Hedging the risks of the stock market means taking the stock market out of the equation for Tom Florence, manager of the 361 Absolute Alpha Fund Ticker:(AAFAX).
The market-neutral fund, which was launched in December, brings 361 Capital LLC's funds-of-hedge-funds strategy to the registered mutual fund space.
The basic idea, according to Mr. Florence, is to hire the best money managers to subadvise the long-only portion of the strategy and then strip out the market beta by using inexpensive vehicles like exchange-traded funds to short the broader market.
“We're not looking for any help from the market,” said Mr. Florence, who also is chief executive of 361 Capital, which has $225 million under management.
“Investors can find traditional long-only returns all day long,” he added “We're looking to protect on the downside by offering half the risk of the S&P.”
On the long side, the portfolio is using 10 different money managers to provide exposure to 12 different strategies across various market sectors and categories.
Mr. Florence singles out the potential alpha from the long-only managers by stripping out the market beta with ETFs, options and futures strategies.
By shorting exposure to the broader equity market, the fund should reduce correlation to the major stock market indexes. The strategy highlights how much actual alpha is being generated by the subadvising money managers.
The stock market volatility during the fund's short history has proven to be a good test for the strategy.
Over a four-week period during February and March, at the peak of the Middle East turmoil, the S&P 500 fell by 6.3%.
Over the same period, the 361 Alpha fund recorded a 1.3% gain.
This past Monday, when a confluence of events drove the S&P down 1.1%, the fund was essentially flat for the day.
Of course, it's only fair to point out that the fund has predictably under-performed the broader equity markets during some of the recent rallies. But that's the trade-off for a strategy designed to reduce portfolio risk and volatility.
The fund's target total return is between six and 10 percentage points over that of three-month Treasuries.
But the key, according to Mr. Florence, is that the strategy lets the long-only managers do what they do best and not have to worry about balancing exposure with short positions.
And by exclusively using long-only subadvisers, Mr. Florence can offer access to some of the best money managers available inside a strategy that goes both long and short.
“We already know that the bulk of hedge fund managers produce negative alpha on the short side, so it doesn't make sense to let them handle the short side,” he said. “This fund lets the money managers focus on what they do best, and we'll use really cheap instruments to hedge out the market beta.”
This is the first registered mutual fund from 361 Capital, but the firm for more than a decade has been building funds of hedge funds for institutional and wealthy individual investors.
In the fund-of-funds format, Mr. Florence and his investment committee do use some short-selling managers, but they still apply and overlay analysis that enables them to hedge out certain market exposure when necessary.
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