The markets today and in the near future are challenging. Generating alpha is the mandate of all investors but the times of 8%+ annually yielded from equity investments with dividends above 3% are quickly evaporating. U.S. valuations are high and demand for alternative investment options is increasing everyday. AlphaClone sees this all as an opportunity. They’ve taken a practical and pragmatic approach to building portfolios that leverages the availability of technology and ace-investor strategies to manufacture alpha. We caught up with them as they launch their AlphaClone International ETF (ALFI) today. The transcript is below.
- Tell us a little about AlphaClone, your investment strategies and ETFs
I’ve known Maz for years. He founded AlphaClone as a research service in 2008 when I was still at Blackrock in the iShares ETF business. His motivation was to find an objective way to monitor and evaluate what the “smart money” was actually doing so that he could make better investment decisions for himself.
What started as a research service morphed into an investment firm in 2010 on the strength of the results he was seeing in clone simulations. He developed the Clone Score methodology and applied it to several investment strategies in separate accounts. Six years later the performance results from those strategies speak for themselves and can be downloaded from our website.
In 2012, AlphaClone launched ALFA, the world’s first ETF to track hedge fund 13F filings. The fund garnered 5 stars from Morningstar on its 3 year anniversary in May of this year, and has outperformed the S&P 500 over a great majority of its existence. On Tuesday, November 10, we are launching AlphaClone International ETF (“ALFI”). All of our strategies are built for long-term investors to take advantage of the highest conviction ideas of the best investors our research uncovers.
- Now that we know a little more about who you are, can you spend a few minutes telling us about your process in the portfolio construction of ALFI?
Our mission is to solve the manager selection riddle for investor. Manager selection is hard for many reasons and getting harder because the sheer number of products choices continues to explode. We do this by analyzing the 13F data set.
The value of 13Fs lies in what they contain, and what they do not. If you look at a manager’s reported performance, it combines many factors including security selection, use of leverage, trading skill, choice of implementation, etc. Yet if you look only at a manager’s reported holdings, you can strip away all of these factors except for one – what did the manager own at the end of a given period.
We have pierced two myths related to this information. First, there is a view that holding periods are very short – in reality, we have found that holding periods are on average around a year, and for high conviction holdings can be much longer than that. Second, hedge fund managers promote their ability to short securities and the value of hedging in part to justify 2-and-20. Yet when we compare most manager’s reported performance against the performance of their reported holdings, the latter is almost always superior.
So if you believe, as we do, that there is value in the 13F data set, you can use it to evaluate every manager that reports. That’s what we have done since 2008 with CloneScore, which guides our continuous manager selection. There are over 6,000 hedge funds; we have durable data and track over 550 of these managers; for the ALPHACLN and ALFIIX indices (which ALFA and ALFI, respectively, seek to track), we choose at least 20 highest-scoring managers from which we aggregate their high conviction ideas.
In the case of ALFIIX index, we aggregate at least 40 high conviction American Depository Receipt (ADR) holdings from managers with the highest score. The index also employs the firm’s innovative dynamic hedge mechanism that allows it to vary from long-only to market-hedged when the S&P 500 closes below its 200-day simple moving average at any month’s end.
Our portfolios are constructed with four risks in mind:
- Manager Risk – we don’t fall in love with any single manager, and systematically rate them and choose those we deem to be the best
- Company / Stock Risk – we believe in concentrating portfolio risk to high conviction ideas, but limit any single name to 15% and the top five names to 50% at rebalance
- Market Risk – we believe in being long the market most of the time, and hedged during periods of protracted market downturns. As a result, we employ a Dynamic Hedge which triggers when the S&P 500 closes below it’s 200-day simple moving average on any month-end.
- Behavioral Risk – of all the risks that can trip of investors, behavioral risk is probably the most dangerous. All of our indices are rules-based, which remove emotion from decision-making and allow the long-term nature of their benefit to have maximum effect.
- What inspired you to launch the new ETF? What international markets does the ETF have most exposure to?
We think international markets are going to be an important area for investors in the intermediate and long term. Equity valuations are more favorable than in U.S. markets by quite a bit. In addition, pursuing the potential for alpha is even more important today for long-term investors given the anemic growth forecasted for equities and bonds over the next several years. This fund gives investors the potential to capture alpha in international markets in a passive, accessible and tax-friendly investment vehicle.
Currently, the index tracked by ALFI has China and Europe as the two most overweight regions. In terms of sectors, technology/Internet and healthcare are most overweight.
- How and where does this strategy fit within a broad-based portfolio asset allocation?
We’re fulfilling the promise of what liquid alternatives were meant to do – deliver performance and protect against investment risks. Maz likes to say we offer liquid alts that don’t suck. Our strategies allow advisors to spend their risk budgets more efficiently because they do two jobs: , drive growth when long, and when hedged break correlations and downside volatility. In a world of stretched equity valuations and lower forecasted returns (eg. GMO, etc.) our systematic approach to generating alpha can be valuable to every portfolio.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.