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Saturday, 21 January 2017
Last updated 4 hours ago
Nov 14 2013 | 10:05am ET
Maz Jadallah, CEO and founder of AlphaClone, said the firm was born out of frustration at his inability to access the world's best active investment managers. Jadallah, a former Time Warner analyst, solved this problem in an analytical way: using 13F forms to identify the high-conviction ideas of hedge fund and institutional money managers, then cloning those ideas in a series of managed accounts (and, as of last year, an ETF). Coming up on its three-year anniversary, AlphaClone manages about $25 million ($17.5 million in the ETF, the rest in the firm's managed accounts) and has a track record Jazdallah told FINalternatives Senior Reporter Mary Campbell he's happy to present to potential investors.
What was the genesis of AlphaClone?
I started AlphaClone because I saw this dataset where hedge funds had to disclose their positions to be a very valuable place to start before one invests their own capital.
It really started out just as a personal project. We built a small dataset and did some simulations around what happens if we follow 13Fs, or follow managers and the results were pretty eye-opening. We decided to build out the dataset to include a lot more managers and go as far back as we could, to 2000, and then just started running research around—we call them 'clones' but they're basically rules-based investment strategies that follow a single manager or group of managers. We got smart about what the right way was to construct clone strategies—you never want to follow one manager alone for obvious reasons, you always want to follow multiple managers so you want to mitigate blow-up risk and performance risk and data risk and all these sort of risks...
We launched a research service in December 2008 that basically sold access to our simulation platform and quickly realized that we had a pretty good product…We registered with the SEC in 2010 and started offering managed accounts to clients. We developed our own handful of strategies and we're coming up on three years now and the results have been very, very good. Last year we launched an ETF because we wanted to make it really easy for financial professionals to access some of our best research and the ETF form is very convenient for that.
How do you choose the managers you follow?
We developed something called the Clone Score, which is basically a persistence-in-return score, from the managers' clones over a long period of time. If you just chase performance, where you've got a high annualized return number for a manager, that's risky. What we do is we slice the manager's holdings into multiple clones and we look at monthly returns and we look for two things: yes, we want you to outperform a threshold but we want you to do that a lot. We don't want you to just hit it out of the ballpark in one year or two years and then underperform the rest because that's not as good as being consistent. We grade everybody continuously every six months. We pick managers with the highest Clone Score. If you think about our dataset, our dataset is nothing more than a pristine view of a manager's long-selection skill, which is the textbook definition of ex-ante alpha, except before the fact, and it's pristine because it's not mucked up by the manager's use of leverage or shorts or hedging, it's just pure selection skill on the long side and we leverage that.
Do you have criteria about assets under management or length of track record?
We've recently added a few funds with really short filing histories because a client wanted to see how they would clone. I think that there's a lot of out-sample risk when you're including managers with relatively short filing histories. I like at least three years of filing history. Beyond that, the managers we clone tend to be fundamental, bottom-up investors whether that's activist or value or high-conviction. Whatever strategy they're deploying, the ones that I think make the most sense to follow are the ones that are fundamental in nature and are doing a lot of fundamental research, not the global macro guys for example or the multi-strategy guys.
The reason these filings are valuable is we've uncovered two things, I call them myths about hedge funds. [First], holding periods are a lot longer than most people think. There's this perception out there that these guys are in and out of stocks every five seconds and that's just not true—the average holding period is about a year and for high-conviction positions, it can be even longer than that.
And the second thing is, at least on average, we're not seeing a lot of outperformance on the short side. We see most of the returns coming from the long side which is the opposite of what most hedge fund managers will tell you. And the reason that we know that is because we can compare the manager's actual long/short performance with the manager's clones, which are long-only, and those performances tend to proximate each other very often. If the clone is doing 30% in a year and the long/short performance net of the manager is 30% or 25% or 35%, then you know instantly that he's not generating a lot of alpha on the short side.
But the ETF is a long/short vehicle, correct?
We use our 13Fs to pick our long positions but that doesn't mean we need to be completely naive about volatility and market corrections, so we have a synthetic hedge, we call it a dynamic hedge, and it's also rules based so it doesn't depend on how Maz feels when he wakes up in the morning [laughs].
What it does is it allows our strategy to vary from being long-only to market-neutral. There are only two states, long-only or market-neutral—and it's based on a technical trigger, the 200-day moving average of the S&P 500 at every month-end. We only ever evaluate the trigger at the end of the month. And so, if the S&P closes below its 200-day moving average at the end of any month, we move from being long-only to market-neutral and then we wait till the end of the following month to evaluate and if it's now above, we remove the hedge. If it's still below, we maintain the hedge.
That hedge has done really well in protecting capital at critical times in the market—it did well in 2001, it did well in 2008...The odds that you're running long-only during protracted bull markets are very high and the odds that you are well-protected during protracted, multi-month bear markets are also high. And because historically you would have run market neutral probably a third of the time on that rule, it gives you the annualized performance you're after but it also gives you the lower correlations and the lower volatility that you're after as well. What it looks like is that you basically invested in the best hedge fund of funds in the world.
How many positions do you tend to hold? Does it vary by strategy?
For the strategies and separate accounts, it's between 10 and 30. I think our International strategy holds 10 positions, 10 ADRs; our Activist strategy holds 15-16; our Momentum strategy holds 25; our Select strategy holds 30; and our ETF holds 70.
Tell me about your Activist strategy.
It's long-only. It's our best performer over the last 36 months...It's got an annualized return of 24.5% annualized over three years.
I think activists have done really well in the last three years, it's been a great market for them, there's been a lot of value, there's been a lot of agitation for change. I think they've done better than other approaches because I think activist strategies are less susceptible to the overall market than say, a market-directional long/short strategy would be.
What is your next-best performing strategy?
Actually, on a relative basis, our Momentum strategy is doing really well. I think it's outperforming both it's long/short and it's long-only benchmark, which is what you want.
That Momentum strategy, it's cool because we tend to look at the manager's recent performance and we're not looking for momentum stocks, per se, we're looking for momentum of the manager's clones. So the strategy tends to pick managers that are doing well in the current environment for whatever reason and we pick managers based on that and then build a strategy based on their disposed positions. And that one tends to tilt small-cap as opposed to our Select, Activist and Value strategies and our ET—they all tend mid to large caps.
What is the role of AlphaClone in the average portfolio?
We seek to augment or replace a manager's long U.S. equities allocation. We don't want to be viewed as a liquid alts strategy; we don't want to be viewed as a sliver of a sliver of a sliver. We're really going for the equity allocation inside the portfolio and because our strategies tend to be dynamically hedged, it's just a better way to gain exposure to the U.S. market.
It's a strategy that's mindful of risk and allows a person to actually spend their risk budget a lot more intelligently. Today in portfolios, people tend to mitigate risk simply through diversification, they never think about these dynamic decisions that allow their portfolio to change from being long to market neutral and so, that's really where we belong, that's where we want to be, the U.S. equity allocation.