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Only a small number of firms featured in the HFM InvestHedge Billion Dollar Club have remained independent in the face of continued industry consolidation; Aetos Alternatives Management is one of them.

The New York and Menlo Park, California-based group is approaching its 18-year anniversary and is still run by its co-founders, Anne Casscells and Michael Klein.

The group is at peak assets, managing $11bn as of December 2018, and Casscells and Klein have built a stable business and a strong team, which has an average tenure of over 15 years for its senior investment personnel.

Named after a Greek mythological eagle, considered to be a good omen, the group was not structured as a traditional FoHF on its founding and has attracted a client base of large institutional investors by positioning itself as more than just a hedge fund allocator.

It acts as an outsourced CIO, runs advisory mandates and has seasoned capabilities in direct and co-investments.

Aetos has deliberately remained independent and Casscells and Klein have started to future-proof the firm for it to remain that way.

Jonathan Bishop and Andrew Walling, who have been with Aetos for 15 and 14 years respectively, were appointed deputy CIOs last year. The duo joined Casscells, Klein and James Gibbons on the firm’s investment committee in 2014.

Aetos kicked off 2019 with the promotion of seven staff to partners (see Soaring staff, below), taking the total number of personnel with equity ownership to 11, out of a team of 35 employees.

Approximately half of the newly appointed partners are on the investment side, while the rest span risk, legal, client and finance teams.

“We have no intention of going anywhere. We are just being responsible,” Casscells says. “Part of growing people is to give them increasing responsibility. That’s how you retain people for a long time. Everything we have done is in that vein.

“We are still the ones who turn the lights on in the morning and turn them off at night, but we wanted to leverage people that could be CIOs at other firms,” she adds.

Klein explains that Aetos’s independence has allowed it to remain an investment‐led organisation, rather than an asset gatherer. “Firms that have public shareholders and parent companies have asset and revenue targets to meet. We seek first and foremost to provide strong risk‐adjusted returns and a high level of service to our clients,” he says.

Many multi-manager firms have disassociated themselves with the FoHF moniker today, but Casscells and Klein didn’t even view Aetos as a traditional FoHF when it launched in 2001, they say. Aetos was built as an investment firm; a research platform that looks across all asset classes, not just hedge funds.

This approach drew on Casscells’s previous experience as CIO of the Stanford Management Company, where she was responsible for the investment of over $10bn in endowment funds on behalf of Stanford University and helped build out its direct hedge fund programme.

Aetos’ first client was a large US foundation for whom they ran a separately managed account. The foundation outsourced its entire hedge fund investing process to Aetos and the mandate also included sourcing private equity opportunities.

Its commingled funds were launched in September 2002, offering investors access to three strategy-specific SEC-registered 1940 Act funds – long/short equity, credit/distressed and arbitrage/relative value. Clients can customise their allocations across the funds and alter their allocations as required.

Today, 80% of the firm’s assets are managed in separately managed accounts of diversified hedge fund portfolios and focused areas such as credit, activist portfolios and opportunistic real estate.

Aetos also uses SMAs to strategically partner with clients as an extension of staff, bringing them a broader CIO perspective and access to the most senior investment professionals at the firm, in addition to managing a hedge fund allocation, an approach several multi-managers have adopted in recent years.

Aetos has been assisting clients in this way since 2003, when it was awarded its first OCIO mandate, a $400m allocation which encompassed everything from long-only equity and high-yield investments to private equity and hedge funds.

Partnering with Aetos A sample of hedge fund managers the FoHF firm has invested with:
• Davidson Kempner Capital Management
• Farallon Capital
• Egerton Capital
• Anchorage Capital
• Centerbridge Partners
Source: SEC filing

Casscells and Klein are often asked if they have expanded their product offering as competitors have, moving into new areas such as advisory and co-investments.

Aetos has been providing these services to clients for most of its history but has shied away from marketing them openly. “We have consciously avoided product proliferation,” Klein says.

Aetos has managed a hedge fund portfolio on an advisory basis since 2005, when it began a $300m relationship with a well-known US endowment, where the investment committee retained ultimate investment discretion.

Additionally, Aetos has been making direct investments, stemming from its own macro research, since 2007. Its first foray into direct investing saw it short sub-prime mortgages on behalf of several large clients.

The transaction was structured and implemented by Aetos directly, without the assistance of a hedge fund manager.

Between 2010 and 2012, Casscells and Klein saw a lot of deal flow around co-investments and began executing credit and equity-related deals for several of its separate account clients on an ad-hoc basis, consistent with its philosophy of providing transitional capital to capitalise on dislocations or forced selling.

In January 2013, Aetos was tasked by one of its largest SMA clients to set up a separate portfolio where it would have full discretion to make idiosyncratic co-investments in a systematic way.

Casscells explains that the team is still in close dialogue with the client, but from a corporate governance standpoint, it wasn’t realistic for this large institution to take a co-investment idea to their investment committee with a week’s notice. The client gave Aetos $500m, with the objective to invest in opportunistic investments across asset classes.

“Large institutions tend to be resource-constrained and may not have our background in corporate finance and investment banking,” she says.

“Our team has a stringent framework for evaluating these things. We have the ability to go into a data room and create our own financial models for the assets, run various scenario analysis, look very closely at the downside, and turn it around in a week or two, which is often the timeframe required,” Casscells says.

To date, the firm has invested more than $800m in capital for its clients across 21 co-investment transactions.

“We are not claiming that there aren’t institutional investors that can do this directly. There are some teams that are staffed to do this, but it is relatively few,” she adds.

Historically, Aetos has provided co-investments to its larger separate account clients but, more recently, has opened that access to investors at a smaller minimum investment size.

Co-investment deals targeted by Aetos typically focus on dislocations lying in the seams between hedge funds and private equity, with a duration of two to five years where there is the potential to earn above average risk-adjusted returns by acting as a provider of transitional capital.

Co-investments represent a significant part of what Aetos has been doing in recent years, due to increasing demand from some of its clients. These co-investments are usually made with a manager, but idea generation can come from Aetos’s own research.

The team is presented with close to one hundred opportunities every year, but according to Casscells the number they really dig into is closer to 50.

Aetos has been invited by managers to co-invest with them in portfolios of non-performing loans in Europe, for example.

The group’s own research led to a CLO co-investment at the beginning of 2016, after energy prices fell the previous year. The price drop was hard on the high-yield and collateralised loan obligation market and resulted in the BBB tranches of mezzanine debt trading at 500 or 600 basis points wider than comparable rated corporate debt, which the team saw as a dislocation opportunity.

The team has worked on several activist positions and most recently has made a co-investment in Trust Preferred Securities issued by small and medium-sized banks in the US from legacy financial crisis assets that have been put into collateralised debt obligations.

“These CDOs are illiquid and haven’t traded very often, but at times you can invest in those with a margin of safety and the prospect to earn double-digit yields. There are also some levers you can pull to accelerate the return of capital on these, so we have done one opportunistic investment in this space and if things come our way, we may get another bite of that apple,” Casscells says.

Soaring staff Aetos promoted seven staff to partners last month:
• Jonathan Bishop, MD, co-deputy CIO
• Andrew Walling, MD, co-deputy CIO
• Joseph McDonald, MD, manager of ODD
• James Conzelman, MD, head of client relations and business development
• Scott Sawyer, director, CFO
• Filbert Cua, director, research
• AJ Chen, director, research

Aetos has seen its assets grow since the financial crisis, bucking the trend of the broader FoHF industry, which has seen AuM steadily decline. Prior to 2008 Aetos managed some $6.5bn, with AuM hitting $10.5bn the beginning of 2017 and ending 2018 at $11bn – its peak.

Klein, a former president of Morgan Stanley’s institutional funds business, explains the firm’s more recent growth has come from taking over existing portfolios where the incumbent manager, whether FoHF or consultant, has underperformed expectations, has gone out of business, or where there are concerns they may do so because they have lost assets, or the team has turned over.

The Aetos team has been hired to transition existing portfolios and focuses on limiting transition losses, or lost opportunity costs, and takes into account the governance constraints that a client has in place. “We are capable of changing the portfolio, taking out the parts they want to change but not taking a wrecking ball to the whole thing,” he says.

Casscells recalls doing this towards the end of 2016, when Aetos assumed management of a separate account, which took six months to transition. Pleased with performance and the overall relationship, the client has recently increased its allocation.

Once a portfolio has been transitioned, Aetos conducts granular monitoring, including of certain securities held by each of the managers. The group has built data management, risk analytics and quantitative systems to assist with its investment risk management, taking advantage of its Silicon Valley location to attract staff with investment and coding skills, the duo highlight.

Aetos has an eight-person team responsible for operational risk management, a function which does not exist in a silo but is integrated with the team’s investment decisions and risk considerations. When doing due diligence on a fixed income arbitrage manager, for example, Aetos’ operational risk teams have expertise across trading platforms, so they can understand what traders do, how reconciliations occur and counterparty risk.

Aetos also has investment analysts, including Casscells, who have settled billions of dollars of fixed income trades over their careers and bring expertise in evaluating the back-office and pricing protocols in place at hedge fund managers.

The ODD conducted on a manager is refreshed annually, with operational risk updates provided throughout the year. The operational risk analyst in charge presents due diligence worksheets and risk score cards, and the quantitative and qualitative observations are presented to the entire investment and risk teams, whereby a decision is made to re-approve the investment.

According to Casscells, the ODD team has always done extensive reference checking, quantitative analysis of the track record and background checks. The main change she points to is that the team has got better at the process over the years.

“We have made incremental enhancements, but they have all been the consequence of a maturing team and us getting smarter; it hasn’t been in reaction to a problem that we had,” she says.

“We have evolved with the industry, we have built up an extensive database of people to make our reference checking easier, and we have built out data systems, so it is quicker and easier to access the information we need.”

The group is selective when considering emerging managers for its portfolios, with Casscells explaining that the Aetos team does not share the same view as some of its peers that emerging managers are always the best way to go.

In her view, this approach can ignore the complexities involved with starting a hedge fund, of hiring operational teams and getting investors in, which can all distract a manager in the first few years.

This is not to say the firm doesn’t invest with emerging managers. It has participated in founder share classes for lower fees – but it sets a high bar for doing so. Right now, the team is negotiating with a new manager, where Aetos would be a significant contributor to putting them in business.

The fund, which is based in San Francisco, will focus on liquidity providing arbitrage strategies, fulfilling a role in the capital markets once dominated by bank trading desks.

We have the ability to go into a data room and create our own financial models for the assets

ESG is an area where the firm is devoting more resources. Aetos is a signatory to the UN’s Principles for Responsible Investment (PRI) and Walling is a member of the equity hedge PRI strategy group, which works to define guidelines for hedge funds in responsible investing.

Aetos has used its technology systems and its monthly, quarterly and annual conversations with managers to collect ESG/SRI-related information. As the strategy evolves the team will use this to figure out the best way to put ESG principles to work, Klein explains.

Casscells feels good about how the world is set up for active management and low-beta strategies in 2019. She expects the return of volatility in the markets will result in risk assets re-pricing to create opportunities for managers to refresh their portfolios and put in new positions that will offer better alpha.

The team is particularly interested in fixed income arbitrage, as the disappearance of bank prop trading desks means much more of the liquidity provision can be done by hedge funds than 10 years ago.

Aetos also believes that environment will create an attractive opportunity set for investors with a nimble, opportunistic approach.

It expects discrete dislocations in different parts of the capital markets that are likely to reward those investors who possess the flexibility to underwrite and execute investments quickly, before the “institutional investing herd” has time to receive approval during their quarterly committee meetings, the duo tell HFM InvestHedge.

The team is also positive about the way the credit market is setting up and they have seen opportunities on the short side.

In the US there are firms in the investment grade universe that may not stay there forever. The triple B segment of the investment grade universe has more than doubled in size and Klein explains that, if the economy starts to slow down, some of those companies are going to fall out of BBB and investment grade, which will cause dislocations and create opportunities.

Conversely, they expect to reduce their allocation to merger arbitrage. Several large deals are set to close in the first half of the year, with Casscells predicting it is unlikely that the volume of new deals will be attractive enough to merit the overweight position that the strategy currently represents in their portfolios.

Flying high on HFM InvestHedge.


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