Sunday, 28 August 2016
Last updated 1 day ago
Aug 28 2013 | 10:33am ET
The new Litman Gregory Masters Alternative Strategies Fund is a mutual fund providing investors access to hedge fund managers. Currently, the fund has four underlying sub-advisors—ranging in strategy from arbitrage to opportunistic income. It manages $600 million and is open to adding new sub-advisors.
Jeremy DeGroot, CIO of Litman Gregory Asset Management and portfolio manager for the alternative strategies fund, says it's a good fit replacing some portion of a traditional stock and bond portfolio. He spoke recently with FINalternatives Senior Reporter Mary Campbell.
What distinguishes the Litman Gregory Masters Alternative Strategies Fund from other mutual funds employing hedge fund-like strategies?
We think we have world class managers and that, first and foremost, is what I think makes this fund different. In addition to that, the benefit of having different strategies in one fund vehicle gives you additional diversification.
We [also have] a very attractive fee structure for the fund. We had a definite objective of having reasonable competitive fees and so we have capped the fees on the institutional share class at 1.49%; the minimum [investment] there is $10,000 on most platforms, so a reasonable investment minimum for an advisor. And the retail share class with a $1,000 minimum is capped at 1.74%.
Tell me about your first four sub-advisors.
We first drew upon our existing universe of managers that we had invested with in the past, so that would be the case for FPA, Steve Romick and his team. We'd been an investor with FPA—First Pacific Advisors based in Los Angeles—including a hedge fund run by Steve Romick, going back 10-15 years.
Loomis Sayles, we've been long-term investors in the Loomis Sayles Bond fund. We've done deep, qualitative due diligence on and been investors with them over 15 years and knew the quality of their credit research, knew Matt Eagan from his work with Dan Fuss, and then did the additional work specific to their strategy for our fund.
Jeffrey Gundlach and DoubleLine, our history with him doesn't go back as far as FPA or Loomis, but we had done a lot of due diligence to invest in a hedge fund that he was running at TCW before he left to start DoubleLine, and then followed that up with full due diligence specific to the Opportunistic Income strategy he is running for us.
And then in the case of Water Island, the arbitrage managers, we had already been investors in their public merger arbitrage mutual fund, so we knew them well. But we took our due diligence to an additional level when evaluating them as a potential sub-advisor for our Alternative Strategies Fund.
What factors do you consider in evaluating potential sub-advisors?
The work we do is a combination of qualitative and quantitative research. The quant side is thorough analysis of historical performance and, for these strategies in particular, understanding the downside risk, the volatility—how they managed through some rough market periods in the past we thought might give us insight into how they might manage through future volatility and 2008, that was a pretty rough period. The managers had all been running similar strategies, so we were able to analyze and discuss with them actual performance through 2008, gaining some insight into what drove their performance, any mistakes they might have made, how they learned from that experience.
Are you concerned about how big a percentage of a manager's assets you represent?
In the case of these four managers, they all have very, well in some cases, very large assets—Loomis Sayles manages roughly $200 billion in total, DoubleLine has obviously grown extremely rapidly to $50-$60 billion; Water Island is in the low single billions, they're not a huge firm; and FPA, the strategy Steve Romick [runs] is maybe $15 billion; so I think...we're a relatively very small percentage of their overall assets under management.
So you tend to select large managers?
I think we don't go in saying 'We only want to invest with managers that already have a huge asset base.' That's not been the starting point. A starting point is, we want to have a basis for having a high level of conviction, confidence in a manager and having a track record to analyze and to discuss with them...and to understand how they managed through different economic and market cycles, that is really important to us to help us gain confidence looking forward.
In the case of Gundlach, when we hired him for our fund, he wasn't running $50 billion, he still had the cloud of the litigation hanging over his head [Gundlach both sued and was sued by his former employer, TCW] but he had a tremendous track record in terms of...risk-adjusted performance so we weren't worried about being a large percentage of his total assets in that case, we thought about the litigation risk for example, but it wasn't an asset question.
We're not closed off to much smaller managers but we really want them to have a track record...We don't believe performance repeats...but I think the risk management side, that may have more validity in terms of understanding again how they structured a portfolio how they think about risk and then being able to test that against past performance.
How do you allocate between the four sub-advisors?
When we launched the fund we said our neutral allocation would be equal weighting [of] each of these four managers.
There's not a targeted dollar amount. There is the default allocation of equal weighting and there is a sense of how big each of these managers is, what their asset capacity for us could be.
Are you looking to add additional managers?
We are definitely open and looking at other potential strategies and managers to add to the fund if they meet that hurdle I mentioned at the beginning. We're not going to just add a strategy for diversification if we don't have confidence the manager really has skill to execute that and add value...
Things we've talked about are managed futures,...certainly a distinct type of strategy, that's an area we've done a lot of work on. Long/short equity, in theory would be appealing, in practice identifying a skilled manager who's willing to work for mutual fund fees [laughs], it's kind of the old story, are they really that good when they could be running a hedge fund, making their 2 and 20?
Long/short credit, other arbitrage strategies, those are strategies we'd consider. Market neutral again, in theory, could be interesting but in those cases it really does come down to confidence in a specific manager and we're not there yet.
What advantage does a hedge fund manager gain by working with you?
I think there is that positive halo effect to associating with Litman Gregory, to have been selected or identified to be a 'Litman Gregory Masters Funds’ manager. They view that as a benefit to their overall business even if we are a pretty small sliver of their total asset base.
[W]e'll be patient with them if they're going through a period of underperformance if we understand why and that is consistent with how we understand the way they invest. And I think that's pretty rare, the long-term investor mindset, and that's valuable.
Also, these guys are all just super passionate investors. They run a business, they like to make money from running an investment business but they really love first and foremost being an investor and winning and performing for shareholders. And running $150 million [their share of the fund] isn't petty change for them, it's meaningful.
Do you pay typical hedge fund fees?
I would say no. We negotiate—hard-nosed may be too extreme, but we aggressively negotiate the individual sub-advisor fees. You can start with Jeffrey Gundlach, who is running a very similar strategy as a private hedge fund. We're paying him a flat management fee, there's no additional performance fee on top of that and it's, I think, extremely reasonable and the same goes for all the other managers. I think we've negotiated better-than-average fees, particularly for the caliber of managers we have. We're not paying them the hedge fund fees for what we think are hedge fund-like strategies.
How much leverage will your sub-advisors employ?
In the mutual fund world, you're allowed basically up to 33% leverage at the overall fund level. In the case of these four managers, the Water Island team, the arbitrage managers, we expect them to utilize a modest amount of leverage—30%, 40%, 50% at the max, which probably wouldn’t be sustained. And then Jeffrey Gundlach and the DoubleLine strategy have indicated that they may use leverage up to 30% or 40%, which is consistent with how they run their hedge fund. Right now they're not using leverage because the opportunity set isn't so compelling and he doesn't want to take on that additional risk. The arbitrage team is utilizing about 15%-20% leverage on their arbitrage portfolio, and then the other two strategies, Loomis Sayles and FPA will not use a leverage line of credit.
What role do you see this fund playing in the average retail investor's portfolio?
We view it as a good substitute for some portion of your traditional stock and bond exposure—and the caveat is, you should assess this within every client's unique objectives and so forth. But as kind of a starting point, we think a reasonable way to fund our fund would be 60% from your traditional bond exposure and 40% from your equity exposure.