Sunday, 25 September 2016
Last updated 2 days ago
Oct 22 2013 | 1:41pm ET
After decades at financial institutions running billions of dollars, Scott Wallace struck out on his own this year with $5 million and a long-biased hedge fund.
“I must be a slow learner,” laughed Wallace during a recent interview with FINalternatives. “It took me close to 30 years of working for large, multinational, global financial firms to realize I wanted to start my own gig.”
Wallace, who launched Chicago-based Ranger Asset Management* in February, spent 16 years at JPMorgan Chase, leaving in 2000 as managing director in charge of Japanese equities, followed by a dozen years at AllianceBernstein, where he was a partner responsible for the $14 billion large-cap U.S. growth team.
Now, he's managing Ranger Opportunity Partners, a long/short hedge fund focused on large-cap U.S. stocks. The fund typically holds 20-30 stocks in its long portfolio and is up 13.04% through the end of August.
For an old-school manager like Wallace, the fund is a throw-back to “the way hedge funds used to be managed a really long time ago.”
“They were mostly biased to the long side, they made concentrated stock bets, they were good at research and they weren't as concerned about hedging out every last factor exposure or industry exposure or risk because, to a certain extent, if you don't take any risk, you aren't going to have much in the way of returns.”
Wallace also sees great opportunity in a new market environment.
"The last 10 years have been a very unique period in history,” said Wallace. “We've come through a couple of wars and big terrorist activities, a giant financial crisis—markets overall have really done nothing over the last 10 to 12 years. That's more a unique period than the normal state of affairs."
“It seemed to me, for a lot of reasons that we're going to head into a more normalized environment—I like to call it 'the Great Renormalization.' Central banks will do a little less quantitative easing, interest rates will rise globally on a long-term, extended basis, and equity markets in general ought to do better because the starting point for valuations pretty well everywhere in the world is pretty low.”
In this environment, he said, divisions between “traditional” and “alternative” investment approaches may no longer be helpful, he said.
“In the last 10 years, the alternative guys have taken a large share of available, investable dollars. After a cursory examination, one might say, 'Well, that's because the hedge fund guys are just smarter and better investors.' Well, maybe, but it also could be a fact that in a trendless, highly-volatile market, if you have your investment strategy set up so that you can make two-way bets both long and short and you can dampen volatility by using all sorts of alternative instruments, in that environment, that's a better strategy to pursue. And if the only bet you can make being a long/only manager is simply to be long, and simply to take all this volatility, that's just a bad environment for you.”
“The alternative guys look better than they otherwise should have looked, because of the environment; the long-only guys looked worse than they should have looked, because of the environment. And I think the truth is somewhere in the middle.”
In the Great Renormalization, as markets become “smoother,” being generally long or long-biased is “probably a good thing,” Wallace said, but “only being long and having no alternative strategy at your disposal is also a mistake."
“The correct strategy that I see is this hybrid middle ground where you utilize a lot of traditional hedge fund techniques to manage your portfolio, but at the same time you're mostly biased to the long side. In a somewhat lower-volatility environment that is trending upward, it makes no sense to be 'market neutral' or completely hedged or to have every risk expunged from the portfolio. That's going to lead to sub-par, crappy returns.”
Pros & Cons
Running his own shop, said Wallace, one of the things he's come to believe is that in managing money, “the benefits of scale run out faster than most people anticipate.”
“Basically, you run a lot of money, you have a lot of clients, you have a big firm to manage, a lot of staff, and just by virtue of that you end up spending less time than you otherwise would hope actually managing the money. That's been a big surprise for me; it's amazing how much you can get done when you're not writing end-of-year reviews for 20 people.”
On the flipside, of course, small firms can't marshal the resources of their larger competitors.
“Clearly, large firms have a lot of resources,” said Wallace. “You have access to a lot of stuff that small firms don't. But if you're trying to be somewhat more long-term-oriented in your investments, beliefs and philosophy, it's not as big an impediment as you might think. Really good ideas that play out over multiple years tend to have a longer gestation period. Getting the first call or acting in the first millisecond to trade something, I'm not sure how useful that is over the long haul.”
Asked about his current market outlook, Wallace said that after the 2002-2008 period, during which emerging markets wildly outperformed the Standard & Poor's 500 Index, and the 2008-2013 period, during which the two performed about the same, U.S. stocks may be poised for “a little bit of payback.”
“We may be heading to a period where the S&P 500 might do a bit better than most emerging markets on a sustainable basis,” said Wallace. “Part of that's driven by less easy monetary policy, part of its driven by the big commodity super-cycle run-up that we've seen. I'm not going to say it's over, but it has moderated and I think will continue to moderate. There's a little more in the way of headwinds for those emerging market countries which are natural-resources exporting countries."
“Contrast that with the U.S., where you've got stocks that are relatively cheap, especially in contrast to alternative investments, bonds and the like. You've got corporations which I think have managed themselves exceptionally well and have put up very good earnings in the face of modest revenue growth.”
Wallace's final reason for optimism about S&P 500 earnings is more “tactical” but, he said, worth emphasizing.
“Pension costs for big S&P 500 companies have probably been a drag on company earnings to the tune of 3% to 4% over the last couple of years. Given what has happened with equity markets, which have generally risen, and interest rates, which have generally risen, those two things have sort of conspired together to reduce the ongoing size of the pension expense that many of these companies are going to have to bear."
“If you have this negative of 3 or 4% to your earnings, and that goes away and perhaps even turns into a tail wind, that's 3% to 4% of an earnings boost that you didn't anticipate. You're likely to start seeing that next year into 2015. Actually, very few people are talking about that, I think this whole pension thing could be surprisingly strong tailwind to companies that most people don't see today.”
*Since this story was published, Ranger Asset Management has changed its name to Shorepath Capital Management.