What do some of the most successful investors of the modern era: Ackman, Icahn, Dalio, Paulson and Griffin have in common? They run large hedge funds. While the debate rages about whether active investment management outperforms passive, there is no doubt that certain investors have proven remarkably adept at generating above-average returns over long periods of time.
But hedge funds are notoriously secretive and available only to the very rich. How can average investors play the selection skills of these hedge fund gurus?
Among its 51 exchange-traded funds (ETFs) managing some $3.7 billion, New York-based Global X offers the Global X GURU Index ETF (GURU), a $186 million long-only equity fund anchored on the requirement that institutional investors owning more than $100 million of assets publicly disclose their holdings every quarter. These disclosures, known as 13F filings, can provide key insights into the trades of the most profitable active managers in the world.
Academic and industry research has generated empirical evidence that suggests replication strategies based on such filings can lead to outperformance. Moreover, the data shows hedge fund 13F filings tend to be more predictive than those of other institutional investors--underscoring the stock-picking prowess of these managers--and that further screening hedge funds and their holdings can produce alpha.
Modern Trader caught up with Global X CEO and portfolio manager Bruno del Ama recently to discuss how GURU works.
Modern Trader: How does GURU know which funds to follow?
Bruno Del Ama: The first phase of our selection methodology filters the hedge fund universe down to funds whose 13F moves we want to follow. We begin with third-party databases and screen for funds with $500 million or more in assets under management because our research has shown larger funds generate more alpha.
Then we look at the 13Fs for a series of fund characteristics, such as low turnover. Because the filings are quarterly, the more turnover in a fund, the less valuable their filings are to us because position moves are obsolete by the time they are reported. Then we look at concentrations—the larger a position is as a percentage of a fund’s portfolio, the more we can assume it is a high-conviction trade. From there, we filter for funds where the largest position is at least 5%. We end up with a universe that changes over time but typically includes 50-60 managers.
MT: How do you know which positions to replicate?
BD: Once we have the fund universe defined, we take the top holding by weight from each manager, and apply liquidity and market capitalization criteria to them to ensure they can be replicated in an ETF structure. We allocate 2% to each stock and equally weight them within GURU. Obviously, overlaps happen, but we will only count a stock in the ETF once. At the end of the process, GURU holds around 50 equity positions.
MT: How is the portfolio modified over time?
BD: The Solactive index we track rebalances every quarter as new 13Fs are released. We only sell a position if it drops below the third-largest position within the hedge fund in question, or when it is no longer above 5% of its portfolio as revealed in the 13F. The quarterly frequency of the filings means there is the potential to trail manager movements, which brings us back to why screening for turnover is so important.
MT: How did you develop your screening criteria?
BD: All steps we take in GURU are correlated with higher alpha. Larger funds with high conviction positions and low turnover tend to generate greater alpha, all else being equal, than other funds.
MT: What is the capacity of GURU?
BD: There is certainly a size at which there could be an issue. We’ve looked at the fund’s mechanics, and our liquidity filters could eventually create thresholds that would make replication in an ETF difficult. North of $5 billion in assets, we might consider closing it.
MT: Sum up GURU’s investment case.
BD: Our job is to deliver alpha, and we know from the research that the managers and positions that make it into GURU will tend to generate alpha over time. Active management works, but fees can kill it. That’s why taking this approach in an ETF structure is so useful—it’s a passive implementation of an active strategy, giving investors a way to gain active exposure to some of the best investing minds on the planet, but within the low-cost, liquid and accessible wrapper of an ETF.
MT: Does GURU’s performance match your pitch?
BD: Absolutely. GURU has done well, booking nearly 23% annually since inception three years ago. We’re more than 10% ahead of the market on a cumulative basis, showing alpha generation is possible with this strategy, and we earned five stars from Morningstar based on the fund’s risk-adjusted performance and fee levels.
MT: Will the changing interest-rate environment impact GURU? Will it favor active managers?
BD: Yes. The macro environment is very relevant to active managers because they can modify portfolios to suit conditions as they develop. An interesting aspect of GURU is how its sector representations compare against the S&P 500 over time. Combining 50 positions across all these large funds gives us insight about where the collective hedge fund mind is heading—favoring consumer discretionary over industrials, for instance, or mid-cap over large-cap, high volatility over low, etc.
MT: What else does the GURU family offer? What are your plans?
BD: There are two other ETFs in the GURU family: A global version (GURI) that applies our approach to ADRs and foreign companies with primary listings in the United States, and an activist fund (ACTX) that launched earlier this year. We’re exploring a long/short version of GURU, but for now we’re keen to digest and grow what we have.