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As the visitor approaches them from the Thames, BlackRock’s London offices look little different to those of the modern financial institutions that dominate the City. Many mergers and synergies later, this substantial piece of real estate is a showcase for the asset manager’s economies of scale.

But from the inside, the BlackRock fortress feels like a Mayfair hedge fund boutique. Rooms are hung with pictures in an old-fashioned style, with wood and carpeting finished in a more traditional manner.

BlackRock has combined these two styles in one of its flagship retail products, the £864.9m UK Absolute Alpha fund, an equity long-short offering in the classic style of a Mayfair manager. But as it is regulated and appears on a number of retail platforms, the fund needs daily dealing and constant liquidity. This laborious task is where BlackRock’s economies of scale have, according to co-manager Mark Lyttleton, proved vital.

“There’s no way I could have launched this fund sitting in a boutique in the West End,” he says. “You could do it, but I don’t think you could do it as thoroughly.”

Mr Lyttleton is almost as pure BlackRock as it is possible to be. He has spent his entire career at BlackRock and its predecessor firms. He became known principally for his knowledge of UK equities before he took over the UK Absolute Alpha fund in 2005. He was previously the sole manager of the portfolio, but now shares management responsibilities with his colleague Nick Osborne. Among other things, this is because of the marketing burden that the interest in this fund has placed on his shoulders. Without back-up, he confirms, the product would be much harder to run.

But the ease of running a long-short product like UK Absolute Alpha is a side issue at present. After all, hedge fund managers the world over run long-short products, so there is a large talent pool. It is also possible to find brokers who will ensure regular liquidity for the underlying assets and fund administrators to deal the fund daily. The debate is how much all this will cost. And if Mr Lyttleton beats his targets, it will cost you a performance fee.

To an extent, Mr Lyttleton says, he wants to be rewarded for running a more complicated product, although he admits “it’s been a lot less stressful than my long-only fund over the past nine months”. This is chiefly because the fund can go up to 30 per cent net short and thereby profit from market dips, although under normal market conditions Mr Lyttleton says it should only go up to 10 per cent short.

But when the market is going up, the fund can in fact be more difficult to run than a long-only product as the maximum net long position is 50 per cent, which Mr Lyttleton says should be as little as 20 per cent under normal conditions. In rising markets, this means it stands to lose money on its shorts. From its launch in April 2005 to the end of April 2008, the fund’s shorts dipped 1.28 per cent, although from launch to the end of March its shorting made positive gains.

“For many people this is a very new thing – using CFDs, shorting pairs. You have to hold their hands at first,” Mr Lyttleton says. But although he is speaking of some of the fund’s retail investors, Mr Lyttleton himself had never run a long-short product before he began paper-trading the fund in the fourth quarter of 2003. He also never paper-traded the fund under bear market conditions when shorting generally proves most useful.

Mr Lyttleton says if he regretted anything about his performance over the last year, it would be that he did not take on more shorts. “We weren’t that aggressively short in banks. We weren’t short Northern Rock,” he says. “Events were moving pretty fast. We didn’t know how much toxic paper the banks had and how much this toxic paper was going to fall.”

But even if he had shorted Northern Rock, Mr Lyttleton would have been unable to make the returns some of the hedge funds made from it. “We don’t use leverage. If we have a good year, we are not going to deliver a 40 per cent return,” he says. “For many hedge fund buyers, it’s too low risk. We thought funds of hedge funds might have been big buyers, but they haven’t.”

In other words, investors are paying extra to BlackRock for Mr Lyttleton to run a product that is markedly retail-orientated and cautious. “We did see a huge gap in the market between a man with $1m (£510000) and people in the street who didn’t want to be a slave to the market,” he says.

But although it may not be a slave to the market, over its first three years the fund did not dramatically overshoot the index. Over this period, give or take a few basis points, it made roughly similar returns to a high-quality All-Share tracker. “If you go back to spring last year, I was behind the All-Share tracker, and if you go back to March I was probably a bit ahead of it,” Mr Lyttleton says.

But the catch is the tracker made this money in a rising market overall – in other words, the only type of market that favours it. Mr Lyttleton has made it in a market that is inimical to his shorts with what he says is a quarter of the index’s volatility. The product exhibits no historical downside and comforts investors who fear bear markets or turbulence. And as long as the fund beats its targets, BlackRock collects its performance fees in return.

Would Mr Lyttleton have even considered running the fund if there was no intention of introducing a performance fee? He answers diplomatically. “I would have looked at it, but a fund like this is suited to a performance fee.” Given its administrative and analytical costs, one might easily agree with him.

But as the performance fee is not as big as a hedge fund’s, what is the financial incentive for him to keep running it? “There’s no incentive,” Mr Lyttleton says. “I like it, so I’m going to keep doing it.”

Like Mark Tyndall, chief executive of Artemis Investment Management, or Robin Geffen, managing director of Neptune Investment Management, Mr Lyttleton says his passion for long-term investment is primarily what keeps him in the job. His long track record at BlackRock leads one to believe this admiration is as near to permanent as one can get in fund management.

Yet although working at a hedge fund can cause short-term stress, it is difficult not to conclude the retail world is missing out on a good deal of talent like Mr Lyttleton’s due to its comparatively – with the emphasis on “comparatively” – slim pay packets. On the other hand, some managers like Mr Lyttleton seem happier with a reduced performance fee arrangement.

In fact, Mr Lyttleton sees performance fees as a retail industry trend. BlackRock has already announced it is introducing a performance fee of some kind on the UK retail version of its Global Tactical Asset Allocation product. A limited number of other asset managers such as JOHambro Capital Management even have performance fees on long-only products.

It is said performance fees are more suitable for absolute return funds like Mr Lyttleton’s, on the grounds that they are expensive and difficult to run. But even on a long-only product, a performance fee that is conditional on a hurdle can produce something of a win-win situation for the client. If the manager underperforms, the client is not charged. If the client is charged, the manager must have outperformed.

It is debatable, however, as to whether the manager is more likely to outperform if there is a performance fee attached. Managers who are headed for underperformance may take a big punt to get the fee, which means they take larger risks and become more susceptible to underperformance.

From this perspective, the structure of Mr Lyttleton’s fund is reassuring as he does not place big bets on his longs or his shorts. As well as having a small maximum net position, his holding size is minute – between 0.75 and 2 per cent on the long side, and between 0.5 and 1.25 per cent on the short side.

Mr Lyttleton has some wry comments on whether performance fees actually incentivise performance. He says he is glad he is not part of an investment bank where his bonus might be dependent on the gambles of “bond jockeys”. Yet he believes he could see himself running a more aggressive version of UK Absolute Alpha, although he does not think it would be in BlackRock’s interests to run such a strategy on UK Absolute Alpha itself.

The competition for absolute returns from UK equities may soon increase, however. Cazenove Capital Management is launching a UK Absolute Return fund as well as a European Absolute Return fund. The IMA’s new £1.8bn Absolute Return sector will create a new peer group, although it will contain funds with very different risk-return profiles. In April alone, it saw inflows of over £170m.

As Mr Lyttleton points out, the expense of running absolute return funds makes it difficult to wish for less. “If this fund was £100m after three years, we would have been disappointed. There’s a lot of cost that has gone into starting and running it.” And even if your fund holds £9864.9m, performance fees certainly seem to help lighten the load.

1992 – BSc (Hons) in Chemistry, University of York

1992 – Graduate trainee, Mercury Asset Management (later part of BlackRock)

1994 – Fund manager, Mercury Asset Management

1999 – Appointed manager of the BlackRock UK Fund

2003 – Appointed manager of the BlackRock UK Dynamic Fund

2005 – Appointed manager of the BlackRock UK Absolute Alpha Fund

2006 – Managing director, BlackRock