Sat, Oct 25, 2014
A A A
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
Opalesque Futures Intelligence

I Have An Incredible Program – Where are the Sophisticated Investor Allocations?

Tuesday, September 17, 2013

By Grant Jaffarian

Common Emerging Manager Issues and Their Resolutions

Grant Jaffarian is founder of AlphaTerra and former CIO at
Efficient Capital Management.

Price signaling is a marketing theory that suggests the quality of a product can be broadcast through the product's pricing.  The more expensive item must be better than its cheaper counterpart on the shelf, taste better on the pricier menu or last longer than the less costly competitor.  Right?  While I might wish to deny it, the degree to which I want to impress my dinner host dictates not the esoteric excellence of the wine I purchase (I am no aficionado), but the amount of money I pay for the bottle.  In the absence of an expert's knowledge and confidence, price is a subtle and powerful tool to communicate quality, real or perceived, in the consumer goods and services marketplace.

If only it were that easy for hedge fund managers.  The reality for the aspiring emerging manager is that the price offered and the most incredible track record may communicate not quality but a flashing sign that reads "steer clear!" to sophisticated allocators.  How an emerging manager chooses to publicize their performance history to prospective investors must begin with the truth and be followed by a proper contextualization from an institutional allocator's vantage point.

In my experience, emerging managers derail interest not necessarily because their returns are not interesting, but because their inexperience with the seasoned allocator's perspective causes them to inadvertently advertise their lack of institutional preparedness.  In that light, here are five key "do not's" in emerging manager track record compiling.

Do not change your advertised historical returns. Temptations to change your historical track record are around every corner.  Perhaps a new system has been added to the strategy and you would like your past track record to accommodate an improved model.   Possibly one account you have chosen as your public track record is not currently performing as well as another separately managed account with nuanced differences such as markets traded.  The reality is many an emerging manager falls prey to these and other temptations.  Once you have published, you cannot, nor should you, alter your track record.  Nor should your track record differ if an investor sources your returns from a database or from your distributed materials.  This will be found out and reflect on the quality and consistency of your approach.  Instead of a seasoned investor asking clarifying questions, you will likely be dropped from consideration without feedback.

Do not show back-tested returns. A dollar for every "pro forma" track record I have dismissed in my career could put a dent in our fiscal deficit.  All pro forma's share the same look, a near perfect 45 degree angle slanting from zero to "infinity and beyond."  The view that a pro forma can lengthen your track record and give perspective is an inaccurate one.  Providing any pro forma history, even before you have an actual trading history, will almost certainly communicate not that you're likely to make money 80% of all trades but that your lack of experience removes you from consideration.  If only this issue were limited to emerging managers.  Too often established managers introducing new models are tempted to show pro form histories as well.  Evidence of pro forma histories in more established manager's presentations does not validate the use of pro formas as an emerging manager.  It does, however, offer further evidence that we can all fall prey to the pro forma's allure.  If a prospect wants a pro forma they will ask for it, otherwise leave it out.

Do not have trading gaps. Trading gaps in track records demand a "red flag" from sophisticated allocators and will immediately necessitate questions from your prospect. While a performance gap in your track record may be admirably defended, your defense may not be enough to overcome the red flag.  Once you begin trading, unless you're an unusually opportunistic manager who makes a handful of trades a year, make sure you continue to trade without a full calendar month's pause.  Running sophisticated investor money will not afford you the opportunity to simply stop for one reason or another.  Without evidence that you can be consistent in your strategy implementation, you will not garner the confidence of your prospect that you suddenly will trade dependably.  In short, it is difficult to overcome a gap in your track record.  You will struggle to convince a sophisticated allocator that you are worthy of the fees you are requesting.

Do not have huge volatility swings. More so than your absolute return, investors want to quickly ascertain what they can expect from a volatility and risk perspective when they give you money.  This speaks not to how great your year was in 2008 or your terrific month in May 2012, but rather whether they can anticipate within a reasonable range the risk they will assume when they allocate money to your strategy.  Upside volatility in the form of a tremendous month or quarter is unlikely to communicate that you could be up 50% next month as well.  Instead, what upside volatility shows in your track record is that the other shoe will drop at some point.  A sophisticated investor will read the outlier strong month or quarter in your track record as upside volatility that they missed concluding that there will be commensurate downside volatility in the future.  Even a passionate and reasoned appeal to your conviction in the exclusive upside volatility of the strategy is not likely to sway an allocator.

Do not try to convince investors your trading history is longer than it actually is. Above all, be honest.  Only in very rare instances (and in these cases long term there is investor regret) will tremendous skill over-rule whether you can be without question trusted as a money manager.  The most sure-fire way to eliminate an investor's confidence is in trying to broadcast returns that are not legitimate or are manipulated in any way.  Returns must be earned through actual and audit available trading for a separately managed account or fund.  Not only will your business run the risk of violating regulatory demands which is fatal for your business but your reputation will be, and fairly so, tarnished without a high likelihood of rebirth.  Do not run this risk; do not publish returns that are in anyway controversial.  If you are genuinely a terrific investment opportunity, you should not need to pull strings to show a track record that represents your skill.

Prior to forming AlphaTerra™, LLC, Grant Jaffarian allocated approximately 2.9 billion USD at peak assets exclusively to Managed Futures managers as Chief Investment Officer at Warrenville, IL based Efficient Capital Management, LLC.  AlphaTerra™is currently working full-time with Presagium of NY, NY along with operating as a consultant to additional targeted managers on a limited basis.  AlphaTerra™ exists to help source the industry's strongest emerging manager talent to sophisticated investors while preparing managers for the demands of institutional money management. Jaffarian can be reached at: grant@alphaterrallc.com



 
This article was published in Opalesque Futures Intelligence.
Opalesque Futures Intelligence
Opalesque Futures Intelligence
Opalesque Futures Intelligence

Banner

Today's Exclusives Today's Other Voices More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing


  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. Commodities - Oil wreaking havoc on small-cap energy stocks sliding 36%[more]

    From Bloomberg.com: Owning almost anything in the U.S. stock market has been a losing proposition since September. Owning smaller energy companies has been a catastrophe. Hercules Offshore Inc. and Resolute Energy Corp. are among 19 oil-and-gas equities in the Russell 2000 Index that lost more than

  2. Investing - Hedge funds favor equity long/short, Strategic bond managers hedge against further high yield sell-off[more]

    Hedge funds favor equity long/short From Securitieslendingtimes.com: Equity long/short strategies will generate good returns for hedge funds in the future, according to a panel at this year’s Risk Management Association Conference on Securities Lending in Naples, Florida. Panellists Sand

  3. Legal - Ex-hedge fund analyst weeps as judge hands down 5 year sentence, Former Columbus investment manager Steven P. Moore indicted on theft charges, SEBI confirms ban for Hong Kong hedge fund, SEC announces enforcement action against compliance officer[more]

    Ex-hedge fund analyst weeps as judge hands down 5 year sentence From Hereisthecity.com: An ex-hedge fund analyst was sentenced to 5 years in prison for his role in insider-trading scheme. The New York Post reports that former hedge fund analyst Matthew Teeple was sentenced Thursday to fiv

  4. Goldman in talks to acquire IndexIQ[more]

    From Bloomberg.com: Can Goldman Sachs put ETF investors on a liquid diet? Goldman is in talks to acquire IndexIQ, Reuters has reported. Index IQ is a small exchange-traded-fund firm known mostly for products that replicate hedge fund strategies, called "liquid alternative" ETFs. While IndexIQ has 11

  5. Other Voices: CALPERS dilemma should be a warning to hedge funds wanting institutional investors[more]

    From Ian Hamilton, founder of IDS Group. A quick comment on the CALPERS’ disinvestment from the hedge fund market and the jitters it is causing. Pension Funds should not be sheep and follow CALPERS’ decision as the issues that CALPERS has with hedge fund investments are in many ways unique t