Q:  What is the history of the firm and how has it evolved since its inception? A : Our firm has focused on alternative investing since our inception in 2001. We started out building custom fund of funds and found a lot of managers in the industry did not add much value. Therefore, we began creating our own strategies which led to the development of our core mission -- “alternative strategies with liquidity and transparency.” That focus really started post-2008 when liquidity became paramount for investors. Many strategies lacked liquidity because managers chose more restrictive terms even though they were investing in very liquid underlying instruments. Through research and experience, we believe you can provide very good alternative strategies in more investor friendly wrappers like mutual funds. In addition, we believe it’s possible to provide similar returns to what investors experience in traditional hedge funds without the lockups, fraud risk, and lack of transparency. This premise led us to launch a number of mutual funds. Today we have three in the market; two managed futures strategies and a long-short equity strategy. Our flagship fund, the 361 Managed Futures Strategy Fund, was launched at the end of 2011. We started out with roughly $10 million and the Fund has grown to just over $635 million today. Overall, the firm has approximately $680 million in assets under management. The firm employs twenty people with six on the research side. We are majority owned by our employees and management. We have two minority partners in Lighthouse Investment Partners, a large fund-of-funds organization and Lovell Minnick, an independent private equity firm. Since 2009 when my partner Tom Florence joined the organization and took over the reins, he implemented our mission and built out our distribution system which incorporates a hybrid model. We’re a unique organization because the product specialists who interface with our advisor clients are fluent in alternative investments and focus on education. Q:  Why should investors consider investing in managed futures funds? A : In general, the alternatives industry has had substantial growth over the last thirty years. Starting in the early eighties there were only a few funds, most of which were using strategies like global macro investing. Futures were a meaningful allocation both within these broader mandates and obviously in dedicated managed futures funds. As we progressed through the eighties and nineties there really wasn’t a big need for alternatives in a beta driven bull market. The alternatives industry got a lift in the early 2000’s when the tech bubble burst and investors suddenly realized they couldn’t just throw money at stocks and expect to make money. Managed futures got a big boost after the market meltdown in 2008-2009 during which time many managed futures investors enjoyed huge gains. This expanded interest in the space as more investors looked for non-correlated returns. Strategies that are not correlated to equities are important because generally, asset class correlations during periods of stress like 2008 all tend to gravitate to one. With low correlations to most traditional asset classes, managed futures strategies can provide protection against fat-tail events and in our opinion are a much better means of, at least indirectly, gaining a long volatility profile. Finally, managed futures strategies are typically liquid and meet the liquidity needs of many investors. Q:  What are the philosophical foundations of your investing strategy? A : Our firm philosophy begins with a belief that alternative investments should have a place in most investment portfolios. With low correlation to the bond and equity markets, alternative investments deliver diversification, while also providing risk control. They can add significant value to a portfolio, particularly in volatile markets. We also believe that liquidity is of paramount importance in today’s world versus the illiquidity provided in traditional hedge funds. That is why the products we have engineered provide daily or weekly liquidity. Going forward, we view alternatives as playing a greater role in all investment portfolios as advisors, and their investors, become more educated on the power of uncorrelated investment returns. Our investment philosophy is rooted in the belief that day-to-day market movements are dominated by behavioral factors; such as fear and greed. Because transaction costs are lower and information travels faster and is more readily available to everyone, there is an opportunity for the herd to move the market over a short period of time in one direction or the other. What we typically see is that investors overreact over short term time frames due to information flow, the speed of this flow and the ease and low cost of transactions. This phenomenon often throws markets out of equilibrium over transient time frames allowing us to take a contrarian view in anticipation of future equilibriums. For example, when investors are bidding up equity prices over the short run and it’s above what is probably the longer term, or even the intermediate term equilibrium, we want to take a short position and vice versa. If they’re overreacting on the downside, it might be a good time to take a long position. In short, our philosophy is very contrarian in nature. We try to take advantage of behavioral or fundamental factor biases that are very easily explained to investors. Everybody understands fear and greed. Q:  What asset classes are you focused on? A : In our two managed futures funds, we focus solely on equity index futures. We have a long-short equity fund which is obviously equity oriented. As much as everybody thinks the markets are efficient, they are still relatively inefficient over the short run and that allows us to take a contrarian approach. Conversely, most managed futures funds utilize trend following strategies. When the equity markets are trending up or down it’s an asset class they try to exploit the same way they do with currencies, commodities or fixed income. Q:  What index futures do you look at? A : In our domestic fund, we only focus on three equity indexes, the bigger liquid domestic markets including the S&P 500, the NASDAQ 100 and the Russell 2000. We utilize these specific indexes because the underlying mathematical formulas we incorporate pick up on volatility and market choppiness, or what we call noise. These indexes best represent that. Our global fund utilizes nine equity indexes around the world, including the CAC-40 Index that tracks France, the DAX 30 that tracks Germany, the FTSE 100 that tracks the U.K. and the KOSPI Index that tracks South Korea. We are still trying to take advantage of what we call short term counter-trend movements by utilizing different mathematical formulas that can best exploit specific markets. Q:  How many factors are in your models and what drives your returns? A : There are only three factors in the model driving our domestic fund. It’s very simple and I have a bias towards simplicity having both evaluated and invested in a lot of quantitative strategies over the years. Our experience is the ones that tend to have a lot of factors, at some point in time stop working, or the manager can’t understand why the model is not working as well as it did historically so the manager starts to tinker. We have a very good understanding of what drives the strategy’s returns, which are noise or choppiness of the markets and volatility. So in a very choppy, highly volatility market we should do pretty well. Since we launched the Fund in late 2011, the level of noise and volatility in the market has been in the bottom 20% of what we’ve seen going back fifteen years. We’ve still been able to produce returns that are toward the top of our category, which is a testament to how stable, predictable and consistent counter-trend models can be relative to trend following which have obviously struggled. Q:  Can you provide more detail on the three underlying models? A : The first we refer to as a market environment filter and it’s simply looking at whether there has been a significant short term move in prices. It’s based on the assumption that equity markets tend to rise over time. The more they rise in the short term the greater the opportunity for a correction. So generally we need a price correction to turn on the first model. Once the filter turns on, we then look to two other underlying models. The assumptions on the other two models are that prices tend to mean revert in the short-term and markets tend to express immediate moves that are counter to what would be most prudent given the luxury of hindsight. So we’ve got one model that is attempting to identify when the markets will mean revert. We’ve got another model whose premise is that people tend to follow the herd and you really should be contrarian. So model number two is just looking for short term mean reversion and then model three looks at intermediate performance. Performance as an input is unique as most inputs to quantitative strategies include things like price, time, and volatility. Both of these models produce a signal either long or short. If our filter’s on and the two underlying models agree, we will take the appropriate trade. If the two underlying models disagree, then we make a strategic allocation to cash which is where the strategy is invested over 75% of the time. We’re very selective in our trade opportunities. So, for example in our domestic strategy we’ll take roughly twenty to thirty trades per year and be in cash over 75% of the time. As we identify significant overreactions in the market, we’ll take a trade. In the first quarter, we had six trades of which four were winning trades and two were losing resulting in a hit ratio of 66%. Our average invested length was 2.7 days, which is right in line with the historical average. Finally, our expectation per trade is in the range of fifty to ninety basis points and we came well within this range in the first quarter. Both of these statistics are consistent with expectations. Q:  Can you share a few trade examples? A : We took a long trade at the close of business on February 3. The market was up eighty-six basis points the first day, it was down forty-four basis points the next day, up a hundred and twenty-four basis points on day three, at which point one of our underlying models said we’ve had enough and this is probably as far as the move will go. We closed it out realizing nearly 1.5% on the trade. So, market volatility helps us specifically with the amplitude of the trade return. A good example of a trade that didn’t work out was in mid-March when we took a short trade that lasted two days. On day one, the market was up 1.2% but on day two it was down approximately 0.6%. We closed the trade out for a loss of roughly 66 basis points. This is a good example of the signature of a typical losing trade where we tend to recover about half of our maximum drawdown. Q:  What do you do when your trade is not working? A : We know we’re going to have losing trades, but because we have a great deal of insight into what drives our returns we are able to stay with our strategy. We stick with our models and we don’t tinker with them. In a lot of our early testing, we found that things like stop orders were degrading to our model. One interesting statistic is that about a third of our trades should be losing trades, but as we discussed, when we experience a losing trade we typically recover about half of the maximum adverse excursion or peak-to-trough level of loss experienced during the trade. This is exactly why stop losses are so degrading to returns, you just never know what your drawdown is going to be and inevitably you stop out at a larger loss than the trade would have generated if left alone. We have approximately fifteen years of historical data which includes in sample and out of sample testing and we know what trades should look like. If they start stacking up and aren’t looking right then we would know that. What’s been very fulfilling and interesting about our strategy is that the statistical signature has been very consistent both in sample, out of sample, and with live trading. The bigger question is do we look at model degradation? We believe that analyzing model degradation should be an important part of any quantitative strategy. Now degrading could mean that expected return has simply gone down because your environment isn’t very good. So you have to control the analysis for your environment. A lot of people say models break. What happens when your model breaks? In my thirty years, 99.9% of models didn’t break, the manager broke them. So why do managers break their models? Typically it’s because they’re in a period of stress, they’ve got dozens of different factors, and fewer degrees of freedom from a statistical standpoint. This means they often don’t understand how all those variables are relating to each other; hence they don’t understand what’s driving the poor performance. As a result, they fiddle with the model and change it. The manager breaks the model. The models themselves probably would have performed fine if they simply stuck with it. Q:  How do you incorporate learning and fine tune the models? A : We do perform constant monitoring and are always researching potential improvements, but our goal is to not fine tune the model. Basically we have an investment thesis that we believe will last for a long period of time. For our two managed futures funds, our investment thesis is that investors experience fear and greed and it is expressed quicker today than ever before. This results in an anomaly where you have short term overreaction in the market. Therefore, the strategy will stop working when fear and greed are not expressed in the market anymore. I don’t think that’s going to happen for a while. So it’s a pretty simple investment thesis with a high likelihood of persistence. As we’ve discussed, we believe strongly that strategies that are simpler and based on a concrete, well-thought-out hypothesis are the ones that tend to work. Strategies that are just statistically based or curve fitted, may work for a while, but will eventually fail. We require an underlying thesis that’s based on some type of fundamental or behavioral bias. Then, we perform rigorous research to determine what we’ll need to do to capture the anomaly and we build it with the expectation that we’re not going to tinker. We’ve built and utilize a very sophisticated degradation analysis. We review the analysis closely both formally and informally on a regular basis to determine if there is something wrong with the models outside of the environment or other factors. If there was a structural flaw, we would have to make a course correction. To date we haven’t had to do that. Q:  Does low volatility in the market hurt your return? A : Earlier I referred to the fact that volatility dictates the amplitude of our per trade return. So when volatility is low it doesn’t necessarily mean our success rate is lower. It’s not. What is lower is our per trade return. If we were targeting seventy basis points per trade and volatility is low, we might only get thirty. So what’s happened is the low volatility has compressed our returns, but it hasn’t compressed the robustness of the model. We can only take what the market gives us. Now I would contend that volatility, just like any other factors in the market, is mean reverting. What’s really exciting about our strategy is if we’ve been in a low volatility environment, which we have, sooner or later it’s going to revert back to normal volatility meaning, theoretically, we should have outsized returns going forward. Q:  Why do you think volatility is so low even though there are more tools to create volatility and easier and cheaper ways for people to participate in the noise? A : That’s a great question. I’m not sure that anybody knows why, other than low volatility is a sign of complacency. Let’s face it, since March 2009 we’ve seen pretty good equity market returns. It feels somewhat like the late ‘90’s when you could virtually get good returns at will. Internet stocks were coming out at outrageous valuations, which is not that different from what you’ve seen recently in social networking. The result is strong upward trending markets where people just don’t care about risk. Since the financial crisis, this has been artificially dictated by the Fed holding interest rates low and inducing investors to take risk. Investors have no incentive to lend money by investing in fixed income because rates are so low. They’ve got to do something to generate returns so what are their alternatives? They’re going to go out and put money in risk assets and that’s what’s been driving up asset prices and driving down volatility. Now sooner or later the punch bowl has to get taken away. I’m not sure what’s going to happen, but it’s probably going to at least take away the tailwind from risk assets. Q:  What has been driving returns in managed futures funds? A : Over the last few years, a lack of sustainable trends in many asset classes has hampered returns. In addition, most managed futures strategies don’t require much margin to get the necessary notional funding and as a result end up holding significant cash reserves. Historically, about half the return from managed futures strategies has come from short term fixed income investments. If the excess cash reserves are held in money markets and money market rates are 5%, now we’ve got 5% on 80% or 90% of our assets. But when rates are zero, we’re earning nothing on cash reserves. However, the absolute rate of return goes up in a rising rate environment. So not only do we get a benefit from increasing volatility, we get the benefit of rising rates. It’s a really good future. Q:  Do you analyze the trades that do not work? A : Yes, we analyze them to make sure they’re consistent with what we have seen historically. As discussed, we spent a lot of time up front, testing various modifications and their potential impact on returns. The fact of the matter is the strategy is so robust that any modifications to the model parameters or risk management were degrading. So all we’re concerned about in our losing trades is do they look similar to what we would expect? We do a lot of testing internally including things like bootstrapping, Monte Carlo simulation and creating hypothetical markets with different directional biases and different paths. This helps us to determine whether or not the model is still working within the parameters that were originally designed. Q:  What questions should financial advisors ask as they evaluate managed futures strategies? A : Advisors in general need to look at a strategy and first ask the question why it should work. In our case, we’re playing off of fear and greed and short term market overreactions. It’s a very simple thesis, but it works. Interestingly, there are a lot of mangers who can’t explain why their strategy should work. For example, they might say something like, “we buy low P/E stocks and low P/E stocks outperform high P/E stocks over time”. If you dig further and you ask why focusing on low P/E stocks should work, they can’t answer it. That’s not good. What it tells me is they don’t know the drivers of their returns. I think one of our biggest strengths is our experience. The principals and senior management of our firm have done this for a long time. We’ve invested in a lot of managers and have managed money. What we’ve tried to do is incorporate the best practices that have been successful elsewhere. I would encourage advisors to really focus on asking pointed questions because if this alternative trend continues, you’re going to see more entrants into the market and it’s going to be harder to discern the good from the bad. Why should it work is a good simple question. Another good question is “how much leverage do you employ?” Historically hedge fund returns within traditional limited partnership structures have been driven largely by leverage. You can’t utilize as much leverage in a mutual fund unless you implement with futures, swaps or other derivatives. So I think it’s imperative for advisors to really look at these strategies and determine how much risk the managers are taking. Do they really understand what the drivers of their returns are? Do advisors understand what kind of return stream they are going to get and whether it really diversifies their portfolio? Q:  Do you utilize leverage in your mutual fund structure? A : We do not utilize leverage in our domestic managed futures strategy, but in our second fund we can be levered up to 150% on a notional basis. That said, we expect to reach that level less than 3% of the time. On average our global managed futures strategy will have gross exposure of 40-50%.