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Blast of fresh air

INTERVIEW: Maverick hedge fund manager Hugh Hendry tells us about Venus's effect on market cycles, and the voices in his head that tell him to invest in agriculture and prepare for deflation.

Hugh Hendry's infectious enthusiasm makes you like him, want to believe him and want to invest some money in his funds. The maverick hedge fund manager peppers his conversation with epithets; some witty "The gravest sin in investing is to be right, but too early"; some catchy "Bright people can tell you 10 good reasons why they're wrong"; some opinionated "The notion of fundamental analysis in the City is no different to someone bashing the scriptures"; and some verging on comedic "I hear voices...".

It is difficult to take Mr Hendry seriously when he says he makes stock choices by following the advice of the voices in his head and the patterns of lunar cycles. But the free thinker counteracts this with serious points about markets, themes and stock-picking.

Interviewing him, I feel a certain responsibility as a summer 2006 interview with The Times newspaper ended in him receiving death threats and being followed by an Icelandic TV crew after he was quoted as saying "I want to be known as the man who bankrupted Iceland".

Mr Hendry made his name at Odey Asset Management where he managed a range of funds from $1.0bn of long-only European mandates to the Eclectica Fund. In 2002 he became infamous for taking his equity fund out of equities and into cash and bonds, in the meantime preserving client's money. He eventually fell out with mentor Crispin Odey ("When I joined Crispin my confidence plunged. It's bad luck to communicate with genius.") and in partnership with Simon Batten, a fellow partner at Odey Asset Management, bought the contract to run the Eclectica fund.

In 2005 they established Eclectica Asset Management, a specialist asset manager, focusing on analysing markets and trends. Under Mr Hendry's investment guidance (Mr Batten looks after the business side), the analysts look for unloved areas of the market and stocks or sectors that have dropped by at least 70 per cent but that have not hit new lows for a number of years.

Eclectica's funds include:

•CF Agriculture Fund - global equities relating to agriculture and farming issues

•CF Eclectica Continental European Fund - equities in Europe excluding the UK

•CF Eclectica European Fund - equities in Europe including the UK

•Eclectica Fund - an offshore hedge fund.

Mr Hendry manages the hedge fund and the agriculture fund personally.

His main expertise is market cycles: "They come in two parts with an intermission."

"Everything is cyclical," he says. "It's copying patterns in nature." He could get carried away with the Venus Lunar calendar. "It takes earth 365 days to go around the sun. Venus takes 25 years. One day I will do a doctorate on the Lunar frequency of Venus and its engagement with the earth."

But back to markets. "We buy things that have been down on their luck for a long time," he says. "We look at 10-30-year cycles and typically end up being early. For example, we were looking at agriculture in 2001 and 2002."

Super softs

After 30 years of consolidation and declining prices within agriculture, Mr Hendry believes that we are at the beginning of a long-term agricultural supercycle and that the conditions are in place for the next upswing in profits. "Corn, wheat and farm-based crops are no higher in normal terms than 30 years ago and the intervening period had inflation," he says.

The CF Agriculture Fund, which launched in June 2007, is a good example of Eclectica's investment approach at work. "Agriculture has been a great place to be in the past two years but for the 28 previous years it's been really bad. Because of that there's no publicly endorsed agriculture sector. Up until a year ago, there were no specialist funds."

Mr Hendry doesn't think much of common critiques that there has been a bubble in agricultural commodities. "That's financial McCarthyism - you don't call anyone a communist now - it's a bubble," he says.

"It's far too immature to call it a bubble. The last two months have seen an enormous fall in commodities, especially agriculture. There has been a bubble but not in agriculture - in credit."

Other facts that he finds intriguing ("My lunar calendar switches a light on and I become curious") are insurers - "They were big in the 1970s and are now tiny" - and banks, which he thinks will be down for 25 years. "British Steel employed 150,000 people in the 1950s. The only thing that employs that number to day is the banks."

He is also fascinated by Japan: "Japan peaked in 1990 but with my Lunar calendar I don't think the Nikkei will be at 40,000 again in seven years' time or even 10 years. To throw my clients money in I would have to see Japan outperform other markets for two years."

The two-year rule

This is his general rule for investing: a year or two of outperformance and then he gets in. A new fund will follow this strategy within the FTSE 350. The CF Eclectica UK Relative Momentum fund launched in July 2008 will have exclusively systematic stock selection, only owning the very best stocks in the FTSE 350 as demonstrated over the last 18 months. The rationale is once set in motion, outperformance continues. "Momentum is a dirty word - I don't like to use it. I think we should change the name," he jokes.

Not afraid to antagonise people, Mr Hendry is gloating about a recent sparring on his regular CNBC slot with the head of Lloyds TSB Private Banking. "I'm down 10 per cent so a bit ticked off and I said lots of outrageous things to him."

He castigated his opponent for holding BP - "BP is the worst performing oil stock in the world. Oil has gone up but BP has gone down" - and banks: "That's why you're down 20 per cent this year."

He thinks most fund management is "nonsense" for calibrating risk using tracking error. Here is how he thinks you should analyse an actively managed fund: "Look at the top 10 holdings and if you recognise them, you're just holding the market so you should buy an exchange-traded fund instead."

He's at pains to explain how difficult the job of a hedge fund manager is: "Markets operate under the notion of paradox and irony. The rewards from hedge fund managers' speculation are the highest rewards for intellect on the planet. Therefore it makes sense that brilliant people become hedge fund managers. Therefore, how do you explain Jon Wood?"

The perils of being too clever

In September 2006, Mr Wood, a former top trader with UBS, started SRM Global Fund in Monaco with start-up capital of more than $3bn, a record for a hedge fund start-up. However, over two years Mr Wood's investments in several high-profile casualties of the global financial crisis turned sour, resulting in a 34 per cent loss in 2007 and a 77 per cent loss so far this year. For example, SRM bought a large stake in Northern Rock just weeks after it ran into trouble, confident that the situation could be salvaged.

With the cautionary tale of Jon Wood in mind, Mr Hendry spends time looking for "intellectual traps that rational intellectuals might fall into".

"The market is a conceptual device to capture bright people," he warns. "Hedge fund managers have concentrated themselves into a narrow column of commodity portfolios and shorted financials."

He thinks the biggest trap is to fall for a business with the best prospects. For example, in the agriculture sector "everyone loves Potash Corp", a Canadian company. "It's gone up 25 times already and has now fallen to $170from $250. If it fell to $120 I would be more likely to buy it."

But he doesn't like to interview managers. "I very rarely meet company management because they shine with enthusiasm and it's infectious. The manager of Potash Corp is brilliant."

Deflation threat

Bearish on equities ("I think shares will go down even more"), Mr Hendry is a 'peak interest believer' and is one of a growing group of managers who are preparing their portfolios for deflation. Should the hawkish posturing of today's central banks continue, he thinks we risk a period of sharp deflation.

"There will be a place in the world where gold and oil trade at very high figures. To get there we need a deflationary shock which gives the Fed reason to slash rates. If interest rates go down for two or three years then it will sow the seeds."

If future behaviour is going to be of that nature you have to buy bonds. ("I said that in 2001 and it was too early," he rues.)

"The brightest people on the planet are bearish bonds," he says. "But the only thing I can see to buy is the bond market; that is 0 per cent government bonds, default-free and with long maturity." He points out that ten-year Treasuries were up 15 per cent in the year to June 2008.

To prepare for a deflationary shock, Mr Hendry has 25 per cent of his European fund in bonds ("Uber-bonds, I love the name"). For the rest he is buying bond proxies, such as utilities and water. "The greatest financial calamity that any of us have seen is a great environment for bonds," he says.