Stockholm (HedgeFonder.nu) – Efficient Capital is a rare breed of a diversified manager that exclusively invests into managed futures / CTA and offers its investors what is in effect a fund of fund of CTA. Set up in 1999 in Warrenville, Illinois just outside Chicago, the manager currently manages around two billion Dollars. Efficient has a stringent investment process which includes 150+ onsite visits a year. Maybe only a handful of people have the insight to the CTA world Efficient would have. We are therefore delighted to have had the opportunity to interview Grant Jaffarian, Efficient’s CIO. (pictred) And here is what he had to say:
HedgeFonder.nu: Efficient invests exclusively in Managed Futures. Can you define your universe to us, starting off by telling us your definition: what is a Managed Futures Fund and what is not?
Grant Jaffarian: Managed futures is first and foremost defined by the underlying instruments being used by the managed futures funds. Markets utilized should be limited to futures instruments, OTC foreign exchange instruments along with forwards and options on those instruments. Secondarily, managed futures traders should pursue alpha opportunities and not rely on passive beta exposures for profit.
HedgeFonder.nu: Can you give us an overview of the different sub-classes you identified within CTA, and if possible drop a name to each sub-category you like.
Grant Jaffarian: There is a tremendous level of diversification even within the managed futures space. Any attempt to differentiate into specific sub-classes would be incomplete. However, in general, these categories have helped us evaluate the broad categories of managers in the industry:
- Long Term Trend Followers – managers that trade trend opportunities over an average trade length timeframe between 10 days and 180 days. These managers tend to be 60-90% correlated to one another. Example: Winton Capital.
- Differentiated Long Term Trend Followers – managers that trade a more diversified basket of strategies but also over a 10 to 180 day timeframe. They often are between 40-70% correlated to Long Term Trend Followers though they may have cyclical correlation patterns. Example: Cantab Capital.
- Short Term Trend Followers – managers that trade trend opportunities over an average of 1 to 10 days. These managers are between 20-50% correlated to each other and to Long Term Trend Followers. Example: CFM: Discus.
- Global Macro Managed Futures Traders – these are traders who utilize discretion instead of systematic approaches, involve significant fundamental information in theire decision making and unlike “traditional” global macro programs avoid beta exposure in their position taking generally speaking. Example: Denali Asset Management.
- Unique Diversifying Managers – managers who have no correlation to any of the previously mentioned categories and trade in a unique fashion that could be over very short or long durations, utilize unique strategies or target specific markets. Examples of some sub-strategies in this category are:
- Volatility arbitrage
- Pattern Recognition
- Relative Value
Example: Quantmetrics Capital Management.
HedgeFonder.nu: Many investors, be it private persons or institutions, would pick one or two large industry names that would quite often have some MAN AHL DNA in it, be it AHL, Winton or Aspect, and maybe a well know local fund when adding the first CTAs to their portfolios. What do you think of that?
Grant Jaffarian: All three of those firms, Man AHL, Winton and Aspect are terrific organizations for whom I have a tremendous amount of respect. They all three do everything with excellence, from ongoing research and execution to back-office and operational infrastructure. All three of those managers have high correlation to each other as they are all Long Term Trend Following managers. If you were to pick a single manager in the industry it would be my recommendation that you choose a long term trend follower and those three are all deserving prime candidates. Investors might also consider that selecting only a single or even several long term trend following leaves a very meaningful amount of upside potential and diversification benefit out of their portfolio that investors can access to further increase the opportunities in managed futures. Even though long term trend following constitutes a majority of trading among managed futures traders, both historically and currently, the benefit to investors does not end just with that one sub-strategy within managed futures. That’s where a multi-manager approach targeting appropriate exposures across varying strategies can provide an enhanced and more risk cautious approach.
HedgeFonder.nu: What do you see as the main advantages in using a product like Efficient rather than using individual funds and composing your own CTA exposure?
Grant Jaffarian: Efficient Capital has focused on nothing but managed futures multi-manager products since the firm’s inception in 1999. No products have been offered outside the industry. As such, Efficient Capital has been able to invest all energies in managed futures.
Products offered by Efficient Capital, starting with our core product, the Efficient Diversified Fund, are unique in the managed futures space. Whereas most multi-manager solutions in managed futures allocate the majority of exposure to large long term trend following managers, Efficient does not. The Diversified Portfolio instead targets a 33% risk adjusted exposure to traditional long term trend followers and supplements that exposure with other techniques and strategies that are completely diversifying from the long term trend. The result is a well balanced strategy by timeframe, strategy and market that is better positioned to capture the long “optionality” inherent in managed futures.
Additionally, Efficient exclusively utilizes managed accounts with traders. This allows Efficient products to offer daily liquidity and even more importantly run constant risk management in an automated fashion as a result of full transparency.
HedgeFonder.nu: Your portfolios are typically very broadly diversified, holding positions in over 40 underlying managers. Why do you find it necessary to be set up so broadly?
Grant Jaffarian: As you can imagine, this is a question that is asked frequently and it is a terrific question. First, it is very important to remember that managed futures is an industry that pursues pure alpha returns. As such, adding managers to your composition will not bring you closer to an underlying beta type exposure as would happen in the traditional equity space, as an example. It is theoretically possible, therefore, to continue to add increment value, albeit at a diminishing rate, with each manager added.
However, it is certainly the case that in any single market environment, you only need 12-15 managers for an “optimal portfolio.” The question is whether or not you can have perfect anticipation of what the next market period will provide. The reality is, different environments demand a different composition of 12-15 managers. In actual fact, as you analyze periods of time in chunks (using classic step-forward analysis or more complex methods) one continues to discern that more than 12-15 managers are needed to be prepared for new environments. We continually run analysis to create an ever more robust portfolio in anticipation not of what would have been best in the past, but what will be most advantageous moving forward. As a result, we have found that a manager count closer to 40, provided each manager can add standalone top-tier value and add diversification benefits, proves more optimal in the long term.
HedgeFonder.nu: Without going to deeply into the investment process, what typically makes you add a new manager to the portfolios. And why, typically, would you redeem your investment?
Grant Jaffarian: Efficient has a relentless manager search process. As a team we visit typically more than 150 managers on-site in a given year. As a result, finding new talent that has the potential of capturing alpha returns is a big investment. When we add a manager it will always be a combination of both quantitative and qualitative analysis. New managers must have terrific stand-alone potential of hitting our target of a .6 Sharpe ratio over the long term. Additionally, qualitative excellence is demanded in all areas.
When it comes to removing a manager, it is essential to remember that as a general expectation, almost all managers will have their worst drawdown in the future. That means that at some point during your investment cycle, it is reasonable to expect their worst drawdown. Therefore, cutting a manager solely as a result of a drawdown is not sufficient. It is important to combine performance significantly with an understanding of market environment and the manager approach, ongoing research and other qualitative factors.
HedgeFonder.nu: Efficient was an early investor in what are today household names in the managed futures world, like Transtrend or Winton. Can you spot any of the new, smaller managers that have what it takes to be a billion Dollar fund? Can you name them to us?
Grant Jaffarian: As you can imagine, with our time and financial investment in manager search, we would prefer to keep some of our most promising managers relatively hidden! That said, there are a number of very dynamic promising managers on the horizon. Efficient Capital continues to be a group interested in reviewing and visiting talent even earlier in their lifecycle. Investing in younger managers is a careful business which is handled with rigor and perspicacity.
HedgeFonder.nu: What, it your opinion and experience, does it take to bring a CTA manager to a billion Dollars?
Grant Jaffarian: The reality is the formula is fairly straight forward: performance + institutional infrastructure and approach + AUM. This is not a “law,” but with those three factors working in tandem growth is more likely to be an inevitability. However, there is no “quick solution” to make it as a manager. It takes hard work and expertise across every area to reach that level of AUM as a function of delivering on the aforementioned factors.
HedgeFonder.nu: In a world very much driven by statistics, mathematics and systematic approaches, can you tell us more about the human factor. How does the managers personality character and personal environment influence your investment decisions? Did you (or would you) step away from allocating money to a manager solely because of such personal factors?
Grant Jaffarian: The human factor matters. The degree to which it matters is a difficult subject. Certainly there are cases in which human factors are absolutely paramount, and other instances in which the systematic nature of the program demands a greater weight beyond human factors. On the allocator side, an investor must be aware of the many human bias that may impair best judgement. The same is true on the manager side. The best approach in our experience is to hold managers and allocators both accountable to their view of the human factors. In this way, experience can be gathered more quickly than simply sitting back and assuming that one’s own qualitative evaluations of human factor influence are accurate.
To more specifically answer your question, there have been instances in which the human factor has been a prevailing influence on our deallocation decision. These decisions, however, have always been coupled by a quantitative evaluation, a careful inspection of underlying position taking and style drifts, alongside automated risk management and trigger alerting.
HedgeFonder.nu: Why do you have the exclusive focus on managed accounts? What really is the advantage to you and your investors by having them rather than investing in a fund structure?
Grant Jaffarian: The advantages are tremendous. First, managers do not control our investors cash OR the underlying positions. They are authorized only to transact at a given notional allocation on behalf of our fund’s master trading account. This means that as the multi-manager, Efficient can remove exposures immediately if needed, discontinue an allocation and/or move cash (through a fully segregated and independent 3rd party administrator) for safekeeping.
Additionally, managed accounts provide transparency. This transparency is essential when considering position taking and risks to major market moves. Without it, an investor could end up with the exact same position taking through their fund allocations without even realizing this was the case.
Further, managed accounts provide Efficient the ability to negotiate better terms and fees at every stage. Better fees should be negotiated at the exchange level, execution and clearing levels and of course manager’s own incentive and management fees
HedgeFonder.nu: Since 2008 many CTA managers, especially long term trend followers, have been struggling to show strong positive, uncorrelated returns and at a CTA congress recently in London there was some discussion that 2012 would be hugely important for the industry to underline the case for the asset class again. Can you briefly talk us through the challenges you faced as an industry and where you expect the light at the end of the tunnel to come from?
Grant Jaffarian: The biggest challenge by far has been the degree to which markets have been jittery and uncertain as a result of previously unprecedented levels of intervention since early 2009. Market intervention and support has not just occurred to a dizzying degree in the US and Eurozone but throughout the world in general. This has meant that risk-off scenarios which typical occur with volatility spikes, have for the most part been muted in the last three years. The real question is: will this manipulated “muting” of historically common eb-and-flow risk-off market swings be sustainable? Are we witnessing over the last three years a “new norm?” If, indeed, as a global economy it is a possibility to continually and indefinitely loosen fiscal policy and infuse markets with cash then perhaps fundamental weaknesses in the markets can be forever offset. I fear that the reality is, especially in light of growing deficits, difficulties in the Eurozone, fears of slowing Chinese growth and other factors make the current situation of policed volatility and risk-off market corrections is becoming increasingly untenable. Meanwhile, a free flowing marketplace is an environment in which the CTA industry has proven it can thrive and, indeed, it is likely to do so again. In the current market environment with heavy intervention, it is fair for investors to be weary of managed future’s ability to perform. However, in the long run (5 year window as an example), there is no question that an allocation to alpha seeking directionally opportunistic strategies is highly advisable.
HedgeFonder.nu: What would your suggestions be for a retail investor with a 100.000 Dollar portfolio wanting exposure to CTA. With the means a private person has, what should he be looking for, what should definitely make him step away?
Grant Jaffarian: Efficient Capital has always catered to the institutional investor. As such, it is very difficult for me to advise a retail investor as that is a market segment beyond my level of experience. Any investor, however, should be very well aware of the cost structure hidden and disclosed in any investment. That is also true in managed futures, the reality is that fees can and will significantly eat into longterm return potential. This is why at Efficient Capital we invest heavily in understanding where every penny goes so that at the end of the day, we can maximize the return to our investors.
HedgeFonder.nu: Can you share a piece of market wisdom with us?
Grant Jaffarian: Given the difficulties faced in the managed futures industry over the last several years, the one thing that we have a lot of is humility! And we are very grateful for it. Often the world would like to assign outperformers with a high level of “brilliance,” and perhaps they deserve it. Likewise, underperformers may typically at least temporarily get the opposing “status.” The truth is often more in the middle for both categories and being honest with oneself is critical.
I truly wish I could offer tremendous market wisdom. Instead, I would merely suggest that it is important for investors to remember that virtually all market sectors, industries and economic scenarios tend to be cyclical. It is very easy for our human biases to impair our ability to make optimal decisions. It is worth investing in understanding how our biases affect us in order to put ourselves in a better decision going forward.
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