Former Artio Managers Take It Slow in New Venture

They're giving it another shot.

Managers Rudolph-Riad Younes and Richard Pell amassed an outstanding record from April 1995, when they took over what was then known as Julius Baer International Equity (now Aberdeen Select International Equity (BJBIX)) through the 2007-09 financial crisis. But then that fund--and a similar, younger one, now known as Aberdeen Select International Equity II (JETAX)--stumbled. (Both funds adopted the Artio label after Younes and Pell set up their own shop of that name.)

By the start of 2013, after four years of subpar performance including a disastrous 2011, Artio's international funds had suffered extensive outflows, and their long-term records had become tarnished. In February 2013, U.K.-based fund giant Aberdeen Asset Management bought the Artio firm, primarily for its bond portfolios. In late May, Aberdeen took over as advisor of all Artio funds. After the sale, the bond-fund managers shifted to Aberdeen and continued to run their funds, but Younes and Pell were replaced and did not join Aberdeen.

They did not go away, however. The managers kept the portfolios intact with their own money, and opened a boutique, R Squared Capital Management. They took with them the compact team of five analysts they'd been working with during their final months at Artio. Younes recently spoke with Morningstar about Artio's issues, his new firm, its new fund, and its future.

The Past
Younes concedes that Artio's problems extended beyond the extraordinary market conditions in the wake of the financial meltdown. In order to deal with the torrent of inflows attracted by their funds' success, he and Pell had hired a group of new analysts and altered some of the existing team members' responsibilities, all the while trying to adjust to the added commitments entailed in running their own firm--one that had gone public in 2009, at that.

As it turned out, he says, the asset bases of the funds and related accounts were allowed to grow too large, and the organizational changes led to internal missteps. Thus, Artio was not in a position to effectively deal with the unprecedented challenges of the chaotic post-crisis market environment, which could have raised havoc with the managers' macro-based style even under the best of conditions.

Younes didn't say so, but it's also clear that once the fund outflows began in earnest and Artio's corporate stock price began to plummet, resulting in a clamor from unhappy shareholders of both the funds and the firm, it fueled an unpleasant cycle that fed on itself. Those troubles demanded more and more time from people whose time was already in short supply.

The Changes
In October 2012, Younes and Pell, recognizing the problems and under pressure from falling asset-management fees as outflows continued, cut their analyst staff roughly in half and made other cost-cutting moves. (Staff levels elsewhere in the firm had already been reduced and U.S.-focused stock funds liquidated.)

In some cases such paring down could be seen as unwise, compromising the traits that had allowed the funds to succeed. But in this situation, Younes argues--with justification, looking at their history--that rather than altering a successful formula, these moves restored the situation that had existed in better times. He and Pell had initially achieved success with a very small staff of analysts and a straightforward mission focused on international investing, and with no other funds. Artio had launched a variety of new funds that required attention, even though other managers took the main role on them.

For the record, Artio International Equity outperformed the foreign large-blend category, the MSCI EAFE Index, and the MSCI ACWI ex USA Index by wide margins from the beginning of October 2012 to May 22, 2013, when management was ceded to Aberdeen. Younes attributes the outperformance to Artio's organizational changes, but of course over such a short period other factors could have been responsible.

The Plans
Younes says he and Pell have learned from their mistakes. They have no plans to launch other funds for five years and perhaps longer, focusing all their attention on RSQ International Equity . Younes and Pell don't plan to actively seek investment in the mutual fund or other accounts until the end of this year or early 2015, after they're satisfied that the current arrangement is functioning well. (Younes says that he, Pell, and other team members currently are about the only investors in their $52 million fund.)

In another contrast with the Artio experience, Younes says he and Pell plan to close the international strategy to new investors at the $15 billion level, should it ever get there. That would be far below the $70 billion-$75 billion in assets that Younes says the international funds and related accounts gathered at their peak.

Their strategy, meanwhile, will be the same as it was when the funds had a more than decade-long run of success under the Julius Baer and Artio labels. Macroeconomic outlooks will continue to play a substantial role here. However, the fund will have around 120 stocks in its portfolio, much fewer than it had during some of the Artio years, when it ballooned to several hundred names.

The team also is familiar. Besides Pell and Younes, the other named portfolio manager is Michael Testorf, who had worked on the funds with them since 2000. The five-person analyst staff includes two from the days going back to Julius Baer, two retained from the Artio-era expansion, and one junior analyst.

A skeptic could say that rather than being a sign of admirable caution, forgoing outside investment at this point simply allows the fund to start building a track record without the complications of inflows, outflows, and marketing and client-relations duties. It's true that managing a fund is easier under these conditions, but taking that route does seem prudent given the prior experience.

The Portfolio
Whether the new firm, using its old strategy, will perform as it did in its golden age is an open question. For the time being, a look at RSQ International Equity's first published portfolio shows that while Younes and Pell have taken a more measured approach to their business in response to the lessons they learned from their Artio experience, on the investment side they haven't built a cautious, indexlike portfolio. At the end of 2013, the fund had a weighting in Continental Europe about 20 percentage points higher than the foreign large-blend average, much of that coming from a big overweighting in the region's financial firms, and they had significant underweightings in Japan and energy.

This profile makes it clear that, while these managers are shying away from the limelight for now, they're still willing to take a stand. Investors who value truly active management should appreciate that. But with memories of the latter stages of the Artio experience still strong, investors will probably want to see strong, sustained performance and continuing organizational stability before they commit any money.