A Strategy to Keep Volatility Low

05/24/2012 7:30 am EST

Focus: ALTERNATIVE INVESTMENTS

Asset manager Rick Lake explains how his alternative fund-of-funds helps investors manage the downside risk of too much volatility in their portfolios. He tells MoneyShow.com how the fund blends various approaches to achieve that low degree of volatility.

Kate Stalter: Today, I am on the phone with Rick Lake of the Aston/Lake Partners LASSO Alternatives Fund (ALSOX), which has a four-star rating from Morningstar.

Now Rick, a month or so ago, I was speaking with Stu Bilton and Ken Anderson over at Aston, and they singled out your fund as one they wanted to talk about. And as you and I were chatting here before we began recording, you explained that the actual fund was formed about four years ago, but the strategy has been around longer than that. Can you explain the genesis of this, and why the fund itself was formed?

Rick Lake: Sure. Here at Lake Partners, we’re a hedge-fund consulting firm for institutions, and we’ve been working in the alternative space for decades.

There was a great development back in 1997. There were some regulatory changes, which allowed mutual funds to adopt some of the risk management techniques that were previously reserved to hedge funds and institutions.

So, we launched the LASSO Long and Short Strategic Opportunities Portfolio, dedicated to alternative mutual funds, back in 1998, and we were fortunate enough to join up with the Aston folks, and provide this strategy to the public in a mutual fund a little over three years ago. This is our fourth year with the fund.

Kate Stalter: Ken and Stu over at Aston were talking about the low volatility and why that’s an important strategy at this point in time. Can you elaborate on that a bit more, on how that plays out in your fund?

Rick Lake: Sure, low volatility is an important consideration for all investors. And the virtues of low volatility were rediscovered after the 2008 bear market. What investors discovered is that negative numbers can have a damaging impact on long-term returns.

So, if you could keep volatility low in your portfolio, you could enhance your returns over time. In the LASSO portfolio and in the ALSOX mutual fund, we dedicate our investment strategy to maintaining low volatility over time. In fact, every day we have a daily volatility guideline, where we want the whole portfolio to stay within a band of plus or minus 1% a day.

We’ve found that we’re able to keep the portfolio in the band 97% of the days, and on the days when volatility might be picking up in the marketplace, that’s our call to action to review the portfolio if need be, reduce volatile exposures, so we can keep that smooth ride going.

Kate Stalter: Now, this implies that there might be a little more trading than perhaps just a regular equity fund or fixed-income fund. Would that be the case?

Rick Lake: Well, there are two levels of activities here. There’s our level of activity as a fund-of-funds manager, and then there’s what happens inside our fund.

You know, we are dedicated to other funds that use alternative strategies, so we’re a fund of funds, and some of our underlying managers use active long-short strategies in different asset classes. And we guide the team and the mix on our team, to make sure we stay within our smooth ride, low-volatility mandate.

Kate Stalter: Explain to me, then, Rick: How does this fit in with an investor’s overall portfolio? The person that’s looking at the mix of what they have—equity, fixed income—where would this fund fit in?

Rick Lake: It’s a complement to traditional strategies. You know, the growing interest in liquid alternative mutual funds is driven by three benefits:

  • First of all, investors are looking for tools for risk management.
  • Second of all, investors are looking for additional sources of return beyond old-fashioned stocks, bonds, and cash, each of which can present some frustrations these days.
  • And thirdly, investors are looking for ways to diversify their portfolios, to enhance their balance of risk and return.

So, liquid alternative mutual funds and the LASSO strategy serve as a complement to all these traditional assets, and we found that investors might take a little bit out of their equity allocation to put in our fund, they might take a little bit out of their bond allocation to put in our fund, and they’ll mix that in to help diversify their overall monthly asset portfolio. So, we’re striving to provide a diversification for investors.

Continued…

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Kate Stalter: I wanted to drill down a little bit if we could, just for a moment, and talk about some of the specific holdings within the LASSO Fund.

Rick Lake: Sure, let’s talk about our largest holding, for example, which is the Robeco [Boston Partners] Long/Short Equity Fund (BPLSX), which is a long/short equity fund, top ranked in its category. It’s been around for a decade.

It has an interesting mix of long positions in stocks the manager favors, and short positions in stocks the manager might be concerned about. And when you mix these long and short positions together, you have two ways to make money, and you can also complement the longs and shorts to help smooth the ride out.

This is one of the most experienced long/short equity managers...but the fund has closed. As a previous investor in the fund, we still have access to it, and we’re glad to bring this type of all-star long/short equity manager to our investors.

Kate Stalter: How do you go about seeking out managers that have strategies that would complement each other? In other words, to form the balance that you are looking for within your fund?

Rick Lake: Now that’s a very interesting question. What we do is, we take our 23 years of research and hands-on investing in the hedge fund and alternatives world, and apply it to the growing universe of alternative mutual funds.

So, if you look at the world of alternative mutual funds, there are actually multiple opportunities. There are certain long/short equity funds. There are long/short fixed-income funds. There might be long/short commodity funds or global macro funds, and each one of these strategies has different risk return characteristics.

We want to blend together funds that might zig when another zags. We want to blend together funds that have different sources of return. So they might take turns, if you will, providing potential profits to the fund. And we want to mix together funds that have different risk characteristics, so together, they can all provide a smooth ride.

The process is frankly, roll-up-your-sleeves, deep research, coupled with a lot of quantitative and almost scientific work. And perhaps most importantly, there’s an art to alternative investing, which is only acquired through long experience. We’ve been doing it quite a long time, and we want to be a resource to our investors.

Kate Stalter: Last question for you today, as I mentioned upfront: You have the four-star rating from Morningstar. One of the points, though, that they did bring up—and I’ve seen this with a number of the funds in the alternative category—was an expense ratio of about 2.54%. That does seem to come up in the alternative space. What would you say to that? What would your response be?

Rick Lake: Well, there are a couple of things to consider. The finer liquid alternative mutual funds actually provide access to Rolls-Royce style investing for the price of the good solid American sedan.

In the mutual-fund world, those expensive profit-sharing fees that hedge funds charge are severely restricted. So, these are our bargain Rolls-Royces, if you will. And in the case of our fund, our underlying funds come in at about average for the category.

And the category expenses also include, because of regulation, the cost of the short selling and hedging. And then, we charge an industry-standard 1% to serve as an experienced tour guide to this area. So, if an investor can get a Rolls Royce for the price of a new American sedan, I think that’s a great deal.

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