Man Group plc - Annual Report 2007

Asset Management in focus
Man Investments is a global leader in the fast-growing alternative investments industry with funds under management of $61.7 billion at 31 March 2007. It provides innovative products and tailor-made solutions to a diverse group of private and institutional investors worldwide. Through its multi-managers – RMF, Glenwood and Man Global Strategies, and through its single managers – AHL, Pemba and Bayswater, Man Investments has succeeded in developing leadership in hedge funds and has interests in other asset classes.

In its core hedge fund asset class, Man Investments distributes guaranteed products and open-ended products to private investors through a unique and extensive network of around 2,000 global and regional distributors. Institutional asset gathering is typically through direct relationships and is coordinated through dedicated relationship managers. Man Investments’ track record stretches back more than two decades and defines the standard for excellence in an industry whose central goal is to provide diversification away from traditional equity and bond investments. Man has a powerful global presence, supported by strong product development and structuring skills, and an extensive investor service and distribution network.

Man Investments’ robust market position has allowed it to continue to grow its profits with profit before tax in the year to 31 March 2007 up 13% to $1.3 billion. This was against a backdrop of challenging market conditions for the performance of our private investor products, as demonstrated by Man Multi-Strategy Guaranteed Ltd which was up by only 3.1% for the year. This was principally due to our exposure to the managed futures style, with AHL being down 4.8%. Our institutional products had more favourable returns with RMF recording +7.7%, in line with the HFRI Fund of Funds Composite Index.

Business environment
Historically, investors have had the majority of their investments in the large traditional asset classes of equities, bonds and cash. However, as investors and their advisers have become more sophisticated, demand has grown for other asset classes, particularly those with low correlations to equities and bonds. This makes sense for overall portfolio management and allows investors to improve the risk-adjusted returns of their total portfolios. These other investment categories include hedge funds, private equity, real estate and other physical assets such as commodities.

Man Investments is focused on hedge funds and ultimately we are providing products to investors who wish to gain exposure to this area. We are therefore in competition with other providers of similar hedge fund products. We are also competing with providers of other categories of investments given that investors are seeking to invest their portfolios in a mix of products that will give them attractive risk-adjusted returns.

Industry outlook
Conditions in the hedge fund industry continue to be very favourable. Net inflows were $163 billion in the year to March 2007, strongly up from $43 billion in the year to March 2006. Total funds under management at March 2007 were $1.7 trillion, up 32% on the previous year.

Even after allowing for an element of leverage, this still represents a small percentage of total investable assets worldwide. As can be seen from Figure 1, funds under management in the hedge fund industry, when measured against total investable assets (calculated as market capitalisation of all equity markets plus total debt securities as measured by the Bank for International Settlements), have only risen from 0.8% in 1997 to 1.4% in 2006. This relatively measured growth reflects the fact that the pool of investable assets has grown dramatically in recent years assisted by the increase in sophistication of global capital markets, of which the growth of hedge funds represents only one of a number of factors.

Projections for the hedge fund industry anticipate strong rates of growth at around 15% per annum. The fastest area for growth is projected to be on the institutional side, although actual inflows are still expected to be split equally between private investor and institutional, given the larger absolute size of the private investor funds under management.

Single manager hedge funds
The management of hedge funds remains very fragmented. The 10 largest managers have a cumulative market share of around 16%* and only 9% of hedge funds have more than $1 billion funds under management. Likewise, the industry remains relatively immature and only some 24% of hedge funds have been in existence for more than seven years. In this context, Man Investments stands out with a track record dating back two decades (see Figures 2 and 3).

Whilst the hedge fund industry continues to grow rapidly, with a large number of new entrants joining each year, there is evidence that there has been a gradual flight to quality with the largest managers benefiting at the expense of the smaller ones. The share of total funds under management (FUM) of the largest 100 hedge fund managers had grown from 45% at the end of 2001 to 58% at the end of 2005.# This implies that the top 100 hedge funds have grown their average funds under management at a compound annual growth rate of nearly 30%, from an average $2.6 billion, up to a current average of $7.1 billion.

Our principal single manager product remains AHL which had funds under management of $18.5 billion at the end of March 2007. In addition, we have 49 associated single managers sourced through our Man Global Strategies programme, with another $10.6 billion. We have this year chosen to highlight as new core managers both Bayswater, a quantitative global macro manager from our associated manager programme and Pemba, a European credit manager that was formerly part of RMF. The majority of the funds under management managed by both AHL and our associated managers are sold through our Guaranteed Products which are discussed below.

The largest hedge funds* in this segment include JPMorgan Asset Management ($34.0 billion), Goldman Sachs ($32.5 billion), Bridgewater Associates ($30.2 billion), D E Shaw ($26.3 billion) and Farallon Capital ($26.2 billion). With regard to managed futures to which we have a deliberate overweight, principally through AHL, the total funds under management in this style were $170 billion+ at the end of 2006 and other leading managed futures players* were Campbell & Co with $13.8 billion, Graham Capital, $5.2 billion and Crabel Capital Management, $3.3 billion.

Fund of hedge funds
There is a second distinct segment of the hedge fund industry, in addition to single hedge fund managers, which are the fund of hedge funds managers, who typically earn an ‘overlay’ fee for structuring a portfolio of underlying hedge fund managers. This segment services two discrete markets – private investor and institutional. The single manager hedge funds discussed above typically have high minimum investment requirements and are generally not interested in dealing directly with private investors. However, private investors tend to have higher return targets whilst favouring more concentrated levels of managers and style exposures than institutional investors.

Man competes in both segments. The private investor segment is covered through Man’s open-ended products which comprise around 15% of our total funds under management. The institutional segment represents around 40% of Man’s total funds under management, but given that we only capture the overlay fund of funds fee, this institutional segment represents around 20% of the profits of Man Investments.

The top 142 fund of hedge funds†, which manage over $1 billion, collectively managed around some $820 billion at 31 December 2006, representing an increase of more than 28% compared to the prior year. This is in line with the growth of the overall hedge fund industry at 29% over the same time period. The fund of funds industry remains fragmented and there is a view that the mid-sized players will find conditions more challenging going forward. The top 10 managers, with a combined $263 billion of assets under management, grew 37% from the prior year, faster than the broader fund of hedge funds segment.

The other largest fund of hedge funds† in this segment include UBS ($43.4 billion), UBP ($34.6 billion), Legg Mason (Permal) ($28.6 billion), HSBC ($27.6 billion) and Julius Baer (GAM) ($27.7 billion). There is only one remaining independent fund of funds manager in the top 10, other than Man (Grosvenor Capital, the tenth largest, with $18.9 billion)* – seven are subsidiaries of banks and the eighth is part of the asset manager/broker Legg Mason. These managers owe their size and growth to a material degree to the allocation of discretionary assets from within their group affiliates. This trend seems set to continue with a number of fund of funds players having been acquired by banks in recent years. And growth continues to be very strong for most hedge fund of funds whatever their size.

Our largest fund of funds manager is RMF, which had funds under management of $24.2 billion at the end of March 2007, the bulk of which is sold to institutional investors. In addition, we also have Glenwood ($6.4 billion), the majority of whose assets come from private investors.

^† Source: InvestHedge, which ranked largest fund of hedge funds at end December 2006.
^* Source: Absolute Return magazine, which ranks all managers that hold over $1 billion at January 2007.
⁺ Source: Barclay Group
^# Source: Alpha magazine, which ranks the largest 100 hedge funds at the end of each calendar year.

Guaranteed products
The final and smallest segment of the hedge fund industry is the guaranteed products segment, a relatively small niche within the hedge fund industry. This area also overlaps with the more generic guaranteed products market to a limited extent. The latter is essentially dominated by the major banks who structure products on a wide range of underlyings of which hedge funds is one of the smaller categories.