FM: With Salient you have changed you focus from managing pension money to building investments. Why did you launch these series of funds?
LP: The basic reason we launched our funds is that there were things we wanted to do as allocators that we didn’t find good products to do them through. We wanted to fill a hole that we saw in the set of offerings out there and decided we would do it ourselves. We want to be efficient in the market place. We want to have a tremendous amount of liquidity, low fees, transparency in an investor friendly structure.
FM: There have been a raft of alternative 40-Act products launched since 2010. How you expect to compete in this space? Are you offering them to pensions or bundling them in diversified products?
LP: What we are doing is definitely different but it is different in a counterintuitive way. Rather than come up with the most complicated structures, we are trying to create things that [offer] pure access to these return streams. So with trend following we’re offering access to a pure trend following strategy across 40-50 futures markets. We don’t have overly engineered stop loss program or signals that use a combination of RSI and MACD and reversals. Ours are very simple signals that identify trends and then we risk weight everything. What defines systematic is that it is rules based and we find that a lot of the industry has over-engineered their portfolios and they haven’t taken in enough [data] in terms of economic environments to really backtest those strategies. Futures and commodity markets beg for active management but that is the discretionary side. All the guys that we [allocate to], and had success with are fundamentally different from what we are doing. We are taking what the market gives us on the trend following side.
FM: It sounds like you are trying to create a pure systematic trend following beta and believe managers have hurt themselves by trying to smooth out the rough edges of trend following.
LP: Exactly. If we have a choppy markets, that is why we have high yield in the portfolio. It is not to dissimilar than selling volatility, in that in choppy markets high yield generally outperform equities and generally outperforms trend following. For example, last year was a pretty bad year for emerging market debt, which is our carry strategy, but that was a bad trade last year. But managed futures, the way that we define it, more than offset that because trend following really kicked in. It is all portfolio construction from our perspective. We are trying to create building blocks that are not readily available to help manager construct portfolios that are more efficient. None of them are the Holy Grail.
FM: Do you think ultimately the 40-Act fund structure is where retail investors will and should get their exposure to alternatives?
LP: We don’t have many constraints. For us the managed futures side is really easy. The only meaningful [glitch] that we run into is a [Registered Investment Company] can only warehouse so much of what is considered bad income and commodities are considered bad income so you have to run it through an offshore group. That is the only piece of it you have to adjust for inside of a RIC. Other than that, leverage is not an issue, the instruments themselves are not an issue, you have 60/40 tax treatment so it works if someone has it through a 401K. It also works if someone has a normal brokerage account. The 40-Act structure is pretty well-suited for this.
FM: In the past year alternatives both hedge funds and managed futures have come under attack for a lack of performance and high fees. Has this attack been fair? What is behind it?
LP: There were some shortcomings with that Bloomberg article but the reality is that managed futures has carried very high fee loads with them and there is not only the incentive fees that the manager charges but if you have two funds and one is up the other is down, your incentive fee is going to be 1% on total portfolio because you paid 20% to the manager that was up 10%, which is completely eliminated by the guy that was down 10%. You are still net down 1% on the portfolio level. That is the drag that is created by the incentive fee. When you layer on top of that a lot of front end loads that the big distributors charge [it gets expensive]. These aren’t meant to absorb 5% to 8% front end loads plus a 2 and 20 structure.
FM: Are you suspicious that some criticism of alternatives comes from the fact that it is a long only equity world and any allocation to alternatives is going to come from traditional investments?
LP: I think that is exactly right.
FM: Are you worried that such criticism will reduce exposure to alternatives, particularly managed futures, when it is needed most?
LP: Absolutely. People are going to have minimal exposure to alternatives when they need it the most. It is just the way the markets work. That is what drives the equity price up, everyone is buying equities and they can’t go down and they sell alternatives to fund it.
FM: A few months ago we interviewed Mark Spitznagel who thought QE was forcing people into risk assets, which will create a greater risk of a market crash because of the heavy government intervention. Do you agree?
LP: I think so but the downside was a depression in 2009. Absent QE we were heading towards a complete breakdown of the financial system and more banks were going to go under. So yes, it definitely increased speculation as we got into the later stages of QE but if we didn’t have QE we wouldn’t have an economy as we know it.
FM: People tend to forget that.
LP: Yea, they do forget that.