear of some of the more toxic instruments in the synthetic credit space - such as the now-notorious CPDO instruments, where it appears that a modelling 'glitch' may have caused the agencies to assign triple-A ratings to products that should have been rated several notches lower.

"We were being courted by all the investment banks to do CPDOs," says Weiss. "But we just couldn't get comfortable with the structure and the risk/reward profile."

Instead, the group is focusing its attention on synthetic credit products involving only the world's best corporate credits - with its highly experienced credit analysis team running detailed proprietary analysis on the 700 or so most creditworthy companies globally and using structured credit positions to express fundamental credit views.

"Everything we do is synthetic," says Weiss. "It is very easy to finance the positions. The liquidity in credit derivatives is very good. Dealing spreads have held up very well in the sector. And, despite all the negative predictions, the credit derivatives market is continuing to grow and improve all the time."

Over the last six years Cheyne's longeststanding investment grade credit fund has produced annualised returns north of 20% - while the firm has also tailored numerous bespoke credit investment strategies for its clients that have generally paid off handsomely.

In addition, the firm is one of the biggest corporate credit traders in the business, turning over some $6-8 billion a month - and its highly active approach to credit fund management is in stark contrast to the welter of static and passively managed products in the market.

It is not just in investment-grade credit that the firm sees opportunities. Cheyne is continuing to expand into new credit areas, with the recent hiring of a US high-yield debt team from US-based SAC subsidiary Intrinsic.

The team - led by Mattias Bullrich, cofounder of pioneering US credit firm ARX Investment Management - has produced a strong start with the firm's new US highyield fund, which is already up by some 3% since its launch in February.

But the Cheyne principals also see opportunity across the rest of the firm's multiplicity of products and strategies. In the event-driven and sub-investment grade credit space, the firm has had a quiet time of late - producing a flat return last year and staying flat again this year in a very challenging market environment.

But the team's long-term track record continues to be one of the strongest in the business - with an annualised return on the flagship Cheyne Special Situations fund still at almost 14% since inception in May 2003, despite the adverse conditions of the last year.

The Special Sits fund has also repositioned its portfolio - with additional hires being brought in to boost its activities in the increasingly promising stressed and distressed space - and Lourie is confident that, having weathered the storm in its space, the group will be well positioned to exploit the current environment.

In equity strategies, Lourie and Fiertz are also looking to add to the equity and equityrelated platform - which currently accounts for about 20% of the firm's total assets under management.

"We are looking to grow the equity business selectively," says Lourie. "It is logical to add to our equity platform, based on a fundamentally-driven philosophy that fits in well with our credit approach."

Performance in the equity funds has been strong - with the firm's Global Catalyst fund, an opportunistic and high-vol global trading strategy, returning around 27% last year and now back in positive territory again for this year after a difficult start in January.

The long-running Cheyne Value Fund is showing an annualised return of some 20%, while the European Opportunities fund - managed on a white-label basis by ex-Morgan Stanley trader Casey Gard out of New York - is one of the most consistent long-term performers in the European long/short equity space.

And the principals see significant opportunities to grow and develop the 'new alternatives' platform - where the latest initiative is the launch of an energy-related infrastructure investment fund, a long-term strategy that has already raised some $700 million from mainly institutional investors at its first closing.

"We are looking to expand in areas where we can create a sustainable edge and where we can get to assets where the value hasn't been squeezed out by the banks," says Fiertz. "Where we see gaps in the jigsaw, we will try to fill them."

So it is clear that the firm believes that the current investment environment is of the type that has historically created the best opportunity sets for hedge funds to exploit - and the sense of enthusiasm and excitement is tangible.

But the firm will not just chase new products and strategies for the sake of it. "We will always look at new strategies and areas, but we need to be able to see clearly the opportunity and to avoid the crowded trade," says Lourie.

At a corporate strategic level, it is conceivable that Cheyne may one day follow the path taken by a number of other leading European groups in selling a stake to an institutional investor - although the principals are in no hurry to do so, despite receiving some approaches in recent years.

Conversely, the firm may also take stakes in other specialist asset management firms - as it has successfully done with the Parisbased convertible bond specialist Acropole, in which Cheyne owns a 33.5% stake - as a way of expanding its own reach.

And, in a business where managing relationships with people is just as important as managing money, Lourie and Fiertz are proud of the loyalty and longevity of the firm's investors over the years - many of whom have been clients for the 17 years that they have worked together, initially designing convertible investment strategies for Morgan Stanley's wealth management clients in the 1990s - and also of the firm's own team.

"Having a collegiate atmosphere - and nurturing a culture of excellence - are very important to us," says Lourie.