Brevan Howard Shows Paranoid Survive in Hedge Fund of Time Outs 

April 1 (Bloomberg) – Alan Howard takes few chances. The co-founder of Brevan Howard Asset Management LLP gave up downhill skiing years ago — at least in peak season. “It’s very dangerous,” he says in his thick London accent.

Nor is Howard keen on driving. A chauffeur takes the wheel of his silver Mercedes-Benz to joust with London’s traffic. “I see all these nutty drivers,” says Howard, 45, shaking his head at Brevan Howard’s offices on London’s Baker Street. “I have no interest in getting excited or upset.” As he speaks, Howard sips coffee, and when the cup is drained leaps up to pour more.

Howard’s allergy to hazards of all kinds paid off last year for his business — managing Europe’s biggest hedge fund firm. In February 2008, he began raising cash, betting that the housing downturn in Europe and the U.S. would cause credit markets to seize up. By the end of the year, he had cut his portfolio of bonds and other securities to $10 billion from $50 billion and was 85 percent in cash and short-term securities versus the normal 65 percent.

Partly as a result of these changes, the Brevan Howard Master Fund Ltd. made a 20.4 percent return in a year when the average hedge fund lost 19 percent and theStandard & Poor’s 500 Index dropped 37 percent. As he moved to cash, Howard locked in profits from a winning bet that the yield curve on U.S. Treasuries would steepen — that is, that the spread would widen between the yields of short- and long-term bonds as the Federal Reserve reduced its target interest rate.

‘The Value of Risk’

“Like all good traders, Alan knows the value of risk, how much risk he can take and the availability of capital,” says Oswald Gruebel, who worked with Howard at Credit Suisse Group AG. “That’s the main differentiation between a good trader and a bad trader, and he was exceptional.”

Gruebel, 65, a former chief executive officer of Credit Suisse, came out of retirement earlier this year to take over as CEO of UBS AG across the street in Zurich.

Howard has continued his winning streak into 2009. In the first two months of the year, the Master Fund’s U.S. dollar- denominated Class A shares gained 8.1 percent. The fund, with assets of $20.8 billion as of Dec. 31, has never had a losing year and returned 14.4 percent annualized from its April 2003 inception through the end of 2008.

Brevan notched that record with volatility that was less than half that of the S&P 500. The firm managed a total of $27.4 billion in seven funds as of year-end.

Bearish

Howard is still bearish. The U.S. recession will persist beyond mid-year, he says. He’s focusing on the near term.

“You have to be more short-term oriented at the moment, ” he said in a January interview, wearing a zippered white cardigan and open-collared blue-checked shirt. “You have to be very flexible and willing to change your mind quickly.”

The veteran trader rarely shares his insights. Howard seldom makes public speeches, and prior to this article, he had never consented to an extended on-the-record interview. Howard declined to be photographed for this article.

“We’re a company that prefers to have a low profile,” Howard says. “That’s the way we are.”

Howard has an instinctive feel for the direction of the markets, borne of a lifetime of intense study of interest-rate, currency and commodity price movements, say traders who have worked with him.

“When he smells danger, and he senses some of his traders haven’t yet, he has no problem laying down the law,” says Zoeb Sachee, who worked under Howard at Salomon Inc. from 1990 to ’94 and now heads European government bond trading atCitigroup Inc. in London.

Hothouse Environment

Howard is constantly engaged with his traders, querying them about events in the markets they troll and looking for insights into interest-rate moves by central banks around the world or the latest economic data.

That makes for a high-pressure work environment. Howard fires underperformers and sometimes entire desks when markets turn against them. “It’s intense, but that’s what I signed up for,” says Vikram Rao, who traded Canadian and Australian interest-rate products and currencies for Brevan in 2004. “Was it one big happy family? No.”

Says another former Brevan employee: “It’s basically accepted that you won’t last there.”

Howard makes no apologies. “When you hire people you need to give them time to see how well they work out and fit in,” he says. “Because we have high standards, sometimes we have to make changes.”

‘He Gets It Right’

Chris Goekjian of Altedge Capital U.K. Ltd., which invests in Brevan, says he has no problem with the hardball approach. “He gets it right more than he gets it wrong,” Goekjian says. “But the important thing is that when he does get it wrong, he cuts very quickly.”

Howard made his reputation, says Sachee, after he sidestepped both the bond market rout of 1994, when the Federal Reserve raised the target for federal funds six times to 5.5 percent from 3 percent and, four years later, the collapse of hedge fund Long-Term Capital Management LP. In 1994, Howard shorted bonds, and in ’98 he got out of trades similar to those of LTCM early and invested in U.S. Treasuries.

Brevan is a so-called global macro firm, whose portfolio managers wager billions on the direction of interest rates, currencies and commodities. Modern macro trading dates back to the collapse of the Bretton Woods fixed-exchange-rate system in 1971, which ushered in an era of floating currencies — and the opportunity to wager on them.

Surpassing Soros, Jones

Howard’s fellow macro traders include hedge fund luminaries such as George Soros,Paul Tudor Jones and Louis Moore Bacon. As of December, Howard managed more money than any of them.

Brevan’s success contrasts with the disarray of the rest of the hedge fund industry. The average 19 percent loss among hedge funds was the industry’s worst performance since at least 1990, according to Chicago-based Hedge Fund Research Inc. Macro funds did better, returning 4.7 percent on average after fees.

Investors yanked an estimated $154.4 billion out of hedge funds last year, sending assets down to $1.41 trillion from a peak of $1.93 trillion in the second quarter of 2008.

Risk aversion colors every facet of Brevan Howard’s operation, from the redundant power systems in its offices to the Master Fund’s early use of multiple prime brokers to spread its risk. And Brevan won’t park cash with investment banks; it deposits its T-bills with custodial banks such as Bank of New York Mellon Corp.

Credit Suisse Veterans

Brevan Howard’s four other founding co-partners all came from Credit Suisse First Boston’s proprietary fixed-income trading desk, where Howard was a managing director from 1997 to 2002. They are: Jean-Philippe Blochet, Christopher Rokos, James Vernon and Trifon Natsis. A consultant hired to help name the partnership tossed together the first letters of their last names, added some vowels and came up with the otherwise meaningless “Brevan.”

Beyond these partners, some 30 other Brevan Howard traders buy and sell everything from government bonds to index futures on desks as far flung as New York, Washington, Tel Aviv and Hong Kong. They work with 14 economists and strategists to craft trading strategies designed to profit from the specific markets they are assigned to.

While Howard is undisputed top dog, the firm’s capital allocation committee draws up mandates, or written contracts, for each trader. The mandates describe the instruments they’re allowed to wager on, in what markets they can invest and how much capital they can risk.

Rewarding Top Performers

Those who generate profits get a slice of them in their paychecks — plus the likelihood of more capital. That means top performers get the lion’s share of assets: Adjusted for risk, 70 percent of Brevan Howard’s money is allocated to the top seven traders.

The traders who aren’t earning a profit find themselves under withering scrutiny. A trader whose portfolio falls 4 percent will meet with Brevan’s chief risk officer, Aron Landy, who will likely reduce the money he or she manages and direct a change in tactics and a lowering of risk.

An 8 percent loss triggers a change in the trader’s mandate and a further cut in capital.

A 12 percent drawdown warrants a “time-out” — a shutdown in trading that may result in a resignation or dismissal. Says one Brevan employee, who asked not to be named, “If you last two years, you’ve done well.”

A Canny Exit

Even in the bloodletting, Howard’s timing is canny. He began winding down the firm’s convertible arbitrage desk in July 2007 and shuttered it in March 2008 because the strategy involved too much risk. Convertible arbitrage in its simplest form involves buying convertible bonds — securities that can be converted to shares at a certain price — and shorting the underlying stock, locking in the yield.

In 2008, firms following that strategy lost 33.6 percent on average, according to HFR.

Brevan has built a reputation as a home for hedge fund talent; traders who are fired or leave have become stars at other firms.

“I have never seen a group of people who are better at what they do than they are at Brevan Howard,” says former Brevan trader Rao, who says he left by mutual agreement in 2004. “I’m talking Tiger Woods good, Michael Jordan good.”

Rao is now head of fixed-income trading at Toronto-based Scotia Capital Inc.

Staccato Bursts

Howard, who is roughly 5 feet 5 inches tall, is the top trader. He oversees 20-25 percent of the Master Fund’s capital, or about $5 billion. He talks in staccato bursts and, racing ahead of the conversation, interrupts himself and others, finishing sentences with phrases like “blah, blah, blah” or “et cetera, et cetera, et cetera.”

Brevan Howard just moved into modernized offices on the site of the former headquarters of department store chain Marks & Spencer Group Plc in Marylebone, south of Regent’s Park. In late January, the offices were still a work in progress. A worker carefully positioned a leather club chair in the vestibule. Light poured through etched-glass partitions, brightening the veneered walls.

On the trading floor, row after row of computer screens glow beneath cool fluorescent lights. Foreign exchange or equity traders are in one row, emerging markets in another.

Howard’s desk is indistinguishable from everyone else’s. He may punch in a trade one moment and then spring up to pepper a strategist with questions about, say, an upcoming jobless rate figure. He obsesses about “black swans” — difficult-to-predict events that can wipe out a fund. The term was popularized by hedge fund manager and author Nassim Taleb.

Rapid Moves

Howard may ask his traders how their holdings would stand up if, say, Iran conducted a nuclear weapons test.

Howard is known by rivals and former colleagues for rapid in-and-out moves: buying into a position in the morning, exiting at noon and then piling back in before the close of the market. In an interview, he points out that if Brevan hadn’t blown out of its early-2008 bet that yield curves would steepen, the firm would have made far less money on the bet, because long-term rates plummeted later in the year.

Former Brevan traders say simply watching Howard at work is enough to improve their skills. “He has this almost unique radar for determining what can hurt him,” says Trevor Price, who was head of European fixed income at Credit Suisse until 2005. “You could call it paranoid, but he’s usually right.”

Fixed Income Focus

Howard’s specialty is fixed income and foreign exchange trades. They are the backbone of any global macro strategy. Howard frequently talks with economists to try to discern trends, including former Bush administration economic adviser Lawrence Lindsey and New York University’s Nouriel Roubini, who predicted the financial crisis.

Howard hunts for what traders call “asymmetrical outcomes.” For instance, in early 2004, as the economic expansion was gathering momentum, the Euribor, or euro area interbank offered rate, was 2 percent. Howard was willing to wager that the European Central Bank wouldn’t raise rates, which some analysts expected in response to rising commodity prices. He figured the bank had a track record of inaction.

Using call options, which give a holder the right but not the obligation to buy a security or other instrument at a set price on a future date, Howard constructed a so-called three- legged butterfly trade: He bought call options on an ECB rate index that would turn a profit if rates remained stable rather than rising, as the market expected.

Howard also sold options that would lose money if the ECB cut rates but would expire worthless if it did nothing, allowing him to pocket the premium.

Hedging Risk

To hedge out the risk of the central bank cutting rates, Howard bought a third call option that would be profitable if it did.

The maximum loss on the trade was 10 basis points of the notional value of the options. The maximum profit was 25 basis points. (A basis point is 0.01 of a percentage point.) From June 2003 to December ’05, the ECB left its Euribor benchmark borrowing rate at 2 percent. Howard pocketed 21 basis points.

“I’d say Alan is the best trader I’ve seen in my life,” says Irvin Goldman, founder of New York consulting firm IJG Advisors LLC and a former co-head of Howard’s proprietary trading desk at CSFB. “He’d construct trades that have outstanding risk-reward profiles. He just has it. He’s unique.”

The Brevan Howard co-founder had a head for numbers from an early age. He was born in September 1963 in London, the oldest of three children of a mechanical engineer who ran a company that built power stations. At Hasmonean High School for Boys, a state school in Northwest London, Howard mimicked his father’s interest in math and science.

Good at Physics

“He was quite good at physics and one of the top students of his year,” recalls Lionel Finkelstein, who taught Howard physics.

Howard sponsors a school math prize at Hasmonean, and its math department was named after him in March, says head teacher David Meyer.

Howard graduated from Hasmonean in 1982 and then attended London’s Imperial College, a technology-oriented university, graduating with first honors and a master’s degree in chemical engineering in 1986. “I figured engineering was a good degree because it was analytical,” Howard says.

Even before finishing his first term, Howard was lured to the City, London’s financial district. He landed a summer job at the London Stock Exchange, where he didn’t do any trading. His job: managing the keys for the LSE’s complex of offices.

Salomon Bond Trader

His first job out of university was at Salomon, where he was assigned to the Eurobond desk. He got a leg up in 1986 when senior members of his team took their bonuses and left to join rivals, and he was given more responsibility.

Howard stood out for his ability to recall hundreds of positions held by customers — crucial at a time when trades were done by phone, says Jeremy Amias, who ran Salomon’s U.K. bond sales at the time. Knowing which clients held what was an advantage in helping a trader unload inventory.

Howard had a ferocious work ethic. Simon Meadows, his first boss at Salomon, recalls one Monday morning when Howard came to work with a thick sheaf of papers showing the relationship between various bond spreads that he had been studying over the weekend.

“He said, ‘See, if the difference is 2 basis points we buy them, and if it’s a half basis point or less we sell them,’” Meadows says. “He spent his Sunday afternoon working on that while I, I don’t know, rode my bicycle.”

‘Direct Remuneration’

At Salomon, Howard got to know the managers of the biggest macro hedge funds, who did business with the firm. “We built up fabulous relationships with hedge funds: Moore, Soros, Tudor,” says Sara McKerihan, who worked with Howard in bond sales and is now a managing director at Citigroup. “Alan would argue with them, he’d disagree with them on the markets, but he wouldn’t go against them.”

In the early 1990s, Salomon was in turmoil. CEO John Gutfreund resigned amid revelations that Salomon had submitted false bids to evade limits on Treasury bond auctions. Berkshire Hathaway Inc. Chief Executive Officer Warren Buffett had temporarily taken over as chairman, and the management he put in place was talking about rejiggering compensation.

Howard didn’t stick around to see his pay cut. “As a trader, you want some direct remuneration in some form or another, and the firm was moving towards less and less of that,” he says.

‘You Have a Doubt’

After nine years at the same firm, Howard also wanted to know whether it was he or Salomon that was the real star. “You have a doubt in your mind as to whether you can make it on your own,” he says.

In 1995, at the age of 31, Howard joined the London securities arm of Tokai Bank, running interest-rate trading for Europe. Tokai later merged into what is now Mitsubishi UFJ Financial Group Inc.

In 1997, CSFB, then the investment banking arm of Credit Suisse, hired him as a trader, later making him head of a proprietary trading desk for European fixed income.

One of Howard’s admirers was Gruebel, who was the head of Credit Suisse’s private bank at the time. In 2001, Gruebel gave Howard’s team about $1.2 billion in private bank money to manage alongside Credit Suisse’s own capital.

For much of his time at CSFB, the bank was convulsed by scandal; by 2001, it faced a half dozen regulatory and criminal investigations on three continents. In July 2001, CEOAllen Wheat was forced out and replaced by John Mack, now CEO of Morgan Stanley. CSFB and nine other firms paid $1.4 billion in December 2002 to settle regulators’ claims that they misled customers. CSFB’s share of that was $200 million.

Cost Cutting

Wheat had battled defections by granting big contracts to CSFB’s traders. When Mack joined, he tried to get traders to tear those up, former Credit Suisse employees say. Howard and his colleagues generated profits of about $500 million in 2001, according to former Credit Suisse executives familiar with the matter. That made his team among CSFB’s highest paid — and a potential target for Mack as he tried to reduce costs.

“Mack got a list of who was getting the most bonus, and Alan was near the top,” says a former Credit Suisse executive. “It was a very crude method because we lost our best revenue producers.”

Mack declined to comment on the matter through Morgan Stanley spokeswomanJeanmarie McFadden.

‘Amicable’ Resignation

In February 2002, Howard and a group of his traders resigned. For his part, Howard calls the departure friendly, saying it was triggered by Mack’s concern about having the same desk manage both the firm’s and clients’ money. “It was totally amicable,” he says. “It was fully understandable given what Credit Suisse was going through.”

Brevan Howard opened in July 2002 with assets invested by Credit Suisse private banking clients. The Master Fund, which was officially launched on April 1, 2003, with $870 million, got off to a tame start. For the last nine months of 2003, it returned 4.6 percent compared with the S&P 500 Index’s 32.9 percent.

The next year, a Brevan marketing document says, it returned 14.6 percent. Its 14.4 percent annualized return from inception through 2008 beat the S&P 500’s 3.1 percent return despite the fund’s low volatility.

Today, Brevan’s traders are under more pressure than ever. Their immediate overseer is chief risk officer Landy, 46, who has a Ph.D. in engineering from the University of Cambridge and first worked with Howard at Tokai. A former fixed-income derivatives trader, he understands stress. “Trading is a tough job, and losing money can be a very unnerving experience,” he says.

Small Fires

Landy says his job and that of his eight risk managers is to nip problems in the bud. “You put out the small fires very quickly,” Landy says. If a trader resists reducing what looks like a losing position, Landy is direct. “I say, ‘You don’t love your portfolio more than your job, do you?’” he says. “‘So calm down and reduce your portfolio to lengthen your job prospects. That’s a good trade.’”

No one is immune from Landy’s directives. Howard himself has been forced to cut positions.

The mortgage finance crisis worried Howard as far back as early 2007. He says he suspected that the then nascent subprime contagion would spread and eventually undermine banks’ willingness to finance hedge funds. So Brevan slashed leverage in its bond portfolio to three times assets in January 2008 from more than five times assets at the start of 2007.

Liquidating Risk

In July 2007, after two Bear Stearns Cos. hedge funds collapsed, Howard had Landy do an audit of all of the firm’s risk positions, which he pulled together over a single weekend. “The goal was to liquidate anything we thought could potentially be a problem,” Landy says.

As markets worsened, the firm exited about half of its positions in credit-default swaps — two-party agreements guaranteeing payments of bonds or other securities — to eliminate the risk that one of Brevan’s counterparties would go bankrupt. And it got out of options whose expiration dates were two, three or more years in the future, based on Howard’s belief that the banks that wrote them would become reluctant to trade them, which is what eventually transpired.

Howard says Brevan’s current focus is all about the short term — as it usually is, whatever the markets are doing. He expects yield curves to steepen and volatility in the fixed- income and forex markets to continue. That view, however, may change tomorrow. “You have to adjust to the market and be pragmatic,” Howard says. “I don’t like it, but that’s life.”

Sledding Accident

Friends say Howard relaxes his intense focus on risk on holiday at Crans-Montana, a Swiss ski station. For years, he, his wife, his four children and friends have hiked for 20 minutes up to one of the slopeside restaurants, famed for fondue. After dinner, they strap on miners’ headlamps and sled in the dark.

Last year, Howard took a tumble while sledding, wounding a tendon in his left shoulder so badly that it required surgery. “I’ll never do that again,” he laughs, safe in his Marylebone conference room. Danger, Howard learned anew, never takes a holiday.

To contact the reporters on this story: Richard Teitelbaum in New York atrteitelbaum1@bloomberg.net; Tom Cahill in London at tcahill@bloomberg.net.

Last Updated: March 31, 2009 19:00 EDT