Q:  What’s the investment philosophy of the Generation Fund?

A: Sand Aire is a multi-client family office that is based in London. We were one of the first multi-client family offices in the U.K. and we have been around for over ten years. Now we manage about $1.8 billion and we take care of a dozen families. All those families are very different, with different risk profiles and return aspirations.

The Generation Fund, which manages about 200 million pounds, is our flagship product. Its name reflects our long-term investing horizon. The fund was established with the idea that a family should double its money over a generation after allowing for inflation, costs, and income. To do that over 30 years, we end up with investors looking for a nominal return of about 8% with a low risk profile.

Considering the dynamics of the stock markets, that is a difficult but achievable target which fits with the objectives for most of our individual clients. Overall, we aim to generate a fairly consistent return through the right mix of assets and managers.

Originally, the fund invested along the traditional lines of bonds, equities, and cash, but with the recent changes in U.K. regulations, we’re including hedge fund exposure, private equity exposure, and property exposure. Our process is geared towards finding unique managers or managers with a bias towards absolute return. We believe in open-architecture and we were one of the first groups in London to follow this route.

Q:  What is the strategy for achieving your goals?

A: We don’t directly buy individual stocks, although we do have the expertise to do that. Our strategy is to scour the world for the best managers that fit our clients’ investment needs. We employ managers operating from the U.K. as well as the U.S., Europe, and Asia. Those managers should have an absolute-return orientation and we should consider them to be “the best of the breed”.

We also believe in diversification although, as the markets become more correlated, the benefit of diversification in the traditional sense is becoming less important. Our strategy is to identify new uncorrelated asset classes, and also look to diversify between management groups. It doesn’t make sense to put all our money with one particular group because of the biases that find their way into investment houses. We also diversify between opportunities, meaning that we look at non-traditional and traditional asset classes depending on the family’s return aspirations and risk profile

Q:  How do you select the funds you invest in?

A: Over the years we have developed an internal database with several thousand managers. We also utilize external databases. We try to use them in intelligent ways to identify specific skillsets, and consider specific periods of investment performance. Overall, we tend to look for managers with more defensive qualities and with absolute return orientation.

The selection process is fairly traditional. Through quantitative screening we generate a list of managers that we consider to be interesting. Then the work is entirely qualitative. Similarly to you, we review the funds’ investment philosophy, the rationale behind the decisions, the process, etc. We focus on the professionals because this is still a “people business”, and we examine the structure that exists to support and motivate key people.

One of our advantages is that we have managed money ourselves and we know what to be cautious about, what questions to ask, and if the answers make sense. Most importantly, the structure of the fund and the ideas of the managers should fit with the individual portfolios of our client base.

We usually end up with more managers in smaller investment houses, although we do approve and use managers from bigger organizations. A big problem of our industry over the last 10 years has been the priority of business risk over the investment risk. While the investment risk often stays with the client, the business risk is reduced as far as the organization is concerned. But if a manager is entrepreneurial, he tends to invest in an entrepreneurial way rather than to worry about the business risk and the performance relative to the index.

So we’re more at the entrepreneurial end of the spectrum. Sometimes managers have only a few million pounds under management when we first find them; some of them, however, have become much bigger along the way.

Q:  How do you approach portfolio construction?

A: We use modified value at risk, or MVaR, as our leading parameter and we generate a whole series of portfolios for each of our clients. Over the years we have done a lot of work on traditional measures of risk. About 20 years ago volatility was at the cutting edge of analyzing risks, today this is not the case. The modified VaR approach reflects our absolute return bias and allows us to reallocate the downside risk of the portfolio.

Then we use a simplified optimization technique and we present the portfolios and the returns to each new client. The technique in itself is not that simple, but it is important that the end product does not look too complicated because we talk to people who aren’t necessarily financial experts.

Often, we come back to our philosophy of doubling assets over a generation for new clients. We create an asset allocation which we believe best meets our client’s needs, taking into consideration their own thoughts. If somebody doesn’t feel comfortable with hedge funds, we won’t use any hedge funds.

So we create a range of different portfolios and discuss them with the clients. We look at how these portfolios would have performed historically and make sure that the client is comfortable with what we propose. Then we try to find the appropriate managers; obviously people that are good at investing money and whose investment philosophy fits with our clients goals.

Q:  Could you explain in more detail the modified value at risk approach?