When Brian Cunningham launched 361 Capital in 2001, he was using his already extensive experience in the alternative investing world to build custom fund-of-fund products. He had spent his entire career as a consultant allocating to other money managers. But after a decade of allocating to other traders, he thought he would try it for himself. He began with a hedge fund replication product that would use futures to adjust the portfolio’s beta.
“I looked at a lot of money managers and believed that it wasn’t that hard and we could probably do it better and that is what we did,” Cunningham says.
So, in 2011, he launched 361 Capital as a commodity trading advisor, trading index futures. Cunningham was part of the emerging trend at the time of offering managed futures strategies in a 40-Act Fund wrapper. The mutual fund that focused on countertrend programs performed well out of the gate, ranking
#1 in its fund category and remaining in the top quintile — as rated by Morningstar — when he left in 2014. The fund managed more than $700 million at its peak under Cunningham.
“We had a lot of success, but like any single strategy portfolio, it had days it did well and days it didn’t do well, so I came up with the idea of putting together complementary strategies in a portfolio,” Cunningham says.
So in 2014 he left 361 Capital to launch Synergie Capital Management to implement his diversification strategy. He paired his short-term countertrend approach with two other non-correlated styles.
The philosophy was the same as with 361 but he created new models and added diverse strategies. Synergie trades a short-term countertrend strategy that trades five markets — S&P 500, Russell 2000, Euro Stoxx 50, CAC 40 and the Nikkei 225 — two short-term trending strategies he calls hybrids that trade the Nasdaq 100 and a relative value strategy that trades the CBOE Volatility Index.
The kicker — while Cunningham was on the cutting edge of offering managed futures mutual funds more than five years ago, Synergie has been registered as a commodity pool with plans to offer managed accounts, but will not be offering the program in a 40-Act fund format.
“There are a lot of landmines awaiting CTAs in the 40-Act space, not the least of which is the [Securities and Exchange Commission] is considering limiting leverage,” Cunningham says. “There are a number of things [it takes] to get CTAs into a 40-Act fund, the first of which is if you are trading a commodity you have to do it through a Cayman trust. That Cayman trust allows a lot of firms to hide performance fees. It was prevalent in fund of fund mutual funds where they would allocate money to CTAs behind a Cayman Trust and could pay on the performance fees. As you know you can’t do performance fees in a typical 40-Act Fund.”
The key issue, which is still unresolved, is the SEC plan to limit leverage on 40-Act funds to 150%. “If you limit leverage to 150% in the CTA space that is going to kill 99% of the returns of most managers,” he says. “I don’t think investors know what they are paying in fees. And last but not least, with the vast majority of CTAs being trend following they just aren’t providing the returns.”
Cunningham adds that the biggest drawback may be diversification rules. “It has always been difficult to put alternative funds in a 40-Act fund. It is not going to go away, but I don’t think it is the most efficient way to run money,” he says.
He acknowledges that the perfect structure for offering managed futures to retail has not been created yet. “The thing you get with the commoditization of hedge funds, is trying to stuff as many dollars as you can into these strategies that are capacity constrained,” he says. “Mutual funds are an asset-gathering business, and asset gatherers don’t always make the investor the best return.”
That is why Cunningham went back to the future in offering his program as a commodity pool. “When I left 361, I decide that I wanted to provide the best returns to investors, and the best way to do that is to have multiple strategies in a portfolio and to limit your capacity. If you limit capacity in a space where fees are being compressed so dramatically… I just don’t know how people are going to be able to do that.”
So far it has worked out. Synergie, which officially launched as a CPO in December, earned 30.02% in 2015, 15.98% in 2016 and was up more than 8% in January 2017 trading Cunningham’s proprietary capital and is now looking for investors.
Despite its strong start, Cunningham says that the market environment has not been ideal for his approach. “Interestingly, the market environment has been terrible the last two years, primarily because the volatility is so low. In a higher volatility market environment we will do much better,” Cunningham says. “It has performed better than I anticipated. I have one countertrend model, two hybrid shorter-term trend following models with more precise inflection points and a relative value model.”
The largest allocation is to his countertrend model, 60%, with the remaining risk split evenly among the hybrid models and relative value.
“The highest correlation is around 0.1 to 0.2, but the countertrend models tend to be negatively correlated to trend following (hybrid) and they are roughly zero [percent] correlated to the relative value model,” he says. “That is one of the things that became apparent at . Any single strategy model is going to have a drawdown from 20% to 30% but if you can run models with roughly zero correlation in a portfolio, [you’re] able to squeeze at least half of that drawdown out. Our target drawdown is 15% to 18%, and these individual models can have a 30% drawdown by themselves.”
Cunningham tends to underpromise, as the strategy, which has been slightly negatively correlated to equity markets, has outperformed its 15% target in the first two years, despite a less than ideal environment.
“There are two things that are drivers of our returns: market choppiness and volatility. How often a market swings up and down — which in January was a lot — is very good for us because it creates more trades,” Cunningham says. “One of the characteristics of a countertrend model is it has a high batting average. We expect to be right on two thirds of our trades and therefore I would like to take more trades; and choppiness gives us more traders. Volatility determines the magnitude of returns per trade, so that is what has been holding us back the last two years.”
Cunningham anticipates doing a soft close when his assets reach $400 to $500 million, but says he has capacity up to $1 billion. “The nice thing about our countertrend model is that it could be applied to a lot more markets around the world. We could trade 12 to 13 more markets to add to capacity. With countertrend it is good to trade more markets.“
He also could trade other markets than the Nasdaq 100 in his hybrid model, such as the Russell 2000, but he says, “the Nasdaq seems to be a sweet spot, and we have no other Nasdaq exposure in the portfolio. It also tends to be one of the more volatile indexes and I like volatility. It is the best result with the current mix.”
He acknowledges that growing assets is harder in the CTA/CPO space, but thinks it will be better in the long run. “The one disadvantage we have versus the 40-Act space is our audience is smaller because there aren’t as many investors that can meet the accreditation requirements,” he says. “[But] in the 40-Act space you tend to have attrition; just natural turnover in a portfolio. You are going to lose about 30% of your assets every year on average. I managed hedge funds before and I never saw that. What we experienced in the 40-Act space was kind of a bucket of cold water in the face. I would rather have a stable asset base and get to know my customers real well because it is hard to acquire new business.”
So Cunningham is returning to his roots, and he suspects just in time. “The biggest flows in mutual funds are coming from defined contribution plans. Defined contribution plans don’t like investing their money in funds that have a 200-basis point expense ratio, which leaves out the entire alternatives world. It is going to be hard for alternatives to raise assets in that space,” he says. “I would not go into the 40-Act space again, I don’t think it meshes well with alternatives.”
When he launched his managed futures fund in the 40-Act space in 2011, Cunningham was somewhat of an outlier. His new program, offered as a CPO, is one as well. “That’s what makes a good trader, you have to be a little bit of a contrarian, that is why I like countertrend so much,” he says.