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Liquid Alternative Investments For Ordinary Investors

Barron’s did a nice special report this week on AQR’s liquid alternative investments. AQR, which is run by Cliff Asness, John Liew and David Kabiller, is a pioneer in the liquid alternatives space and manages an impressive $141 billion in assets. They also happen to be a competitor of mine. My partner, Dr. Phillip Guerra, has developed an entire suite of liquid alternative strategies based on many of the same principles used by AQR. As Barron’s writes, Since U.S. stocks peaked in July, few investments have produced strong returns. Global stocks, junk bonds, and most commodities have declined-in many cases, sharply. And many so-called alternative investments have failed to provide hoped-for diversification benefits. Just look at the big losses suffered by some notable hedge funds. The situation hasn’t been much better among liquid alternatives, or mutual funds that use hedge fund strategies such as merger and convertible arbitrage, long/short equity, and trend-following in futures markets. Yet, against this tough backdrop, a bunch of academics are delivering. Their firm, AQR Capital Management (AQR stands for applied quantitative research), is a distinctive investment manager that seeks to translate academic insights about finance and the markets-such as the appeal of value and momentum investing-into winning quantitative strategies for institutional and retail buyers… Indeed, the stock market selloff since the start of this year has shaped up as a key test of whether liquid alts can deliver the promised diversification and protect investors during downturns. Liquid-alt funds have been rightly criticized for generally disappointing returns during the recent bull market-and high fees, to boot. During a raging bull market, alternative strategies will almost always underperform… as will most traditional long-only active managers. It makes sense to dump every last cent into an S&P 500 index fund and be done. But the kind of market we’ve experienced since 2009 isn’t normal. It was a product of low valuations following the 2008 meltdown and the loosest monetary policy in history from the Fed. But with the market now in expensive territory and with the Fed’s easy money policies slowly on the way out, an alternative strategy makes all the sense in the world, at least with a portion of your portfolio. You want returns that are uncorrelated to the market. You’re not betting against the market, mind you. You’re just looking for something that marches to the beat of its own drum. I like what AQR is doing. But there’s a big problem with it: While they advertise that their alternative funds are liquid, they are all but unattainable for the vast majority of investors. The minimum investment on many of their mutual funds is as high as $1 million. We can do it better. With an investment of just $100,000 (and actually less with our robo-advisor option), we can execute a comparable strategy and do so with far lower fees. To see how our results stack up against AQR and the rest, take a look here . I’m a big believer in the benefits of a long-term buy-and-hold strategy, particularly for younger investors. But I’m also realistic and realize fully that a long-only strategy will go through long periods of underperformance. From 1968 to 1982 – a period of 14 years – long-only investors in U.S. stocks wouldn’t have earned a single red cent. Now, I have no way of knowing if we are about to enter a long dry spell like that. But if you are in or near retirement, doesn’t it make sense to have at least a portion of your portfolio in a strategy that zigs when the market zags? Disclaimer: This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results. This article first appeared on Sizemore Insights as Liquid Alternative Investments for Ordinary Investors

Hedge Fund Peer Groups Are Hazardous To Your Wealth

In his seminal 10 Things Investors Should Know About Hedge Funds Dr Harry Kat documents a big problem with hedge fund peer groups. Funds in these peer groups do not belong together because their performance is not correlated. They behave differently. Click to enlarge Consider, for example, “market-neutral.” This very popular strategy comes in many forms — dollar, beta, style, sector — the list goes on, and many funds that call themselves market-neutral should not. Kat finds correlations to be a mere 0.23 among funds in market-neutral peer groups, substantiating the fact that these funds are different from one another. These funds do not belong together. Consequently, hedge fund managers win or lose based on beta rather than alpha. Back to Basics Hedge fund due diligence can be distilled down to two crucial questions: (1) Do we like the strategy that this manager employs? (2) Does this manager execute the strategy well? Common hedge fund due diligence, as it is practiced today, answers the first question with hot performance, and accepts conceit and concealment as answers to the second. This is a shame because investors have been shammed by fake due diligence. The Madoff and Stanford scams were enabled by the due diligence sham. Here’s a simple 2-step due diligence approach that is rigorous and sham – free. (1) The adage “Don’t invest in what you don’t understand” is particularly relevant to hedge fund investing. To address this issue we recommend that the researcher complete a fairly straightforward profile like the following: Sample manager profile Approach long: Exposures to styles, sectors, countries, etc., as well as exposures to economic factors. Approach short: Exposures to styles, sectors, countries, etc., as well as exposures to economic factors. Direction: Amounts long and short Leverage Portfolio construction approach: Number of names, constraints, derivatives, etc. If we can’t complete this profile, we don’t invest. That’s the deal. If we can complete this profile we can move on to the question of manager competence. The profile gives us the option of replicating or hiring (make or buy), so we want to know that value – added exceeds fees. (2) Perform Scientific Tests of Manager Competence: There’s nothing worse than a mediocre doctor or a mediocre hedge fund manager. Albert Einstein once said ” The problems we face today cannot be solved at the same level of thinking that created them. ” A corollary is that it’s unlikely that the people who created the problems can succeed at fixing them. The solution to the problems with peer groups and indexes is actually quite simple, at least in concept. Performance evaluation ought to be viewed as a hypothesis test where the validity of the hypothesis ” p erformance is good” is assessed. To accept or reject this hypothesis, construct all of the possible outcomes and see where the actual performance result falls. If the observed performance is toward the top of all of the possibilities, the hypothesis is correct, and performance is good. Otherwise, it is not good. In other words, the hypothesis test compares what actually happened to what could have happened. Using the profile described above, a computer simulation randomly generates portfolios that comprise a custom scientific peer group for evaluating investment performance. A reported return outside the realm of possibilities is suspicious, and can be explained in one of three ways: T he return is in fact extraordinary, the return is fraudulent, or we do not understand the strategy. Of course the test itself cannot tell us which of the three possibilities is the reality, but it does give us motive to look. In other words, the hypothesis test either validates the credibility of reported performance or provides the wherewithal to question the incredible. Financial audits are not designed to provide this validation. The Challenge of Change Behavioral scientists tell us that we are all hard-wired to resist change. We want to continue to use hedge fund peer groups. Advocates of change preach “change talk,” the language of overcoming the challenge of change. We need to hear and understand the disadvantages of the status quo , and to appreciate the benefits of a new, improved future. Most importantly, people need to listen, so the message should be entertaining. That’s why we produced a short video on the Future of Hedge Fund Due Diligence and Fees to re-frame your thinking. In the future we won’t pay much for hedge fund exotic betas (risk profiles). We’ll pay for superior human intellect instead. We’ll know the difference because we’ll abandon simpleminded performance benchmarks like peer groups and indexes, and replace them with smart science. Disruptive innovation will elevate our comprehension and contentment. Everybody will win. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Bears Miss Out On Social Media Payday

Social media shares have borne the brunt of the recent market selloff but few short sellers are lining up to short the market despite its recent underperformance as tracked by the Global X Social Media ETF (NASDAQ: SOCL ). Social media companies make up half of the once hotly tipped but now largely discredited , “FANG” trade of fast growing tech companies with a global presence. The market’s recent shunning of these high flying mercurial shares, spurred on by a spate of disappointing tech earnings and wider fears surrounding the health of the global economy means that every one of the acronym’s four constituents are trading over 10% off their recent highs. The headwinds faced by the sector’s flagship stocks are reflected in the overall sector as the Global X Social Media ETF hit a two and a half year low earlier this month. While the fund has rebounded somewhat in the last 10 days, it is still down by 13% ytd which is more than twice the fall seen by the rest of the market. The headwinds felt by the sector have been relatively universal as eighty percent of the ETF’s constituents have seen their shares retreat year to date. Collapse catches short sellers out This recent collapse of the once popular trade looks to have caught short sellers out as the ETF’s constituents entered 2016 with a below average short interest. In fact, demand to borrow the fund’s constituents fell by over a third last year and short interest stood near a two year low prior to the selloff. This indifference towards social media shares runs against that seen in the rest of the market where short selling stands at multi year highs. While there has been a 7% increase in demand to borrow social media shares since the start of the year, that number also trails the increase in shorting activity seen in the S&P 500 where average short interest is up by double digits since the start of the year. Lack of appetite universal As with the fall in share prices, the lack of appetite to sell social media shares short is fairly universal as only seven of SOCL’s constituents see any material short interest as defined by having more than 3% of shares out on loan. Pandora (NYSE: P ) is the most shorted of the lot with 8% of its shares now out on loan. Its shares have fallen by a quarter as investors’ fret about the company’s prospects in an increasingly crowded streaming field. Ironically, Groupon (NASDAQ: GRPN ), which was the highest conviction short at the start of the year, has become a painful short as its shares surged following Alibaba’s (NYSE: BABA ) disclosed stake in the online discounter. Short sellers have covered 10% of their positions as their trades went against them. The only firm to see a material rise in short interest across the field since the start of the year has been LinkedIn (NYSE: LNKD ) after its shares nearly halved in the wake of a disappointing earnings update. While short interest in the professional social media firm has since quadrupled, the 2.1% of LNKD shares now out on loan is still less than that seen at the start of 2015. Investors not buying dip Investors in SOCL have shown little patience to ride out the recent volatility as over $32m of funds have flowed out of the ETF since the start of the year. These strong outflows represent over a quarter of the AUM managed by the fund at the start of the year which underscores the wave of negative sentiment felt by the sector since the start of the year.