A few weeks back, I attended a due diligence forum in Denver, Colorado with 361 Capital, an alternative asset manager fairly new to the mutual fund space. They currently manage five funds across three strategies: long/short, counter-trend managed futures, and “macro opportunity”. In looking over the offerings, the macro opportunity fund has been a dismal failure since launching two years ago, and was not even mentioned at the forum. That’s okay – I wasn’t planning any diligence on it given its performance history.
The global long/short equity strategy is their clear leader, and the strategy they focused half of the presentations around. The fund began trading 30 months ago, has a clearly defined process, executed by a brilliant investment team. Funny thing is, it’s sub-advised by Analytic Investors, and 361 Capital has no control of portfolio selection or trading. Though 361 Capital has their own investment team and traders, they’re simply the marketing arm for Analytic Investors’ historically successful strategy with this particular fund.
I happen to be “one of those guys” that asks a lot of questions. At a “due diligence forum”, fortunately it is welcomed and encouraged. As I listened to the smart folks from Analytic Investors walk us through their investment process, I came up with my own idea of how to “test” if Analytic Investors and 361 Capital really add value to the investment research that exists (though they create and publish much of it). I asked a pointed question at the forum trying make them squirm, but it was answered politically, rather than directly. You know how that is given the constant election cycle media circus that dances in front of us.
I give them the benefit of the doubt for sidestepping my question, as it would have been nearly impossible to respond on the fly to my challenge. When I got back to the office and discussed with Joyce my experience at the forum, I walked her through my challenge, only to discover that I was right. Looking back at the fund’s results since inception, we could basically replicate how they invest using only two ETFs. So the question was now if I could replicate the results of their investment process at a lesser cost than they charge inside the mutual fund.
Investment theory is easy to research, and test. On the flip side, practical investments take real money, and need real markets (supply and demand). Capital is not free. So when we “sell short” investments, we must pay margin interest to “borrow” the shares that we sell. Using the tools we have at the office to back test investment strategies, I can – in a vacuum – replicate their investment results. In fact, my results even outperformed the mutual fund by nearly 1% in every 12 month period. However, given the ease of trading in and out of a mutual fund, and the ability to avoid margin interest costs, I plan to continue utilizing the 361 Global Long/Short Equity Fund – because we can’t invest in a vacuum, and we will incur cost drag in our replication strategy.
While I’m convinced their investment process is solid (if not brilliant given the academic research that supports it), after seeing what’s behind the curtain, it took me all of five minutes to replicate it using inexpensive ETFs. We live in a great time to be investing. ETFs have revolutionized the investment landscape, and made it possible for investors like us to keep up with highly paid math wizards at a ridiculously low cost.