An Investor's Experience with Full Transparency
After the Bernard Madoff affair and frozen redemptions in the 2008 crisis, many investors do not want to be in a commingled fund and prefer to have a separate account that provides full transparency. With raising capital as hard as it is, even the largest hedge fund managers have become more willing to manage separate accounts.
Christopher Jones, founder of Diamond Peak Capital with Steve Sapourn, has experience using managed accounts to control risk and invest with emerging managers as well established managers. Here he shares his insights. Mr. Jones was previously at Sapourn Financial and Dekker Capital and was involved with quantitative futures trading. He oversees his portfolio while living by the beautiful Lake Tahoe.
Diamond Peak's CTA- and futures-focused multi-strategy portfolio was one of a small group of fund of funds that made money in 2008. The company started in October 2007 and returned 8.7% in its first fifteen months.
Opalesque Futures Intelligence: Why do you invest via managed accounts?
Christopher Jones: Investing through managed accounts is a core part of our business model. There are situations where a managed account is not feasible and we decide to invest in a pool, but ultimately we don't want limited partnership investments in our portfolio. We want to be a fund of managed accounts.
OFI: In terms of your portfolio, does having a separate account make a significant difference?
CJ: Unquestionably, it makes a big difference. You have 100% transparency with a managed account. Any time during the trading day you can access your account and see what's going on. We use sophisticated risk management software to import daily position data, usually direct from the Futures Commission Merchant or broker. With that information, we manage our portfolio a lot more effectively than we could otherwise.
OFI: How does having managed accounts change your risk controls?
CJ: One can look at the portfolio in a much more detailed way. If we see a risk imbalance in a certain area or sector risk is escalating across managers, we have the option to hedge by putting on a short or long position to offset that risk. This model has been corroborated by how unpredictable and volatile markets have been over the past 18 months. Since starting our fund, we've had positive returns in 70% of the months, despite this being the most challenging environment in living memory. I don't think we could have managed risks as well without the transparency provided by managed accounts.
OFI: What strategies do you invest in?
CJ: We're focused on trading strategies, not exclusively commodity trading advisors. We're willing to look at managers in any space. But we've invested more with CTAs because they tend to be directionally oriented and quantitative, which is also our orientation. Plus, we like them in the current environment. In times of major economic dislocation they tend to perform better.
OFI: Why do they do better in times of turmoil like last year?
CJ: Part of the reason is that many of them follow short or long-term trends and in the recent past there have been strong trends to follow. Also, there are now so many different, tradable futures markets, they can be less exposed through broader diversification than, say, long/short equity managers who trade fewer asset classes.
OFI: Are there other reasons you concentrate on CTAs?
CJ: Futures markets are very liquid. We don't want to be in anything that's hard to trade or value. We want to be able to liquidate the portfolio within a couple of hours if need be, not have to wait weeks or months. And we pass on the liquidity to our investors. Our strong intention is that they won't have to face gates or other barriers to redeeming their hard-earned capital.
OFI: Do quantitative traders have an advantage?
CJ: We gravitate to quantitative traders because in our experience they are more apt to do well over long time periods. Then we watch to make sure they stay in the strategy we invested in. The real-time trading has to match our range of expectations. Abnormally large positions or discrepancies in trades versus the strategy raise a red flag. That's reason to call the manager and have a talk. Investing through a separate account allows us to do that.
OFI: When you invest with managers in other countries, where are the accounts located?
CJ: We hold accounts in the US. We have trades occurring on foreign exchanges or markets but our FCM or brokerage accounts are in the US.
OFI: Do you provide seed capital?
CJ: We don't typically invest with a manager on day one after his launch, but we do invest with emerging managers. We're not afraid of emerging managers because we're investing via managed accounts. It's another advantage that we can take on potential risk with a relatively new manager because we have aggressive daily oversight of the trading. There's in fact not much more risk for us than is the case with established managers. But we typically don't seed traders within our fund. An ideal candidate for us is someone who has been trading for many years but is perhaps starting a new program. If the person has a strong background and most importantly has shown the ability to make money, we may invest at a very early stage.
OFI: What is important for you besides a trader's track record?
CJ: You can't just go by a long track record—any strategy can stop working at any time! A manager may end up with too much AUM for the strategy, or lose the edge due to changing markets. One manager we know with a great 10-year record could not handle the massive volatility swings in 2008 and did much worse than you'd expect from the history. Managers with short records served us better, for various reasons. We watch the trading day by day. The daily return stream is what matters for tight risk management.
OFI: Are newer managers more on their game?
CJ: Emerging managers tend to be hungrier and more focused compared to someone who's already sitting on a large pool of assets, earning hefty management fees. Also, capacity is an issue. Managers will tell you they won't take on too much AUM, but if they do well and institutional investors discover them, they end up overwhelmed with assets. Often that dilutes their return stream. They go from $200 million to $800 million and suddenly they no longer make the double-digit returns they made before. With the transparency we have, we're comfortable investing with newer managers.