Cape Town-based boutique alternative house X-Chequer Fund Management has built a solid business over the past couple of years, now offering two South African hedge funds to its growing institutional and high-net-worth client base.
Founded by Werner Prinsloo in 2007, X-Chequer’s flagship market-neutral fund has been running for just over three years, launching when Prinsloo was with Fairtree Capital, where he was a founding member and fund manager. Headed by Andre Malan, Fairtree was formed as part of the management buyout of the Fairtree Capital Fund from Decillion Fund Management in 2006, faring well since then with two successful hedge fund offerings.
Armed with many years’ experience as a hedge fund manager, Prinsloo, a qualified actuary, opted to move out on his own in order to grow his business.
The strategy has been successful. X-Chequer now has assets under management approaching R1 billion, with around R700 million in the market-neutral mandate and R125 million in the new long/short strategy, which has just over a year’s track record.
“There will be a large overlap between the two funds based on fundamental stock selection,” says Prinsloo, who uses a proprietary system to analyse the country’s top stocks from a fundamental perspective, within a strategic global view. “Where they differ is in directional exposure. The market-neutral fund has very little directional exposure whereas the long/short is more aggressive. That said, it will never be an aggressive directional long/short fund.”
The returns reflect the differing mandates. X-Chequer Market Neutral has gained 16.23% this year to the end of August, with just two negative months since inception in a solid track record that stretches back to mid-2006. The fund has proved its worth in negative markets, rising 20.34% last year after a 14.91% gain in 2007. Now at capacity, it has been hard closed for the past few months.
X-Chequer Long/Short rose 21.48% in its first six months to the end of 2008, gaining a further 21.87% so far this year to the end of August.
“Having been through the first year with the long/short fund, it is now gathering momentum,” says Prinsloo. “We started marketing it in the second quarter and we don’t want to grow it too quickly. We are looking to add R10 million to R15 million per month, with a soft-close at R350 million to establish what life is like at that size.”
Expanding team
In line with its expansion, X-Chequer brought Walker Naudé on board in April, to co-manage the long/short fund with Prinsloo. Naudé completed a B.Com (Act Sci) degree and is a CFA charterholder. He was rated a top quantitative analyst in the Financial Mail before joining Johannesburg-based T Capital, where he co-managed the successful Pardus market neutral and Solario long/short funds with Jacques Pretorius. He opted to join X-Chequer with the long-term view of relocating to Cape Town for personal reasons.
Also part of the investment team are Eugene Prinsloo, Werner’s brother, and Nico McDonald. Eugene is a chartered accountant with 10 years’ financial industry experience, spanning the equity, capital, interest rate and foreign exchange markets, working previously at Merrill Lynch and Citigroup in middle office roles. He joined X-Chequer in 2008 from ABSA Capital, where he was product control head for equity derivatives, credit derivatives and commodities.
McDonald is also a chartered accountant and has completed the CFA examination, joining in 2007 as the team’s research analyst, where he focuses on fundamental research and company analysis. He was previously with Old Mutual, involved in fund accounting of various property funds in the US and the UK.
The investment team uses the same fundamental bottom-up process for both funds, starting with a 12-18 month outlook for the global and South African economy that is revisited on a quarterly basis, including factors such as interest rates, currencies and economic activity. A proprietary in-house model is used to identify opportunities such as sector or market trends, with a focus on identifying stocks that offer value.
On a daily basis, the workload is shared, with the team generating ideas together and each potential trade discussed at strategy level, taking the consensus view. As a house, X-Chequer focuses on mid and large-cap companies, with market capitalisation in excess of R2 billion.
“Our universe is mainly the top 100 stocks, we don’t look at the small illiquids,” says Prinsloo. “We take shared responsibility for the research, speaking to the management of mid-size companies at least once a year and attending results presentations. We spend a lot of time and energy kicking the tyres and really getting to know the companies we invest in.”
“We identify long-term winners and losers in sectors, looking for sector and market trends,” adds Naudé. “Even though we might be investing in the same sector with both funds, the long/short fund could, for example, be naked long in a sector whereas with the market-neutral fund we would also have a short position to hedge any risk.”
Within the portfolios, capital is allocated to differing strategies – among them the low-turnover “winners versus losers” book; a more actively traded book; and an active resources area that comprises no more than 20% of the overall fund size. The team does not play aggressively in the volatile resources space, neither do they trade high volumes of index futures or make forceful short-term allocations. Other factors that distinguish the two funds are differences in net directional exposure, gearing and position sizes.
“Gearing will be different – by nature, you need to gear the long/short fund less than the market-neutral fund,” says Prinsloo. “The long/short fund can also take bigger, more aggressive position sizes. The other key distinguishing factor is the experience and ability that Walker brings to the fund – we see it as an attractive offering.”
Conservative approach
Despite the differing mandates, the team is quick to stress that the long/short fund is by nature conservative, just a little less so than its older brother. Each portfolio comprises a total of about 50 positions in both the long and short books.
“We are not trying to time the market on a day to day basis – we take a view and we stick to it,” says Naudé. “We aim to show consistent returns over the medium term. There will be no wild swings. This is not the type of fund that will give you 40-50% a year but with lots of volatility.”
While the long/short fund targets returns of 20-30% per annum, the market-neutral offering aims for a more conservative 15-20%.
“We aim to protect investors’ capital from significant monthly drawdowns,” says Naudé. “With the long/short fund we will be delighted with a 4% up month. The flipside is that we will not sleep well if we are down by more than 3% in any month.”
X-Chequer’s investors are currently 90% institutional, with 10% high-net-worth investors. Despite its relatively small size, the long/short fund already has seven institutional investors, with the managers also co-invested.
The long/short fund charges a 1.5% base fee, with a 20% performance fee on outperformance above cash, crystallised annually.
“For us a performance fee is more important than a base fee,” says Prinsloo. “We also crystallise fees annually, rather than quarterly. Investors are happy with that as it aligns their interests with ours. It is less relevant with the market-neutral fund, as the swings are potentially bigger on the long/short product, but we have switched to that methodology within both funds. And having sizeable co-investments in all our portfolios means we stay honest.”
Prinsloo notes that last year’s volatile stock markets created some great opportunities for the market-neutral fund. He believes the markets are close to fair value now, having offered one of the best buying opportunities in a decade on the long side earlier this year.
“The easy money has been made,” he says. “Going forward, how the markets perform will depend on the shape of the recovery. In the short term, it could be a V-shaped recovery because of all the stimulus at work in the markets, but it could also be L-shaped, which will take a little longer. There is lots of cash working out there so while there might be a pullback in the markets, the floor is getting pushed up all the time.”
“We are cautious but we are not as negative as we were a few months ago,” adds Naudé. “Markets have re-rated and now we need to see earnings come through. We expect markets will track sideways for the next 12 months, with some volatility in between, but low interest rates are forcing people to put money into equities as they earn nothing in cash.” – Oct 2009
FUND FACTS
X-CHEQUER MARKET NEUTRAL FUND
Inception date: June 2006
Strategy: Market-neutral South African equity
Currency: Rand
Fund manager: Werner Prinsloo, Eugene Prinsloo
Administrator: IDS
Prime broker: Prime Administration
Minimum investment: R1 million
Open to investment: No
FUND FACTS
X-CHEQUER LONG/SHORT FUND
Inception date: June 2008
Strategy: South African long/short equity
Currency: Rand
Fund manager: Werner Prinsloo, Walker Naude
Administrator: IDS
Prime broker: Prime Administration
Minimum investment: R1 million
Open to investment: Yes
