Monday, 24 April 2017
Last updated 16 min ago
Dec 14 2012 | 11:50am ET
Newton, Mass.-based F-Squared Investments has added shorting and leverage to its successful long-only quantitative strategy, producing a new hedge fund and mutual fund. The latter has attracted $320 million to the $9 billion firm in less than a year, a fact that Jim Celico, managing director of F-Squared's alternatives division, attributes to "pent-up demand" for such a product.
Investors may also like F-Squared's fee structure: It is waiving its 1.5% management fee and instituting an 8% performance hurdle on its 20% incentive fee for early investors. Celico spoke to FINalterntatives Senior Reporter Mary Campbell recently about F-Squared's latest launches.
Tell us about F-Squared.
We're a rapidly-growing, privately-owned quantitative investment firm, currently advising a little more than $9 billion in assets. It's foundational philosophy is to lead the industry across multiple style portfolios with an eye towards, we usually say, embedding downside risk control inside of everything we do.
Most of our clients are coming to us to help them manage tail risk, and every portfolio we manage relies on a fairly straightforward quantitative process and uses exchange-traded funds inside actively managed portfolios.
We sub-advise a series of mutual funds for a firm called Virtus Investment Partners, which used to be Phoenix Investment Partners. We sub-advise and manage a series of separately managed accounts, we have a portfolio replication arm and then, obviously, I head up the alternative investments group.
How long have you run your strategy?
The signals that we rely on have actually been live—and what we mean by that is they've had live assets tracking those signals—since April 2001 on the long-only side. F-Squared launched and brought that to market in '06, '07. Our long/short strategy is a relatively new venture for us. Our traditional hedge fund vehicle has a full-year track record, the separately-managed account version has a little over a year, and we took over management of the mutual fund version in February.
Why did you decide to launch a hedge fund?
For a couple of years now, clients, both institutional and retail, have been saying our track record suggests that we have an ability to follow trends accurately and in many cases, when we sell out of a sector, the sector subsequently loses money with a high degree of probability. So it was a natural evolution for us to express that buy-sell as a levered long/short.
We had pent-up demand for the long/short strategy: Even though we haven't gone out and done a real roll-out, the 1940 Act fund has raised $320 million and we haven't even been out there for a year yet. Really, it's pent-up demand, I would say, with folks that knew us on the long-only side and said, "Gee, this works, it makes sense, we need this, it seems only natural you'd express it as a long-short."
Why use ETFs?
We are primarily known as an investor in sectors, so obviously there was a natural fit with sector ETFs for what we do. They provide wonderful transparency, wonderful liquidity and actually a fairly straightforward and simplistic approach. We're trend-following and focused on sectors, and we use the sector ETFs as a critical component to our quantitative models. It was kind of a natural fit. We weren't managing a portfolio and then ETFs came out and suddenly we decided, "This is the way to go." It's just a natural harmony for us.
How do you employ shorts and leverage in your strategy?
We employ dynamic leverage on the long side of our book—in the hedge fund and even the 1940 Act fund. What I mean by that is, depending on how many long positions we have, we'll have leverage on at different amounts. In the mutual fund there's a lower limit, we have a max of 30% leverage in that fund, or 1.3 times.
In the hedge fund, we have a fairly decent-sized institutional book, it is going to employ a maximum of 100% leverage.
And on the short side, the hedge fund is one-to-one and the mutual fund version of the hedge fund is a 0.5-times, so it's a conservative short. In the mutual fund you have a 1.3-times max, 0.5-times max on the long-short and in the hedge fund you have a two-times max long, one-times max short.
You invest across nine sectors with State Street SPDRS. Can you tell me something about your positioning?
Our possible positions are long with no leverage, long with leverage or short a sector. So, we're either long or short. There is one possible scenario where you could end up with a sector where you weren't long or short, and instead actually just might be in cash, because you covered the short on that sector so you have a neutral position, but that's rare.
Typically we are either long or short, and we may have leverage on, on the long side. Every week, we run our engines and we look at every one of the nine sectors and make a decision, or we obviously have a no-change scenario, which is most weeks for us. We're not running a highly-active, high-frequency model here; we're using a trend-following, price momentum-based model.
How long do you tend to hold a position?
Our average holding period, historically, has been about 13 months, but I always temper that by saying it can be bumpy, averages being what they are. If you were to look over the course of the last 24 to 36 months, with the volatility and the change in the market, we definitely have had more changes in our net positioning than we had probably through the period say from 2004 to 2006. And both volatility and the trending sectors support that. We may go periods of time where we are in a sector for a long time, even multiple years, or we may go through periods of time where we're long in a sector only to be short it six months later or a year later.
As a quant manager, have you had to tweak your formula since you first began trading?
One of our strengths, we think, is a fairly straightforward process. So while we've definitely had enhancements—in '07 there was a mathematical, rules-based enhancement that helped us be more dynamic in the way that we adjust some of our moving averages. On the back of '08, with the trading gaps in data and smoothing there, there was a temporary enhancement that we used and that helped us in 2009. And if you look more recently, we've made some pretty significant enhancements internally that help us, particularly on the alternatives side.
So we're always looking to try to enhance, to potentially improve our accuracy. We're very sensitive not to radically change what has essentially been successful. If you looked at us in 2008, on the long-only side, where the bulk of our assets were, we protected amazingly well—our index in 2008 was down less than 2%. And then in 2009 we outperformed the market. If you looked at us last year, we had half the volatility of the S&P 500 in a very difficult environment, a whipsaw environment that really undid a lot of quantitative shops, and we generated a positive index return—slightly behind that of the S&P.
What is your outlook for the immediate future and how will it affect your strategy?
What's interesting about us is we're rules based and we're price momentum-based. We use what we think is the most forward-looking metric in the market, which is the current price. We're not even concerned with why or how the price got where it's at today, we take that current price and reference it against a historical price to determine trend. We wouldn't be predicting the future or trying to say where we think markets are going.
One of the reasons so many people have flocked to us is because, regardless of where it's going, we're going to look at it relative to where it was and if it's trending positive, we're going to own it and if it's trending negative, we're going to short it, and we don't really care what the reason is.
What is the role of this strategy in an investor's portfolio?
Here's the deal: You're in a low-interest-rate environment, you've got embedded risk in fixed-income that people feel is on the rise, they no longer think about tail-risk management in fixed-income as a possibility, they're just asking themselves what the probability is and we think that that's a good conversation to have.
In addition to that, on the back of things like the Bernard Madoff Ponzi scheme and all of the lockups and gates that went up in the financial crisis, we know transparency and liquidity are at a premium. Investors, institutional as well as retail, are willing to live in a reduced return environment for certain types of strategies in exchange for increased transparency, liquidity, and potentially segregated separate accounts.
This massive conversation is centered around two main concepts: One is tail-risk management. These tail risk events seem to be occurring more often, they're obviously destructive, and they don't necessarily fall into the realm of mean reversion, which an awful lot of modern portfolio theory is centered around.
Second is, how are you going to embed risk controls in the allocation? What we're hearing from institutions a lot, retail investors as well, is that fixed-income is no longer able to provide the yield it once did and they need to find returns somewhere else, especially the foundations and endowments. In addition, it's not going to provide the risk control, as it has historically, nor the lack of correlation to say, U.S. equity returns, that it has.
One of the reasons we've seen our demand spike is because if we look at our record relative not only to U.S. equity but gold, some hard assets, even the Lehman Aggregate Bond Index, this long-short strategy can provide inverse correlation.
The long/short equity side of the industry has been an area that has not held up particularly well, and we know a big piece of that has been the short side of the book. We've seen a lot of institutions talk about trying to get long/short managers to break out their long book and just pay them as a long manager and be willing to do some incentive-based compensation or fee on the short book because that's really where the difficulty is.
We have an advantage there because we're trend-followers shorting a sector. Sectors trend naturally, and we can actually execute at the sector level, whereas a lot of the long/short folks, particularly as they grow and take in more assets, have a real struggle to put those shorts on and be able to make money on those, particularly as you move down the capitalization scale.