In structuring the Morgan Creek Global Equity Long/Short Fund—a hybrid best idea fund of funds that was up a little over 25% in 2013—Mark Yusko borrowed an approach used by the giants of the hedge fund industry.
“If you go all the way back to the early days of [George] Soros or [Julian] Robertson, it's what they did,” Yusko, CEO and CIO of Morgan Creek told FINalternatives by phone from his Chapel Hill, NC office. “They would farm out money to compelling individual managers and then they would look at their portfolios and they would double up on their best ideas in a center book.”
“Soros was famous...for saying, 'What's your favorite trade? Okay, I'll buy 10 times as much.'”
The Morgan Creek version of this approach consists of an underlying portfolio that accounts for 80% of the fund's $100 million in assets and allocates to 10-15 managers. The remaining 20% is invested in Morgan Creek Direct—a center book consisting of the those managers' top 20 ideas.
The Global Equity Long/Short Fund didn't always look like this: it began life in 2005 as a private long/short fund. When they launched it, explained Yusko:
“We had this idea that we would create a concentrated portfolio of our best ideas in long/short hedge funds.” The fund performed well from 2005 to 2009, but by 2010, returns began to go down, relative to the index:
“Post-crisis, what we saw was a lot of managers managing a new risk, which was business risk. They started to lower their gross exposure, lower their net exposure. They didn't lose money but they just didn't get as much upside capture as they had before,” said Yusko. “We said, 'Let's think about how could we address this. So I came up with this idea of hybridization.”
“We concentrated the portfolio into our 12 best manager ideas and then from there, we had good relationships with these guys and good transparency and so every month...we look at the holdings on the long side and we rank them, and we take the top 20.”
They ran the hybrid fund on paper for a year in 2012 before launching it in 2013. Yusko said that over the fund's 26-month history—12 on paper, 14 live—there have been six negative months and the fund has outperformed in five of those and been positive in three.
The fund was overweight healthcare and biotech in 2013, which paid off nicely, but Yusko said where they really scored was with their emerging managers, including an Asia/China focused manager who was up over 80% last year—and whose best ideas were up “multiples of that.”
“The direct portfolio contributed 10% of the 25% return on the entire portfolio for the year,” said Yusko, “so that direct portfolio was up about 68% in 2013.”
To make it into the center book, holdings must meet certain criteria, including liquidity. Morgan Creek also likes a name to be held by more than one manager.
The names in the center book are changed once a quarter, while the fund itself is rebalanced every six weeks. Currently, the top 20 is overweight media names, but also includes tech names (mostly mobile handset, mobile internet companies), three healthcare names (bio pharma) and three China internet companies that he describes as “unbelievable home runs.” Then, he says, “there's some other idiosyncratic names that bubble up. We've had some gaming in there from time to time, we've had some other industrials in there from time to time, but I think the combination of strategies is really working.”
Morgan Creek's approach to portfolio construction is top-down, based on five themes, said Yusko: healthcare, energy and natural resources, Asian consumer (or the growing emerging market middle class), the ongoing wealth transfer from indebted developing markets to emerging and frontier markets and Japanese re-flation or Abenomics.
Besides looking for exposure to those themes, they also reserve a third of the portfolio for “good old-fashioned core global long/short guys,” said Yusko.
As of January, the portfolio included Broadfin Healthcare, Tiger Global, Falcon Edge, Teng Yue, Viking, Hound, Tiger Eye, Light Street Xenon and Glade Brook.
A full 83% of the managers in the portfolio are closed—no longer accepting money except from existing investors or no longer accepting money except from clients with special deals—which Yusko considers another value-add of the hybrid fund.
Having 10-15 managers means no manager has more than 10% of the total assets, which he said is “a safe diversification test and it gives us room to have one or two truly emerging managers—really small guys that we're testing.”
Since the 2012 reboot, the fund has grown from 35% net exposure to 60-65%.
“[W]e have to have managers who are playing hard. Who are in the game,” said Yusko. “[W]e can't afford... 'chicken managers'—guys who are 65% long and 30% short. You're just never gonna win that way. You've just got to have a balance sheet that's 150 to 160% gross, you've got to have a net that's more like 50-60%...”
To remain at his target net exposure, Yusko said he might at some point have to adjust the currently long-only center book: “If suddenly all the managers would go to 75% or 80% net, then I'd probably have to put some overlay hedging because I want to stay at 60-65%.”
The fund charges fees of 1% and 10% over a 5% hurdle, but Yusko argues that 20% of that money has no underlying fee. The direct portfolio is “all big-cap stuff,” he said, and could easily scale to $1 billion. Minimum investment is $50,000.
“What I like about the portfolio is it is active, it's active from a top-down perspective in terms of asset allocation, it's active in the sense that all of our managers are playing hard and then it's active in that we're concentrating in the very best of the very best ideas for this 20% portfolio and I think it's unique” said Yusko.
“I don't think there are a lot of people that have implemented the strategy of hybridization and we are excited about the potential for the strategy going forward.”