Sunday, 1 February 2015
Last updated 1 day ago
Apr 30 2012 | 7:08am ET
Texas-based wealth advisor Ed Butowsky “grew up” at Morgan Stanley where he spent 18 years, including a stint as a senior vice president in private wealth management, before striking out on his own in 2005 to launch Chapwood Investments, a private wealth management advisory firm. His latest venture is Paramount Access Advisors, a closed-end management investment company that is about to launch a 1940 Act registered fund of hedge funds. Butowsky says the new fund, set to launch on May 1, will offer access to some of the world’s top money managers for a low minimum investment of $25,000. The key to its design, he says, is correlation—or the lack thereof. FINalternatives Senior Reporter Mary Campbell spoke to him recently to find out more about the new fund.
What was the inspiration for this new fund?
I grew up at Morgan Stanley, I was at one point their number one producer in terms of assets under management and production. I ran the high-net-worth group in the Southwest for Morgan…so my business was all high-net-worth investors. I eventually left and went off on my own and…when I did that I started to realize…that there was a huge need for alternative investments in all portfolios.
[T]he world has changed quite a bit…the correlations of assets over the last 10 years has changed drastically because of computer systems and communications systems. What used to work between 1990 and 2000 in respect to how you built a portfolio just doesn’t work anymore, and that’s because of how high the correlations have become between all asset categories in the long-only world. You’ll find variations from year to year, even multiple years, but generally speaking, your large-value, large-growth, your broad-based indices are moving in sync, so you must find alternatives to provide diversification in your portfolios.
Because of relationships that I have developed over the years, I have had the opportunity to work with some of the biggest and best managers in the world. There are 14,000 hedge funds in the United States and about the same number outside the United States, but [although] a lot of these are registered as hedge funds…there’s a huge difference between institutional managers and those who just leave a Merrill Lynch or a Morgan Stanley and say, ‘Hey, I’ve got $50 million, I’m going to start a hedge fund.’ That’s not what the industry needs, they need…strategy managers with great experience, with great backgrounds. So, that’s why I put together this 1940 Act Fund.
What exactly is a 1940 Act fund?
[A] ‘40 Act fund is registered with the SEC and…follows the guidelines of the Investment Company Act of 1940. Ironically, my father…was the head of enforcement in the investment company area at the SEC and co-authored the 1940 Act amendment with a guy named Bernie Wexler…It’s called a closed-end interval ’40 Act fund…
What we’ve done that’s very special is that we have taken access to the top managers in the world, the managers that have the $20 million minimum, down to a $1 million minimum. We’ve combined 14 managers for our launch into one investment that people can access for as low as $25,000. And that’s what makes us unique: We’re providing investors access to what we consider to be very, very, very high-end hedge fund managers that…are limited by law to 499 investors…
What are your criteria for choosing managers?
We’re looking at only institutional-quality managers. Now…that’s a really hard thing to define and nobody really has defined it perfectly. Part of it is a long-term, audited track record, at least seven years, but preferably 10 years; a lot of it has to do with the company they keep, it has to do with their administrator, their clearing firm, their custodian. If somebody is doing business with a Morgan Stanley or a Goldman Sachs, you don’t want to just…say, ‘Hey, they’re of institutional quality because they are with Morgan Stanley;’ that’s not the case, but all these things combined tend to give you a feeling that they’re institutional quality.
They must have billions of dollars under management to be institutional quality, our managers average $8 billion. We look at their prime broker, we look at their law firm, we look at their legal structure, we look at all of that and that gives us a pretty good feel for them being institutional quality and then we also look at who their clients are. So, that’s part of it, but it’s not one of those, it’s all of these things combined. …[W]e have very high-end firms doing in-depth research and due diligence for us and it’s on a continual basis, this isn’t something that we just do one time and then we’re done, this is on a consistent, continual basis.
What is your current mix of strategies?
[T]he key to portfolio management is the correlations, it’s how investments move in relationship to one another. Our portfolio has a correlation of 0.4 to the S&P 500 over the last nine years and most of our competitors have a much higher correlation than that…[W]e’ve accomplished that by investing…20 to 25% global macro, 20 to 25% event driven, 20 to 25% is relative value arbitrage, 10 to 15% is credit arb, 10 to 15% is emerging markets, 5 to 10% is distressed securities, 5 to 10% is merger arbitrage and 5 to 10% is equity relative value.
We will only use managers whose historical standard deviation is 80% or less than its historical rate of return. We’ll only use managers whose historical downside deviation risk is 50% or less from its annualized rate of return. And we’ll only use managers whose historical downside probability is 30% or less. We’re going to use 12 to 17 individual positions, I think a lot of other firms mess up because they have too many managers…we’re not going to overdo it, we believe that because we’re working with the best hedge fund managers in the universe…we feel very comfortable that these managers know when to make changes in their portfolios.
The key here is the low correlation to most indices, access to the top managers you couldn’t get on your own, if you wanted to replicate this, you’d have to first get one of the 499 slots each one of these managers has; and then the second thing you’d have to do is meet their minimums for each client, so that minimum would be about $70 million for each client if you wanted to replicate the minimum exposures; then you’d have to do the research and hire people with the competence and the knowledge of how to do research, because it’s not easy, it’s very different than a long-only world…[W]e have the top firm that does operational due diligence on these firms, we have the top firm that does the quantitative and qualitative due diligence on these firms, they’d have to be able to do all of that, and then to replicate this thing you’d have to get an administrator, an auditor, a custodian, a chief financial officer, an independent board—you’d have to do all of those things along with the general counsel to replicate what we’ve put together for as low as 1%...
How do you find managers? Or do they find you?
We find them and we don’t really want incoming calls, because we pretty much know the managers that we want. We’ll always talk to firms, it’s always nice to find new firms out there, but…our main focus is distribution right now, finding the right registered investment advisors to work with.
How long do you envision your relationships with managers lasting? How often would you rebalance the portfolio?
We rebalance if a manager becomes more or less than 20% of the original allocation or if a material event occurs where we need to remove a manager. No manager will become more than 15% of the portfolio, either.
You’re focused on large managers. Why large as opposed to small or mid-sized?
For a couple of reasons. I want to just work with the largest and best institutional managers. Some people will say—and I will tell you that I do not disagree that your smaller to mid-sized managers can potentially give you better returns, because they can be more flexible, so I agree with that, but you then have to revisit why you’re investing in alternative investments and it’s not to make huge returns, it’s to find non-correlated assets…
[I]f I have a manager up 150%, that scares me, because I don’t want a manager that can have blow-out numbers like that. You invest in hedge funds for the correlation relationships to the long-only asset category, not for the robust returns and people who do it different than that shouldn’t come to us. If you’re looking for non-correlated [returns] with the top managers in the world, look to us, if you’re looking for huge numbers from small-sized managers, go somewhere else.
What stage are you at currently?
May 1st, we’re launching…We’re looking for marketing help as well…We have a relationship…with Shoreline Associates and we’re looking for additional relationships.
Jan 23 2015 | 1:00pm ET
In our new section, FINtech Focus, we will profile one of these firms each week. While fintech is a broad category, we will be focusing on firms that specifically cater to the alternative investment industry. Read more…