by Maz Jadallah
As of October 31, 2020
Over the prior 34 months, the AlphaClone Hedge Fund Master Index (ALFMIX or “AlphaClone Index”) has outperformed its peers and the overall market on both an absolute and risk adjusted basis Our analysis period is as of the first full month the index’s became available as an ETF, January 1, 2018, through October 31, 2020.
The AlphaClone Index seeks to identify and access investment managers with high alpha potential by analyzing their regulatory holdings disclosures (Form 13F-HR). Other indexes use the same 13F dataset but construct their indexes very differently and, as the table above shows, generate very different results.
For example, the Goldman Sachs Hedge Industry VIP index seeks to access the 50 holdings that are most popular amongst hedge fund managers’ largest disclosed positions. As such, it yields a very different portfolio with only a 25% overlap by weight with AlphaClone’s index (see graphs below).
As always, before considering an index, please make sure to review each index’s methodology document to understand how it is constructed.
© 2020, All Rights Reserved. The AlphaClone logo is a service mark of AlphaClone, Inc. The information contained herein (the “information”) may not be reproduced or re-disseminated in whole or in part without the prior written permission from AlphaClone, Inc. AlphaClone, Inc. is a registered investment advisor with the SEC. Registration of an investment advisor does not imply any level of skill or training. AlphaClone’s investment products seek capital appreciation as their investment objective. There can be no assurance that the investment objective will be achieved. Past performance is not indicative of future results. Consider the investment objectives, risks, charges, expenses and instruments used to implement a strategy before investing. This communication does not constitute an offer or a solicitation to invest with AlphaClone, Inc.
The AlphaClone Hedge Fund Masters Index (ALFMIX) is an index of high conviction equity holdings derived from hedge fund public disclosures and selected by AlphaClone. ALFMIX was launched on August 25, 2017 and is calculated by Solactive. The Solactive Guru Index (GURU Index) tracks the price movements of the top equity holdings of a select group of hedge funds based on the quarterly regulatory filings reported to the SEC. The Index is calculated as a total return index in USD and weighted equally. The Goldman Sachs Hedge Fund VIP Index (GVIP Index) consists of hedge fund managers’ “Very-Important-Positions,” or the US-listed stocks whose performance is expected to influence the long portfolios of hedge funds. Those stocks are defined as the positions that appear most frequently among the top 10 long equity holdings within the portfolios of fundamentally-driven hedge fund managers. The Index is rebalanced on a quarterly basis to reflect changes in reported hedge fund manager holdings. The Russell 1000 Growth Index is an index composed of large- and mid-capitalization U.S. equities that exhibit growth characteristics. The S&P 500 Index is an index of large capitalization US equities. It is not possible to invest in an index.
The Fast Money Takes It Slow
by Maz Jadallah
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It’s a virtual certainty. You can bet your bottom dollar on it. Whenever we discuss our methodology with prospective investors, the first question ALWAYS relates to the delayed nature of Form 13F filings. The implication is that a hedge fund manager is likely to have already exited their position by the time the manager’s quarterly filing is published 45 days after quarter end, rendering the form useless.
After nearly six years, our response is also now very predictable. The truth is hedge funds hold their positions on average for at least a year and for high conviction holdings it can be much longer than that, therefore disclosing positions quarterly can yield valuable information about a security.
In this research note we take a definitive look at hedge fund holding periods. We analyze holding periods for all Form 13F disclosed securities as well as for those held with high conviction. We also look at whether the length of a manager’s holding period is predictive in any way to the efficacy of following their holdings.
Exhibit 1 summarizes the distribution of funds in AlphaClone’s universe by holding periods. The analysis includes every holding for every fund in our universe. Holdings that appear, disappear and then appear again later are treated as separate trades. Holding periods are presented in months.
It turns out the fast money isn’t that fast after all. The average holding period across all positions is over 17 months. It makes intuitive sense then that if managers are waiting on average a year and a half to realize their investment thesis, the fact they must file quarterly means that following them based on their disclosures can make sense …. assuming the manager has skill in selecting holdings.
Let’s dig a little deeper. When it comes to active management, conviction matters. Positions that rank among the manager’s largest will drive performance, for better or worse. Therefore, high conviction positions are where the manager must have the most confidence. High conviction holdings also tend to do better when followed than the average holding overall so it’s worth taking a look at holding periods for high conviction holdings only.
Exhibit 2, summarizes the distribution of funds in AlphaClone’s universe by holding period, for high conviction positions. For the purposes of this analysis we define high conviction positions, as any position who’s size has attained a rank of 10 or lower (a rank of 1 is the highest conviction position and the largest position) in a manager’s portfolio at any time over the course of the manager’s holding period. Like in the previous analysis, holding periods are presented in months.
Surprisingly perhaps for many, the average holding period for high conviction positions is a staggering 4 years! Perhaps the most remarkable outcome from Exhibit 2 is the contrast between reality and conventional belief around how hedge funds invest. Fed by the financial media, investor perception is that hedge funds are charlatans getting rich off of high fees, playing a game that the average investor could not hope to understand let alone profit from. Hedge funds are hot money, fast money, smarter than you money when the market is up, and the money we love to hate when the market is down. The reality of course is the opposite, hedge funds don’t play by a different set of investing rules; they buy and hold, they are patient, and yes, on average they are indeed more skilled than most investors, but that’s because they are more experienced and better equipped, not be because the laws of investing physics are somehow different for them.
Too much of a good thing.
Using 13Fs to follow experienced investors can be deceptively easy. Many investors fall in love with a manager’s stellar returns, with the manager’s brand or their cult of personality. A novice 13F follower figures they can “roll their own” and be wildly successful. Again reality does not match perception. Like any investment approach, success using 13Fs takes doing your homework, it takes discipline and it takes patience.
For example, many 13F followers, including some of our competitors, believe low turnover is a key determinant for success when selecting which managers to follow. The idea is that low turnover managers hold their positions for very long periods of time and therefore following their disclosed holdings makes the most sense, especially when they also have a great historical performance record.
Exhibit 3 correlates manager holding period with the efficacy of cloning their holdings. For the purpose of this analysis we define cloning efficacy by summing the monthly excess returns (2010-2015) of a composite made up of several “follow simulations” or “clones” (e.g. follow top 5 holdings, follow top 10 holdings, etc.) over a US market factor. All simulations account for the delay inherent in 13F disclosures and include the effects of “dead” or delisted securities, thereby avoiding survivorship bias.
The scatter plot above couldn’t more clear. There is absolutely zero correlation between a manager’s holding period and the desirability of cloning their positions. Longer holding periods are necessary to make a manager’s disclosures usable but not sufficient to determine which manager to follow. Like many of the best investment disciplines, utilizing Form 13F successfully is simple but not easy.
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