Eclectica Asset Management is an independent money management firm founded in 2005 by its principal manager and analyst Hugh Hendry. Labeled by many as a firebrand, outspoken and an acutely controversial figure in financial circles, Mr. Hendry’s approach towards money management gained notoriety for its focus on short selling, short-term trading and contrarian bets against whole economies and their attempts at bailouts.

His current approach is almost antithetical to his introduction in 1990 to investment management as an analyst for Baillie Gifford, the patriarchs of long-only and long-term investments. At Baillie Gifford, he must have been smothered by the company’s strident investment strategies, as he left after a two year stint. Following a move to Credit Suisse Asset Management that he found was still not apt for his more “aggressive” thinking, he came up for air in 1999 by joining Odey Asset Management where he met his mentor, or as he puts it, “Frankenstein’s child”, in the guise of the principal of the firm, Crispin Odey. Mr. Odey had made a name for himself during the early 1990s with the success of his European equity long-short fund (a strategy not as widespread then).

It was at Odey Asset Management that Mr. Hendry learned his “methodology”, which is not based on arriving at investment theses from statistically rigid analyses, but through macro, free-flowing, thinking, and only then subjecting the investment views to number crunching. His first gig there was to shortly run the award winning long-only project, Odey Continental European Fund, which had a 3% return under his stewardship even though the matching index was in decline by 26%.

This free-wheeling and somewhat laissez faire management style is the cornerstone of his Eclectica Asset Management which he initially launched within the Odey platform in 2002 under the moniker of the Odey Eclectica Fund. This unconventional approach yielded returns of up to 49.9% in 2003 (as opposed to an S&P 500 return of 29%) for his investors. Although there were many diverse positions contributing to this success, Mr. Hendry’s contrarian bet on gold was the most publicized. His concentrated bet on gold-producing companies, delivered higher returns and lower risk as per the gold companies’ metrics compared to the overall market.

His boast of delivering higher risk-adjusted returns aroused so much jealousy (a pattern that follows his career till today) that a few competitors wanted his fund to be declassified as an equity fund given its cash and bond holdings and sector-concentration. But the reality was that his fund’s mandate did allow him to go to mostly any asset class where the perceived return and risk were favorable in the given conditions of the market – of course, what the media highlighted was the fact that he actually did not feel he had to constrain himself even if the mandate was otherwise. By the end of May, with a gain of 16.2%, the three major holdings of the fund defiantly were Newmont Mining, Royal Gold and Barrick Gold.

More importantly, the year 2003 had a momentous impact on Mr. Hendry’s approach in that he was rewarded by the markets for: (1) arriving at a distinct macro view of the markets through his independent thinking, (2) stress-testing the differentiating view through fundamental and technical analysis, and, crucially,(3) then taking a huge active stance on it. Even though the returns for the Eclectica Fund were positive going forward, both in 2004 (8.1%, underperforming the 10.8% of S&P 500) and in 2005 (15.6% outperforming the 4.7% of S&P 500), as an investment manager Mr. Hendry viewed them with a skeptical outlook as in what he had done wrong despite the fact that they produced “positive absolute returns” on an annual basis. He felt that it was his thinking and consequent actions in 2003 that were truly marked by exceptional money management where the rewards were huge for being right and not average for avoiding perceived risk.

This ongoing self-evaluation was already a recurrent event in his career, freedom of thought going hand in hand with freedom to invest anywhere, indicating the best platform will afford him a full tool of investment options which can be used to build any allocation to take advantage of his macro prognosis. In short, Mr. Hendry had arrived at a juncture where, besides the simple motivation to preserve capital and grow it to the best of his abilities, all other fund categories that boxed his thinking were irrelevant at best and harmful at worst.

Hence in 2005, Mr. Hendry and Mr. Batten decided to run the Eclectica Fund themselves, which was still under OAM platform with assets worth 300 million dollars. The objective of this fund was to seek absolute returns using Global Equities, Commodities, Global fixed income, Currencies, and Credit. With Mr. Hendry being in charge of the investment part and with Mr. Batten in charge of the business side, they were successful in receiving the FSA’s approval to operate the Eclectica Asset Management in June.

In its first fully independent year of 2006, the fund returned 13%, more or less in line with the markets. Of course, how he achieved the 13% is important, but as always the risk factor is ignored by media when the markets are complacent. Fast forward to the devastating market of 2008 (negative 37% return in the S&P 500), and the fund delivered negative 5% return — establishing Mr. Hendry as one of the best hedge fund managers. Currently the fund is up 38.65% year-to-date for 2011, with an extraordinary 22.5% return in August and 11.0% in September

Today, the Electica Fund, under Mr. Hendry’s direction, boasts managing 700 million dollars. He leads a team of a dozen or so personnel in an unassuming office in the posh Bayswater area in London. His matured investment philosophy is best summarized on his website with the following dictums: (1) Focus, (2) Discipline, (3) Independence of thought, (4) Timing, (5) High regard for the market (“it is divine”), (6) Pragmatism (conviction is overruled if the market does not confirm it), (7) Accommodating mistakes (cutting losers, easy to do if the fund holds a multitude of positions), and (8) Risk management. Some of these dictums are further elaborated below from interviews of Mr. Hendry.

As for Risk, Eclectica characterizes itself as an opportunistic fund which utilizes its balance sheet to the fullest extent (not unlike an operating business). The risk appetite, which is imperative for higher returns over long term, is kept in check by risk controls that have been developed for containing/restraining “mistakes of the manager”. This fund has paved its way to one that has outgrown its equity-based roots to the full scope of wide investment potency.

This is best reflected in their commodity trading. The Eclectica Fund, like other high profile CTA funds, is run with a variety of time frames of 1-month, 3-months and 1-year. Generally CTAs are systematic and methodic traders, but Mr. Hendry’s approach is judgment based. The main point of the fund is to construct a long-term track record by amalgamating together a series of high absolute returns for distinct calendar years. The importance/dominance of the calendar year helps in various manners not just for the fee structure but by giving the manager a cushion to increase leverage/risk and hence increase returns to investors. This inflexion point comes in handy as it gives more to commit outright to generate larger absolute returns.

A further advantage of the 12-month period is in investment management/risk management. Mr. Hendry utilizes position sizing to assess profit potential and stop loss levels moving averages and price change over time. The impact is in all traded markets, as Mr. Hendry stipulates: “the Nikkei has traded at an average level 17,000 over the past 25 years” and “the NASDAQ which peaked in 2000 was running at 25% above its 12-month moving average.” These considerations of how markets trade, give fodder to Mr. Hendry for future activity.

In regards to independent thought, Mr. Hendry views himself as a code-breaker relying on cyclical/historical influences on trading markets. He utilizes long term price date and charts to indicate when bear are hibernating and bull markets are beginning to rouse. His aim is to identify “a series of virgin bull markets” by investing in mainly in rising price trends.” It’s like walking past restaurants: I only want to go in if I can see it’s busy,” he deadpans. He uses relative price charts (compared to the index) for stocks as well. Perspectives accumulated over a couple of decades where price exceeds long term moving averages can potentially translate to for a multi-year gain. However, short-term timing may be a little tricky. Under such circumstances, Mr. Hendry often implements the observation using options instead, i.e. when a bull market has been established, positions may be taken in futures yielding outright risk assumption.

However, not all positions are directional but might deviate to the utilization of variance swaps and options to give an alternate perspective to market volatility. Positions are severed and sold once they infringe upon pertinent moving average of the price. All multi-year bull markets are provisionally consolidated and amended. Based on longest moving averages, the primary positioning, i.e. long-term bull, is altered for interim profit when the traded prices drop through the short term and the bull market position is abandoned to stop loss levels.

In terms of diversity of holdings, the fund holds 300 to 400 positions and there is nothing carved in stone to determine the closings of positions. Both the analysts and dealers take their respective stances on closing of positions but the buck stops at Mr. Hendry’s desk. Debates might take place over implementing a closing trade for days and sometimes weeks, however, it is Mr. Hendry’s action that settles the score. His tendency is “to cut a third and think about the rest. I’ve found acting first and philosophizing later (to paraphrase Soros) to be the best approach.”

Further, Mr. Hendry justifies the absence of price targets by pointing out that although the fund has a notion of where a security should be traded, it tends to rely on a positive trend-positioning itself as long as it remains uninterrupted. Again, convictions are not religiously held on to when there is lack of market verification.

Mr. Hendry credits his former employer and mentor Mr. Odey for his understanding of many of the above dictums. Also, like Mr. Odey, he is the thought leader in his own company. The portfolio managers and traders at Eclectica do not concern themselves with substantial research but instead concentrate on monitoring and building portfolios. The sole purpose of the analysts is to take care of the nitty-gritty of date to buttress Mr. Hendry’s ideas and to execute the assignments as “disciplined deviants”.

Besides the flagship hedge fund, Mr. Hendry has created two publicly-traded funds, with a low investment minimum: The Eclectica Absolute Macro Fund and the Eclectica Agricultural Fund.

Akin to the hedge fund, the Eclectica Absolute Macro Fund aims to generate positive and uncorrelated absolute returns in every market over a twelve month period. It utilizes actively managed strategic asset allocation of all assets qualified under retail funds. It employs a variety of financial instruments including but not limited to global equity, bonds, foreign exchange and cash. High portfolio turnover is a substantial characteristic of the investment approach.

To further mirror the hedge fund, the Eclectica Absolute Macro fund also indirectly invests in commodities via financial indices, in structured products, and exchange traded funds, notes and commodities. The fund also utilizes contracts for differences with aim of shorting. Further, the mandate is kept open allowing it to use derivatives, forward transactions, hedging and long and short positions.

Currently, fixed income dominates the retail portfolio, rallying in September 2010 due to softening of forward rate expectations. The fund this month has yielded a return of 1.5% bringing YTD returns to 7.4%.

The Electica Agricultural Fund, as the name suggests, invests in global equities of agricultural nature. The primary objective of the fund is to attain long term capital growth by investing in a diversified portfolio involving agriculture and farming related issues.

Current Outlook:

Below are three recent views espoused by Mr. Hendry that exhibit his incisive thinking. He is not enamored by China, hopeless on any work-out for Greece, and his concentration on food producers (through the opening of a whole new fund!) is reminiscent of his famous bet on gold in 2003.

China:

Mr. Hendry’s outlook on the Chinese economy is rather bleak compared to most fund managers. He claims that thee managers are infatuated, wrongly, with the whole prospect by being side tracked by China’s economic growth over the past ten years, averaging 9%, some of them proclaiming that it will overshadow the Us as the world’s largest economy. According to Mr. Hendry China’s growth is false as it relies mainly on domestic bank lending rather than on the expansion of its exports to foreign markets. China’s 27% increase in bank lending towards its GDP is unfeasible and might end up being disastrous.

Since China’s entry to the WTO, in 2001, surging exports from a mere 2% to an unprecedented 11% by 2007. The West’s desire of cheap Chinese exports has resulted in the West owing substantial amount of money to its Asian trading partner. China occupies the position of the world’s largest creditor at $2.3 trillion in foreign exchange claims. Such a scenario has only occurred twice before with the US in the 1920s and the Japanese in the 1980s. in these two instances which led to overvalued domestic products due to a failure to allow the exchange rates to settle to the new economic atmosphere.

The general consensus seems to be that this time it is different. Mr. Hendry, however, disagrees by positing that the Chinese are modeled as the Protestant Capitalists, of yore years in the West. How can an atheist China be ready for working harder and deferring gratification for longer? The state planners are obviously biased to investment over consumption, investing infra-structure with vehemence overlooking the fact that the goal of economic policy being the maximization of households’ well-being and consumption. China’s share of consumption was sitting at a mere 35% of GDP in 2008.

Mr. Hendry claims that China’s motto is to “invest in over-capacity” which is ominous of its downfall. He points out that an economy which represents only 7% of the global GDP is responsible for 30% of global aluminum consumption, 47% of global steel consumption and 40% of global copper consumption. This model leads to “deflationary spiral” which is perpetual and since domestic consumption never grows faster to keep up with supply.

Furthermore, Mr. Hendry points out that it is one thing to create economic growth, but another to create wealth. For example, he posits if one commits to build a new commercial property in Shanghai, it would contribute to GDP growth but would be destructive towards creating wealth if there are no tenants and the vacancy rate is hovering at 20%.

Greece:

Mr. Hendry back in May 2010, took a similarly controversial stance regarding the Greek economy, sparring with none other than Joseph Stieglitz, the Nobel prize winning American economist and former chief economist of the World Bank. Mr. Hendry claimed that Mr. Stieglitz was being “egregiously wrong” and saying to him: “Can I tell you about the real world?” Mr. Hendry does have the tendency to get on people’s, especially prominent ones, wrong side by eschewing subtleties and being blunt. For Greece’s solution he points to John Maynard Keynes who after the first World War posited that the reparations demanded of Germany would only lead to endangering the European economy and prescribed forgiveness.

Mr. Hendry sees the similarities between the Allies and the banks today. However, the message falls on deaf ears as Greece’s economy is depending upon official bailouts from France and Germany who have vested billions of euros in Greece even though being aware that the overrun its credit limit. According to him it’s the “champagne socialists who want to bailout the bankers not the people.”

Analysis from Agriculture Fund:
Prices of soft commodities were down for corn (19%), wheat and soy (both 15%) due to speculators liquidating positions resulting in the largest sell-off ever. The fund was down by 13.2% albeit barely out-performing the DaxAgri index which fell by 13.5%. The fertilizer and machinery sectors being the main culprits in the decline, the fund reduced these positions. However, holdings in the protein sector and processors held up comparatively which contributed towards the portfolios relative out-performance.

Since last month speculators are a lot less long soft commodities reducing net longs by 75% since the begging of September to its lowest level since July 2010. Aggregate gain inventories are not quite as rigid as was speculated in August, particularly in wheat where harvests in Ukraine, Kazakhstan and Europe have been higher than expected. However, corn and soy inventories stayed extremely tight. The fall of corn prices to $6 once again prompted large export sales to China, who has thrice this year stepped in at this price range ($5.50 to $6.00).

Rice prices, however, remain for farmers to invest in 2012 partly due to the flooding in Thailand. Fertilizers do not seem to be ill affected, which declined dramatically in 2008, according to company reports and industry data. Nonetheless, caution is being exercised, for 2012, as far as machinery is concerned especially in North America. Due to this, machinery holdings have been reduced while an increase in protein stocks to 15% from 4-5% has taken place with one new position in Smithfield Foods.

Pork prices have increased by 60%. Since, pork is a staple in the Chinese diet, especially in rural areas, it has become imperative for the government to get the prices down to affordable level. There are two reasons for the surge in pork prices: The margins for hog raising were negative resulting in reduction of supply and hog disease is rampant in China due to lack of modern methods and arcane facilities.

There are two solutions to the problem one being to raise more pigs; however given the life cycle of hogs this will not affect the supply till late 2012. In the short term, an option is to import pork from abroad, mainly from Brazil and the US. Since Chinese pork trades at 30% to premium logistic costs could be easily attained, hence encouraging imports.

This is where Smithfield Foods comes into the equation, it being the largest processor and breeder of hogs in the world. Currently the stock trades at 0.4x sales to incur 5% margins but this could indeed change to 8-9%, if US pork prices were to close the gap with Chinese prices. This would translate into Smithfield’s P/E multiple arriving at 5. The fund has built a cautious position of 3%.

QUOTES

“If there was a way to short Obama, I would.”

“The best macro trade, the best trade of any color, is when you don’t fear the consequences of being wrong.”

“Hello, can I tell you about the real world?” (Talking to the Nobel laureate Joseph Stiglitz, about the prospects of the Euro.)

“I believe in tough love. Let’s look at Iceland. I didn’t invest money in Icesave because they took risks I would never take to offer very high interest rates. You take a risk, you get it wrong, you pay. Instead the government says, don’t worry, here’s my friend the taxpayer with a cheque. You’re impoverishing us all to bail out people who make bad decisions.”

“When one is investing, one is dealing with the future. None of us – regardless of our intellect – have actually been in the future, so we don’t know what we are talking about.”

“We believe the markets are embracing a historic revaluation of hard assets versus their financial counterparts. This reflation will be different to previous examples and the change in the economy is catching out many stock market legends.”

“The financial economy has become the economy and I think we could be subject to one of the other generational shifts whereby I should really be attending the Young Farmers Society as opposed to the London School of Economics.”