Q: What is the history of the fund?

Launched in September 2011, the fund invests primarily in two managed futures strategies: trend following and quantitative global macro. Five years is quite a long time in the world of liquid alternatives, daily liquid mutual funds with hedge fund strategies embedded in them. Both the team managing the portfolio and the process followed have been the same since inception.

Only two changes have been made in those five years. One, my co-portfolio manager and I moved to State Street Global Advisors (SSGA) in September 2014, and so a sub-advisory agreement was established between Ramius, the fund advisor, and SSGA, as sub-advisor. 

Two, when we launched, it was common to charge and pay performance fees in this particular strategy to underlying managers. We no longer do this. 

We consider our fund to be a multi-strategy managed futures fund. It might seem oversimplified by whittling down the universe of strategies to just two, trend following and quantitative global macro, but everything does essentially fall within that. Because of our concentrated multi manager approach, we trade more styles and timeframes, and therefore more markets, making us more diversified than some of our single manager, single strategy peers. 

The trend-following component is technical and momentum-based, and applies across managers and different timeframes, looking for trading opportunities in various market environments. The opposite, a reversionary strategy, the overbought/oversold, also falls within the technical side. 

The global macro strategy tends to be quantitative and should not be confused with discretionary global macro. It’s generally value-based, along the lines of a purchasing-power-parity concept, valuing currencies as an example. 

Value-based strategies tend to perform well when market prices reflect the fundamentals in that particular market, whereas the trend component works well when markets overshoot their fundamentals, creating breakaway-trend environments. Broadly speaking, the sub-segments of peer groups fall into either the value or the technical side of the equation. 

Q: How do you define your investment philosophy?

In terms of tactical trading and liquid alternative investments, we believe markets are inefficient, periodically overshooting their fundamentals. As there is a lot of differential between underlying managers’ performance, we believe a concentrated multi-manager approach vs. a single manager approach is more efficient to capture all of the opportunities within the strategy. 

We try to avoid significant liquidity mismatches. Within daily liquid alternative investment offerings, we look at the underlying markets being traded to ensure the daily liquidity to the client is consistent with the liquidity of the underlying markets, and suitable to managing in the daily liquid format. Many other strategies are not suitable and as a result are not liquid enough or the efficacy of the strategy is weakened to be conducive to the wrapper

Investors do not get paid for assuming operational risk, so our goal, using proprietary managed-account-platform infrastructure technology, is to reduce unnecessary operational risk. All cash positions are held on the platform, not with the managers. 

Q: What is your investment strategy and process?

We start with a broad product concept and set out to capture all opportunities related to timeframes, geographies, markets, and asset classes within managed futures. Then the portfolio managers define the ranges of risk to the different styles, macro vs. trend following, with respect to timeframes, geographies, and asset classes—strategic asset allocation. 

The next step is manager due diligence. We house hundreds of managers in this broad managed futures category in our quantitative systems. There is a deep dive with regard to quantitative due diligence, performance analytics, and scoring of the managers, which are organized by peer groups. 

We have managers that are within the trend-following space across different timeframes, quantitative macro, and some shorter term, including the reversionary strategies mentioned. We have a category specifically for multi-strategy managed futures, and some asset-class-specific managers—commodity-only, or currency-only. 

We create a shortlist of managers after deep dives, conference calls, and parsing the materials and backgrounds; an even shorter list leads to onsite due diligence. For those managers selected, we perform a process on both the investment and operational due diligence sides. As the final step, when they go for approval to the various committees, both sides are presented to the respective committee for approval. 

The next step in the process is portfolio construction, taking into account diversification properties and overall levels of risk. Within portfolio construction we place substantial emphasis on managers’ actual and expected drawdowns, vs. volatility or standard deviation.

From there, it’s all about monitoring and ongoing analysis. We typically have between 150 and 200 different trades in the portfolio. These are all globally based futures, short or longer end of the yield curve, equity indices, futures, commodities, energy, trade softs, metals—all futures—plus currencies, not just against the dollar but also cross-currencies, as futures or forwards. Everything is in futures or currency forwards. We don’t trade anything illiquid. 

Q: Can you explain how you approach such a trade?

One example would be a currency pair—let’s look at the Australian dollar against the yen. If the currency pair is stagnant vs. the value models, the global macro managers will look systematically at that currency pair, taking into account things like interest rate differentials between the two countries, growth forecast, and inflation forecasts. 

They also consider factors like what commodities are produced in these various markets, where the biggest export markets for those commodities are, and a whole host of other purchasing-power-parity types of metrics. 

In this case, over the last couple of years, commodity prices largely weakened until recently. Australia is a large producer of commodities and their biggest export market in many cases is to China. The macro managers anticipated a slowdown in China, and have had a slightly negative view on the Australian dollar. 

Pair it with yen, which is a low-interest-rate currency, something short, and the Australian dollar against the yen would be a negative carry type, a risk-off type of trade, but a trade that has come about typically as a result of value-based metrics, global macro fundamental reasons. You may have a position that is short Australian dollar as a result of that. 

If that position starts to move lower, at some point in time the shorter-term momentum trend followers will start to short the Australian dollar. If it escalates further, medium-term trend followers will sell, and ultimately the long-term trend followers will do so as well, and we end up cascading into a position across both the fundamental and technical sides of the portfolio. 

Ultimately, when trends overshoot and start to reverse, we would anticipate short-term trend followers, followed by medium-term and then long-term trend followers, to cover their shorts, depending on the size of that correction or reversal, and that either the fundamentals would change over time or the currency pair would be sold off to a level where it no longer represents good value from the short side.

Q: How do you choose your managers?

The process begins with quantitative screening. We have a couple of decades of experience in this particular strategy so we are very familiar with most of the names. Nevertheless, we do cold-blooded quantitative screenings to test our intuition. 

We look for managers that together will help us to capture the opportunity set in a cost-effective way. We look for managers with a proven edge in their particular strategy over time. We look for an investment pedigree background, plus what we look for when performing operational due diligence, namely infrastructure, technology, processes, and procedures. 

Q: What is your portfolio construction process?

There are a couple of proprietary tenets to our construction process. The first is how we formulate an equal weight in our view of the manager’s risk level. Each manager has a measure of what their expected drawdown will be, using historic and simulated drawdowns. 

The second tenet is PDI, a portfolio diversification index, a methodology developed by co-portfolio manager Dr. Alexander Rudin, which has been published in academic journals. It is a single measurement of the marginal diversification benefit of adding a new asset, security, or manager to a portfolio. 

If we have a heavy trend-following portfolio, the trend-following managers are likely to have fairly low PDIs. They are complementary to the portfolio, but their similar strategies do not add much diversification. When adding other strategies, be they macro, idiosyncratic, or even reversionary, we emphasize managers that provide a high PDI, a high marginal portfolio diversification benefit. 

The strategic asset allocation, which is currently 65% trend following and 35% macro, dictates the weights given to the portfolio’s individual managers. 

Q: What role, if any, do indices play in your construction process?

The managed futures index we pay closest attention to is the SG CTA Index, formerly known as the Newedge CTA Index, because it has daily updated performance and is representative of all of the different styles, strategies, timeframes, and geographies, and not just trends. 

The drawbacks to the SG CTA Index are that it is not investable, it is not net of a multi-manager fee, and we have yet to see anyone successfully replicate it. We believe the way to mimic its return stream is through active management and by blending all of the mentioned timeframes and styles through a concentrated multi-manager offering. 

It is arguably the only hedge fund strategy with non-correlation while historically enjoying many periods of good performance at times when equities have been stressed. The only other strategy that has low correlation over time is discretionary global macro. Most hedge fund strategies have some correlation to equities. 

Q: How do you perceive and manage risk?

We focus on limiting our drawdowns. We believe our clients are mostly concerned about losing money, not necessarily the absolute level of standard deviation or some measurement of volatility. We establish the drawdown properties of each of the individual managers within their diversification qualities to best weather the inevitable difficult periods. 

As trends accelerate across many markets, the expectation is that that we will eventually be on the right side of those trends. The difficult environments for trend-following strategies, at least over the short and medium terms, are trend reversals, market reversals, and even sideways choppy markets, which are when trend followers struggle to make money and tend to have their drawdowns. 

We do not think of trend followers as being black boxes even though they are systematic. Breakaway trends tend to be a good environment. Trend reversals tend to occur when you have givebacks in terms of profit and loss. 

The macro side, on the other hand, is more value- and fundamentally based, which is partly why pairing the two strategies is effective. In terms of correlation properties they complement each other. Difficult phases for value on the quantitative macro strategy include when price significantly overshoots fundamentals, either on the upside or downside, but that tends to be a good environment for trends. 

We also monitor our managers for potential style drift, where a manager deviates from our expectations. It is uncommon but it can happen. If it does, we look to replace that manager. One reason we might change a manager has to do with our target strategic asset allocation, where a shift in allocation between macro and trend or different timeframe could call for a new manager to the lineup. 

We may also spot a due diligence red flag, where a manager could be called into question. It has not happened in this particular portfolio, but we monitor that on a real time basis. 

The most likely reason we might change a manager is if and when we develop a higher level of conviction with another manager, someone we think will be a better alternative, a better complement to the portfolio, and potentially a lower cost to the portfolio. 

Q: What did you learn from the financial crisis of 2008–09?

The financial crisis was an eye-opener for every investor. We believe it is important for investors to get this type of exposure in a dedicated vehicle, whether via a mutual fund or a limited partnership: to managed futures and the diversifying properties of the strategy.

During the financial crisis, we saw that when the strategy was combined in a multi-manager, multi-strategy, fund-of-funds type of approach, and as those fund-of-funds got hit with redemptions, as markets sold off from a liquidity perspective, the first thing they did was remove the managed futures exposure within the portfolio because it was their most liquid strategy. 

As a result many clients did not have the benefit of non-correlation when they needed it most. 

These trading-oriented strategies were gutted from portfolios for liquidity reasons and, unfortunately, what was left were the more liquidity-challenged strategies, which ended up in many cases in side pockets and gated portfolios.

Yet, the managed futures indices did very well, achieving significantly positive returns with none of the gating or side pockets on the limited partnership side of the hedge fund industry.

We recognized that the strategy could be managed to a daily liquid vehicle, and that clients could benefit if we focused on limiting risk and reducing drawdowns in the overall portfolio.