The DNA of performance
Fund of funds
Pranav Sambamurti, senior VP and partner at SSARIS Advisors LLC, says the tool has interesting implications for fund-of-funds. “If you wanted to have a systematic CTA with medium- to long-term fund of funds, I could go out and hire [a manager at] 2 and 20 or use one of these replication indexes and pay hardly anything,” Sambamurti says. “If you are a hedge fund of funds allocator or manager, you can create a business around a platform like this without having to pay the underlying fees of managers.”
Esther and Marc Goodman, founders of Conyers Group, have a combined 70-plus years in alternatives and have been kicking the tires of the MSR platform. “There are some great managers in the hedge funds world [but] there are thousands of them; a lot are average,” says Esther. “If you can invest in an index that gives you that performance without the fee, it seems like a good deal. It will never replace the stars of the business. But as I look back on our years as a fund of funds manager, there are a lot of average [managers out there]. ” Marc adds, “It is not easy to identify the ones that are above average. The amount of time and energy necessary is not always available.”
That is a key point and perhaps reveals the value of the tool. There are many tools to measure manager performance but not a lot that tell you where that performance comes from. Institutional investors like to take an analytical approach. There are certain exposures they want and certain risk tolerances they can accept.
“It is a very useful tool because some allocators are going to have specific ideas of what they want and need help putting it together,” says Oliver Evans, managing partner for the Apercus Holdings Family office.
It is easier for a manager to select a well-defined style index than to select from among a group of managers who may not be offering that precise exposure. “You have the ability to run your own risk profiles and be able to customize your investment with this type of product and how it fits into what you need for the rest of your portfolio,” says Marc Goodman.
Evans points out that most hedge fund managers rarely generate alpha or generates ‘dirty alpha’ instead. He explains that often a hedge fund is long one factor and short another, such as buying mid-caps and selling the broad market. Such as strategy would be relatively easy to replicate and not truly an alpha driver.
Sambamurti adds, “You could create a business around this. Their value proposition plays pretty well with smaller fund of funds or fund of funds that are trying to differentiate themselves by their ability to offer lower fees. It is huge.”
The alternative space has come under attack because of its fee structure, and MSR, like other investable indexes, offers a more palatable fee structure.
“When returns are good people don’t complain so much but when returns are more compressed like in the last few years, many institutions start to [complain] about the double layer [of fees],” Sambamurti says. “It is not to say it can’t be defended, but if you feel like you don’t necessarily need to have the best alpha of a manager at a particular time—your alpha is really derived from being exposed to a certain strategy type at the right time—then you can build a business with a lower fee base.”
Marc Goodman adds, “People are happy to pay for alpha, but why pay for beta if you already have a method to gain the exposures to certain benchmarks you need and want by paying very little by using an index. Then spend the rest of your time looking for truly beta generating managers.”
Rulle says he is a fan of trend-following even though he thinks his index can replicate much of that sector’s performance. He points out that one of the most compelling analyses of its value is a rolling 12-month performance compared to the S&P 500 (see “Performance when you need it,” below). The first chart shows how managed futures tend to perform at its best during poor performance periods of the broad stock market.
Rulle says, “I always wondered why [trend followers] have not promoted a 50/50 combination of 60/40 (60% long equity investment with 40% long fixed income) and trend following. Rather than trying to persuade someone that they should put some amount of trend following with their 60/40, we decided to create a product 50% 60/40 and 50% trend following.”
MSR offers this index at 100 basis points which provides an investor an all in diversified product. While one can create this with strategic allocations, this offers a pure trend-following approach. A specific manager such as Winton may offer good performance but are you getting the exposure you need? Many managers offer hybrid approaches that combine short-term and countertrend elements to dampen volatility. This may improve the overall return but changes the exposure.
“You get good results but are they 100% trend-following?” asks Rulle. “You wouldn’t have known back in 2007 that [Winton was] going to cut their volatility in half. You don’t [always] know what you are getting when you invest in other managers. With us you know everything that you are getting because you have daily positions; those that invest with us get the algorithms of the index.”
“I definitely think you can build portfolios of diversified CTAs, but unless you can identify the trend followers that really have an edge—and their numbers are better because they are doing something different—then trend following is one of the strategies that you can save money on,” Goodman says. “Unless you can find an edge, don’t pay for it.”
He adds, “In the last few years everyone moved to the largest managers; a tool like this will let people be able to see that the largest managers aren’t necessarily the [most unique].”