ALFA: Cloning the Top Hedge Funds

08/08/2014 10:00 am EST

Focus: ETFs

To select the holdings of this unique ETF, Maz Jadallah—CEO of AlphaClone—assesses the performance of some 500 hedge fund managers, focusing on the top long-term performers.

Steven Halpern: Our guest today is Maz Jadallah, CEO of AlphaClone. How are you doing today?

Maz Jadallah: Outstanding, how are you, Steven?

Steven Halpern: Very good. Thanks for joining us. Your firm AlphaClone Alternative Alpha Fund-with the symbol ALFA-is an exchange-traded fund that invests in the disclosed equity positions held by top fund managers. Could you give all the listeners some background of AlphaClone Alternative Fund?

Maz Jadallah: Absolutely. Alpha was originally started as a research firm back in 2008. We were the first to deploy based on following the disclosed positions through regulatory disclosures called Form 13F-HR.

Every hedge fund manager that manages more than $100 million of other people's money has to file quarterly-with the SEC-a form that discloses their positions at the end of that quarter. Our firm is a pioneer of the use of these public disclosures to derive buy and sell signals around US equities.

We deployed the first investable strategies in managed accounts in late 2010 so we have mostly a three and a half to four-year track record that is audited and gift compliant writing those strategies. We are also the first to deploy an ETF that employs one of our strategies and that is the alternative Alpha Fund with ticker ALFA.

Steven Halpern: The Alpha Fund is unique in that it does not just follow a random set of managers, but rather you invest in the compositions of hedge fund managers who have provided persistent returns over a longer period of time. Could you explain how you determine which fund managers to select?

Maz Jadallah: Certainly, the top thing about investing with active managers is, really, manager selection. There are thousands and thousands of managers and the statistics are pretty damning in terms of what % of those managers are able to outperform broad market indices over a long period of time.

The average investor-even the large institutional investor-has a really hard time picking managers effectively and consistently.

What we have done is, we built a data set of these disclosures from over 500 managers and the data set spans back to the year 2000. If you think about that data set, it's sort of, a pristine data base; what each manager held in each quarter over a long period of time.

That database strips out the use of leverage and the managers own esoteric trading skills. We have the ability to evaluate all managers on an even playing field. Our method of evaluation is called CloneScore.

Our CloneScore is a persistent in return score over a long period of time and we re-score all of the managers in our universe every six months so we're able to switch into managers that are starting to do well and score very highly on our system and move away from managers that are doing the opposite.

We do it without any cost to the end investor. That's our approach; we score everyone and then we pick managers with the highest clone score to make it into our strategies.

Steven Halpern: I understand you also hedge to protect against severe market declines. Could you expand on that?

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Maz Jadallah: Yes, our philosophy is you don't want to put all your eggs into one basket so when we select managers, we select at least a dozen managers to try to mitigate against key man risk or performance risk.

In that sense, it's a virtual fund of fund that we're offering that, sort of, democratizes his access to the high conviction ideas of the manager that we think it makes the most sense to follow.

The big part of our philosophy is that sometimes the market doesn't really care how good you are picking managers; it's going to sell-off. We have a simple non-proprietary dynamic hedge that allows our strategy to move from being long only to market neutral and its binary; it's either long only or market neutral.

The way we decide whether to be long only or market neutral is by simply looking at the S&P 500's 200-day moving average relative to the level of the index at the end of every month.

If the S&P closes below its 200-day moving average at the end of every month, on the next day, we move the strategy from being long only to market neutral.

What the strategy is trying to do is protect capital or protect against market volatility when the market is selling off over multiple months yet still be long only when the market is running very bullish over multiple months.

Steven Halpern: Looking at some of the top hedge fund managers in general, what overall trends have you noticed regarding areas that they are moving towards and potentially areas they might be moving away from in the stock market.

Maz Jadallah: Yes, that's a good question. I think after the 2008 crisis, the largest arching themes have been Safe Haven economies or cleanest/dirty short economies, i.e. the US and emerging markets are, really, have been, sort of, the two big themes.

There was a departure from those two themes in 2013 as opposed to the S&P 500. The Russell 2000 seems to be a favored index or mid cap stocks seem to be favored stocks against hedge funds.

You saw the Russell 2000 really perform very well in 2013. With the sort of up and down markets this year, we're seeing sort of a slight shift to sort of Safe Haven large-cap stocks and we're seeing some hedge fund managers begin to invest sort of seriously in European stocks as well.

Steven Halpern: Could you highlight some of the most popular hedge fund names among individual stocks?

Maz Jadallah: Sure, as of last quarter, the most popular names were in order Google (GOOG), AIG (AIG), Apple (AAPL), Time Warner Cable (TWC), General Motors (GM), and Actavis (ACT).

In terms of large new bets, we saw Icon partners make a really large $1.5 billion bet on eBay (EBAY). We saw Lansdowne Partners make $641 million new bet on Verizon (VZ).

We saw Pershing Square make a $635 million new bet on Platform Specialty Products (PAH). Both Third Point and Lone Pine made half a billion dollar bets on Actavis (ACT).

Steven Halpern: We really appreciate learning about your fund and taking the time to illustrate your ideas with us. Thanks for joining us.

Maz Jadallah: Thank you, Steve, and my pleasure.

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