Monday, 6 July 2015
Last updated 2 hours ago
Apr 12 2012 | 4:19pm ET
Mutual funds with hedge fund strategies are increasingly common, but hedge fund talent at mutual funds is not. Touchstone Investments has struck upon a solution to that problem.
The Cincinnati-based firm, which has nearly $12 billion in assets under management (thanks in part to its acquisition of Old Mutual Asset Management's U.S. mutual funds business in a deal finalized early this year) outsources the management of its hedge fund strategies.
FINalternatives Senior Reporter Mary Campbell spoke with Touchstone's Tim Paulin, vice president of product management and investment research, about third-party managers and hedge-like mutual funds.
In terms of alternative assets, what sort of funds do you offer?
We have three funds that we would classify in the alternatives space currently. One of them is a market neutral fund that’s managed by Aronson Johnson Ortiz out of Philadelphia. It’s market neutral—essentially equal parts long and short equity—versus some funds in the same category that may have a long bias or a short bias.
We also have a global real estate fund, managed by Cornerstone Global Real Estate Advisers, which is investing nationally and globally in REITs. And we just launched, toward the middle of last year, a merger arbitrage fund, managed by Longfellow Investment Management of Boston. That fund is trying to capitalize, largely, on definitive merger agreements.
Would it be fair to say these alternatives funds offer hedge fund strategies in mutual fund wrappers?
What are the big advantages of the sub-advisor model, from an investor’s perspective?
The biggest advantage is that we’re not confined to launching funds based on the personnel we may have within our organization. Mutual fund companies can become defined by a particular style or fund, and they can be discounted with regard to other areas. In any business, you’re looking at supply and demand factors as to the opportunities of which you take advantage. In a traditional mutual fund company, where you’re constrained by the personnel you have on staff, it could be that you don’t have the right personnel.
Recently we’ve seen more and more interest in low-correlated strategies relative to traditional stock and bond investments. Firms that focus on traditional asset classes and don't have the type of personnel with expertise, credentials or background in alternatives would have a hard time launching something that relies on internal staff. If we identify an opportunity where there’s demand, the main question for us becomes, "Is there a particular sub-advisor or group of sub-advisors that we think have a compelling capability to add value in that particular space?"
What sort of criteria do you use to choose your sub-advisors?
That’s what our clients rely on—that we have a devoted process. It’s not just about the sub-advisors but also using discipline with regard to what types of funds we offer—making sure that the funds represent asset classes we want to be associated with. Then, once we’ve made a decision to have a representation within a particular asset class, we apply a discipline to identifying and, on an ongoing basis, evaluating a sub-advisor that we engage for a particular strategy.
The approach we take is going to be consistent with what you would see from institutional consultants and analyst teams. We focus on a combination of qualitative and quantitative factors—what we call SPIDIR. The areas that we focus on are stability, personnel, investment discipline, infrastructure and results.
You used the word "boutique" when talking about advisors. Do you tend toward smaller managers?
There are two answers to that. We don’t want to work with a firm that’s so small that we’re taking a risk because they haven’t really established stability. On the other end of the spectrum, there are firms like large mutual fund complexes that are, naturally, not launching funds out of the Touchstone organization that would compete with their proprietary investment managers. The there are managers already running money within a mutual fund. Given that we have a single sub-advisor approach to things, Touchstone launching a fund that is managed by ABC, which is already managing another fund, just doesn’t make sense. When we say "boutique," we are referring to institutional asset managers that tend to focus on their investment expertise. They may not be big distribution firms, but they’re not necessarily small.
What do sub-advisors expect from Touchstone?
We sign an agreement with each sub-advisor, and we will establish what we think are reasonable expectations with respect to potential asset growth. Depending on the asset class, you might expect that you are going to be able to raise assets more quickly for some asset classes and strategies that are capacity constrained. Investors are always looking for good ideas—small-cap would be a good example; emerging markets is another good example. Our merger arbitrage fund focuses on smaller deals, so it has a capacity constraint to it, as well. There are not a lot of options in that space, so people are more likely to take advantage of such a fund more quickly based on the sub-advisor’s long institutional record and despite the fund not having a long fund history.
How do you gauge demand for a potential new offering?
We distribute exclusively through intermediaries. We have a retail-oriented wholesale team that goes out and calls on the regional broker-dealers, the traditional wire houses and the LPLs of the world. When we’re talking to people at such firms, we’re given good insights about the types of strategies that they find compelling. That’s an important consideration for us—what’s in demand from our clients. Now, that’s not to suggest that just because something is in demand, we’re going to say, “Right, let’s jump on that.” We have to assess whether it’s something that we think is lasting demand or just fleeting demand. And then we also have to assess whether it’s feasible that we could find a compelling investment manager to manage a fund in that particular space.
Can you give me an idea of a strategy you can’t imagine Touchstone ever launching?
Touchstone had a couple of sector funds, but we see that largely as the domain of passive investing. There’s a lot of rotation that goes on there where people are looking just for exposure to the sector for a period of time, and then they move on to another sector that they feel is in favor. We don’t think that that is in concert with our mentality of asset classes that bear a long-term strategic allocation.
In the alternative space, short-bias strategies are not something that we feel are going to be a good opportunity for Touchstone for some of the same reasons as the sector funds. People who are investing in these short-bias strategies tend to be doing it opportunistically based on a market environment, but they don’t necessarily stay there. Another consideration for Touchstone is that we’re still a fairly small firm having just hit the $9 billion mark, and we want to protect our reputation. We would like to avoid associating ourselves with asset classes that may disappoint because they’re complex and can’t be explained to the eventual user of the strategy. We don’t think a blowup just means you lose a lot of money for a client. A blowup can mean that you disappoint people based on what their expectations were relative to reality. We're using that as a filter as we think about what types of strategies make sense for us and for our clients.
So, the second part of the question, is there a strategy, particularly in the alternatives space, you don’t offer now but could imagine offering in future?
We actually scoured the universe for secondary research to learn from others, so to speak, in the alternatives space and then we did some primary research with our clients. We talked to them about what is resonating with them and where they see potential opportunities moving forward, again, applying this technique of trying to learn from our clients and learn from competitive analysis. It led us to some conclusions that the merger-arb fund that we rolled out did make sense. Yet I think what we’re hearing from a number of our clients is that positioning of alternatives can be difficult with clients.
Further, maintaining an appropriate strategy over time when you’re investing in singular strategies that aren’t well understood is difficult. If you’re talking about having, say, five or six alternative funds, then you’re dealing with the mental accounting that investors apply that result in saying, "Well, why is this one performing so much worse than the other one? Shouldn’t we put more money in the strategy that’s performing well and take it out of the one that’s performing poorly?" A buy high/sell low kind of loop can occur. It’s partly that people don’t really have as firm of a grasp of the alternatives space that they tend to have with the traditional space. For these reasons, we would consider a multi-alternative strategy that would package together alternative classes that make sense. There are some funds out there that have started to have some success in this area. We’re not sure that we would do something like that, but that’s a good example of how we would think about the opportunity.
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