During the last decade there has been a push to create investable indexes offering exposure to the beta of alternative investment strategies including hedging funds and managed futures.
MSR Investments has taken that to another level by creating three core models of positive return drivers they believe serve as the building blocks of a wide swath of traditional and alternative returns.
Those strategies are: Long only, trend-following and reversal. How do you get to 1000 indexes from three core models? By mixing and matching them in different combinations and applying them to some or all of the 32 most liquid futures markets with various weightings. They combine their three core trading strategies to build a family of 1000 indexes that can provide exposure to numerous strategies at a much lower cost — 25 to 150 basis points based on complexity and target volatility — than your typical hedge fund or commodity trading advisor charging a 2% management fee and 20% incentive fee, known as 2 and 20.
The MSR Investable Index Platform can be used for multiple purposes. A manager or investor can decide what investment exposure he wants and build a portfolio of simple indexes to gain that exposure, he can build a low cost fund of fund by allocating to various indexes of well-defined exposures. He can also test the correlation and performance of a manager they are investigating against an index to determine if the manager is simply providing beta that can be accessed at a much lower cost, or if he is truly offering something unique or if the program is correlated but consistently outperforming its benchmark index (see “Finding a match,” right).
The trend-following strategy combines various time horizons—from five days to six months—and is based on a combination of the moving average convergence/divergence indicator and a moving average crossover. The long-only strategy is obvious but can be split out to gain broad equity market exposure, global equity exposure, fixed income exposure, commodity exposure or any combination you choose, and the reversal uses a Black Scholes replication options model to replicate the selling of straddles.
“When you replicate the selling of straddles it functions like a countertrend program,” says Michael Rulle, founder of MSR and creator of its index platform. “The concept developed as we began to analyze the actual hedge fund industry,” he says. “We can create and have created an equivalent to something that can compete with the hedge fund industry. The platform itself is a competitive paradigm to how people and investors analyze hedge funds and make decisions on hedge funds.”
“The capability of the platform can use the futures markets to create investment products that are analogues to what you and I would think of as hedge funds even though it is being executed in the futures markets,” he adds.
Rulle points out that the alternative investment universe (hedge funds and CTAs) from 2002 to 2007 went from $500 billion to $2.5 trillion. “In an extremely short period we saw massive growth because there was high demand, Rulle says. “When that much new money (therefore new supply) comes into the market in such a quick period, you are going to see a lot of things very similar to each other.”
Rulle looked at the Credit Suisse Hedge Fund index as a reasonable proxy for the alternative investment industry as a whole. “Since 2005 its actual return is 5.87%, Sharpe ratio is about 0.5—they are an index so you are getting all the correlation benefits of all the 500 managers,” he says.
“If you use our benchmark analysis, that index is [nearly the same] as the MSR S&P 500 index with a target volatility of 10%, which we charge 25 basis points for. This is when we became excited about the possibility of creating a competitive product.”
And the same held true as he used their benchmark finder tool to matches with other sub-indexes.