AlphaClone

Loud Mouth Stocks

 

I was invited on Fox Business News yesterday to  discuss activst investors with Liz Claman.  The activist flavor of the week was Dan Loeb's Third Point and thier activism around Sony Inc. (SNE).   The investor was lobbying the company's management to spin out its entertainment division.  You can read Third Point's letter to management here.  As I mentioned on the show, Third Point's logic is hard to argue with.  Having spent a big chunk of my career working for an integrated entertainment/media company, I can tell you the synergies are never actualized to the extent they are claimed. On the whole, I believe activist investors are net positive for markets.  They keep boards and management teams on their toes and can exert influence that smaller investors simply can not. 

Beyond Sony we discussed whether following "load mouth stocks" (as Liz put it) based on hedge fund public disclosures made any sense.  Interestingly, our Activist Masters Long strategy has been our best performing Core Strategy since we began implementing it for managed account clients in September 2010.  As of April 2013. the strategy has returned 80% net vs. 60% for the S&P 500 (with dividends) over the same period (download performance .pdf). 

That kind of performance says a lot about cloning generally and our investment approach specifically.  For the uninitiated our Activist Masters strategy invests in the disclosed holdings derived from 15 activist investors that we select from our fund universe.  We make manager selections based on our Clone Score appproach - which measures the effectivness over a long period of time of following a particular manager's filings.  

I think a nuance that often gets missed in terms of our portfolio construction is the fact that we always include multiple managers in each strategy.  That's a very important point - a big part of the value our Core Strateiges add is in the fact that we are selecting multiple managers.  Doing so allows us to mitigate single manager risk, key man risk, filings/data risk, and "hot hand" performance risk just to name a few.  Not only that, each core strategy can be thought of as a "virtual fund of fund" with NO manager risk, no fraud risk, and NO switching costs.  These aspects combined are a powerful driver of our strategies' performance potential.

For more articles that discuss the limitations of 13F filings and the criticisms you some times hear as well as our core strategies and how to think about them as part of your portfolio, please read the "Start Here" section of our blog.

AlphaClone and Portfolio Fit

One of the biggest challenge investors who evaluate our strategies come across is the asset allocation decision relative to their existing portfolios. The challenge is really in two parts:

1. In what asset bucket do our strategies belong. Hedge funds? Equities? Liquid Alternatives? Smart Beta?, and

2. Are our strategies best used as satellite or core allocations.

The challenge exists for two reasons. First, we use hedge fund public disclosures to derive our strategies so the first bucket investors instinctively look to place us is “hedge funds”. Second, our products are not structured as hedge funds but in more liquid, transparent, lower cost form such as separate accounts and exchange traded funds so investors look to compare us against other “liquid alternative” strategies. Both impulses, for the most part, are incorrect – how investors should think about our strategies is actually very simple:

• Our long only strategies belong in the equity bucket.

• Our long/short strategies belong in the “hedged equity” bucket.

• Our Hedge Fund ETF Ideas strategy belongs in the tactical asset allocation bucket.

Our strategies seek to be the (or a) “performance engine” inside the investor's portfolio. For investors who don't currently allocate to hedge funds (most), then we want to replace/augment your existing long only equity allocation – passive and/or active. 

For investors who do currently allocate to hedge funds (institutions and other qualified investors), we want to ALSO replace/augment your existing equity market directional allocation (not your absolute return or global macro or any other kind of hedge fund strategy that is not equity and market directional).

As for the question of core vs satellite – the answer is either. AlphaClone Select can replace an investor's entire US large cap allocation as a core offering or augment the investor's existing allocation as a satellite. Same for AlphaClone Momentum and US small cap and so one as you look at each of our strategies relative to their asset category.

To illustrate the above let's compare the backtested performance of a portfolio of index funds against portfolios where AlphaClone strategies replace/augment different segments of the allocation mix. See tables below for the makeup of each portfolio.

 

Index Portfolio

Allocation % | Fund/Strategy | Ticker

15% | SPDR S&P 500 ETF Trust | SPY

15% | iShares Russell 2000 Index Fund | IWM

15% | iShares MSCI EAFA Index Fund | EFA

15% | iShares MSCI Emerging Markets Index Fund | EEM

40% | iShares Core Total US Bond Market ETF

 

AlphaClone – Replace All Equities

Allocation % | Fund/Strategy | Ticker

10% | AlphaClone Select (large cap)

10% | AlphaClone Momentum (small cap)

10% | AlphaClone Activist Masters (activist)

15% | AlphaClone International (ADRs)

15% | AlphaClone ETF Ideas (various)

40% | iShares Core Total US Bond Market ETF | AGG

 

AlphaClone – Replace US Equities

Allocation % | Fund/Strategy | Ticker

10% | AlphaClone Select (large cap)

10% | AlphaClone Momentum (small cap)

10% | AlphaClone Activist Masters (activist)

15% | iShares MSCI EAFA Index Fund | EFA

15% | iShares MSCI Emerging Markets Index Fund | EEM

40% | iShares Core Total US Bond Market ETF

 

AlphaClone – Satellite to US Equities

Allocation % | Fund/Strategy | Ticker

10% | AlphaClone Activist Masters (activist)

10% | SPDR S&P 500 ETF Trust | SPY

10% | iShares Russell 2000 Index Fund | IWM

15% | iShares MSCI EAFA Index Fund | EFA

15% | iShares MSCI Emerging Markets Index Fund | EEM

40% | iShares Core Total US Bond Market ETF

 

The results show improvement in the risk adjusted returns across the board when AlphaClone strategies were added. Improvement is most pronounced when our strategies replaced all equities in the portfolio over a five year period. You can see why this is by looking at the annual returns for each portoflio (see below). During 2008, our AlphaClone Hedge Fund ETF Ideas and our dynamically hedged Select, Momentum and International strategies did a good job of mitigating drawdowns in that year. In addition, during the market run up in 2009 and 2010 our strategies also did well demonstrating good upside capture.

 

5 Year Performance (4/30/2008 to 4/30/2013)
Investor	Annualized Return	Annualized Volatility	Sharpe (1%)
Index Portfolio	3.12%	11.82%	0.18
AC – Replace All	8.57%	9.19%	0.82
AC – Replace US	6.35%	10.38%	0.52
AC – Satellite	3.91%	11.90%	0.24
3 Year Performance (4/30/2010 to 4/30/2013)
Investor	Annualized Return	Annualized Volatility	Sharpe (1%)
Index Portfolio	5.54%	9.23%	0.49
AC – Replace All	5.81%	8.78%	0.55
AC – Replace US	6.62%	9.03%	0.62
AC – Satellite	6.43%	9.40%	0.58

 

Annual Performance (2008 to 2013YTD)
Year	Index	AC-All	AC-US	AC-Sat
2008	-22.22%	-4.81%	-16.25%	-22.09%
2009	19.84%	24.75%	25.28%	20.77%
2010	12.31%	14.77%	13.51%	13.21%
2011	-4.36%	-3.61%	-4.72%	-3.34%
2012	8.90%	8.59%	11.52%	10.19%
2013YTD	4.87%	7.18%	7.91%	5.13%

 

AlphaClone strategies belong in the “equity” or “hedged equity” buckets. Their objective inside a portfolio is to provide the potential for alpha generation during bull markets while mitigating market risk during protracted bear markets. It's that simple.

Clone Madness: Championship

A tournament that was defined early by a lack of upsets has taken a late sharp turn in the final matchup. The ValueAct Holdings Top 20 clone came from behind to win the championship with year-to-date performance of about 12% vs. Eagle Value Partners’ 9.4%. Eagle Value relinquished its place as the top performer over every other time period just when it mattered most of all.

The ValueAct clone owes its strong YTD showing to companies hailing from a mix of industries. A sampling of the best performers includes Intercontinental Exchange (ICE), which has gained about 25% in 2013 and represents one of the few holdings for which the fund disclosed an increased position size in its mid February 13-F filing.

Also adding to ValueAct’s championship win were well known companies like CBRE Group Inc. (CBG) and Adobe Systems Inc. (ADBE), with YTD returns of about 24% and 15.5%, respectively. Rounding out the top performers were Valeant Pharmaceutical International Inc. (VRX) and Willis Holdings Ltd. (WSH), which have respective 2013 gains of about 20% and 15%.

And with that, we conclude the inaugural Clone Madness tournament. We hope you enjoyed following the competition.

Clone Madness: Final Four Results

The championship faceoff has been decided with an unceremonious exit by one of our most heavily followed managers. The Baupost Group Top 20 Holdings clone was beaten handily by Eagle Value Partners, which beat the entire group yet again. Honorable mention is warranted for Eagle Value’s positions in Viacom Inc. (VIAB) and Colfax Corp. (CFX), with respective cumulative returns of 47% and 83% over Q2 and Q3 2012.

While there’s nothing surprising about making your departure opposite Eagle Value in this tournament, it is worth noting that Baupost Group performed worse than every other clone in our original Sweet Sixteen over the past year. A lot of the performance drag took place during the last quarter of 2012, with notable losses from positions in Allied Nevada Gold Corp (ANV), News Corp. (NWSA) and Enzon Pharmaceutical (ENZN).

On the other side we have ValueAct Holdings. This clone overtook Akre Capital Management with performance of 21.4% vs. 15.7% over the past year. Several blowout positions for ValueAct included Gardner Denver Inc. (GDI) and Halliburton Co. (HAL), with 138% and 421% returns, respectively, in Q2, as well as Autodesk Inc. (ADSK), which returned 210% over the second half of 2012.

Check back Monday morning to see who takes home the trophy as our 2013 Clone Madness champion.

Clone Madness: Quarter-final Results

We’re down to the Final Four and competition has gotten intense.

Several very strong clones were edged out by better performance. Appaloosa Management’s Top 20 Holdings clone returned an annualized 15.2% over the past 3 years only to be topped by ValueAct Holdings’ 20.4%.

Baker Bros Advisors, at 31.8%, succumbed to Eagle Value Partners, which delivered the best annualized 3 year performance of 45.9%.

Eagle Value has shaped up to be this tournament’s Louisville, starting as the top seed and fending off the rest of the field’s performance.

Its returns have been strong over much of the last 3 years, but Q2 2011 produced several of the most impressive gains. Positions in Calpine Corporation (CPN), a natural gas and geothermal power producer, and Gentium S.p.A. (ADR: GENT), a microcap Italian biopharmaceutical company, returned 82% and 91%, respectively, that quarter.

We’ll post the winners of our Final Four matchups on Friday morning.