We recently sat down with AlphaClone CEO Maz Jadallah to learn more about AlphaClone’s approach for investing using Hedge Funds Form 13F and the Alternative Alpha ETF (ALFA).
ETF Database (ETFdb): You spent 12 years in senior financial analyst, strategy and technology management roles. Most recently, you were the SVP of Corporate Development at OpenTV (NASDAQ-traded). Could you describe your trajectory going from those roles to founding AlphaClone?
Maz Jadallah (MJ): Being a data geek and engineering undergrad, I’ve played analyst roles my entire career. At Time Warner and at OpenTV, my job was to fix or find solutions to problems using data. In fact, AlphaClone was actually born out of my own frustration as an investor. I had a high opinion of myself around data analysis, but I never really did well in my own personal investing life. And AlphaClone was born out of that frustration. It started out as a simple promise that if I was going to do better in my own investing life, I wanted to uncover what the largest investors, the most prepared investors were doing with their money. That’s when I stumbled upon form 13F HR. As you know, that form is required by the SEC for every institutional investor and hedge fund that manages $100 million or more. It discloses every single long position that the fund has. That’s really when it started. I was really intrigued by form 13F. It was useful in the sense that it really gave you a very accurate view of where the manager was investing, as opposed to where the manager was advocating in his letters or in the media. So it’s a “show me where you put your money” kind of thing. The form is useful for one manager when you look at one or a couple of quarters. It’s more useful when you look at all of the manager’s quarters because they give you a sense of where the manager has been and whether he had been successful historically. But it’s really interesting when you ingest all filings for all managers, because it gives you a bird’s eye view of where the money is flowing in terms of these really established investors. I saw that there was no online cloud-based service that allowed you to interrogate this dataset and uncover whether it makes any sense to follow some of these investors, so I built it. That’s really how AlphaClone was born in December 2008, as a research service offer in the cloud online for any investor to be able to view what a manager has invested in, and determine whether it made sense to follow that manager based on their disclosures.
ETFdb: How did you come up with the AlphaClone score approach?
MJ: So I discovered two things rather quickly when I launched the research business in December 2008. One is I had a strong horse. I think there were a lot of people who were delighted with the ability to simulate investing in these holdings in very powerful ways. I also realized I was in the wrong horse race. The research business can be a very difficult business to scale. Investors are always sceptical, and rightly so. They always want to see the the proof in the pudding. And they’re never really willing to pay for research, so it’s really difficult. And we were espousing a very new investment approach that hadn’t really been established when we first launched.
So for all those reasons, this kind of research business was really challenging. So I decided to build investment strategies using the best research that we had using the data set that we built, and I developed a clone score methodology. And, really, the clone score methodology is born out of one simple idea, which is the challenge of using form 13F in deciding which manager to follow. Not every manager demonstrates skill. Not every manager who demonstrates skill consistently demonstrates skill. So you have to have an approach to determine which managers have skill and to continuously evaluate them. So we developed the clone score algorithm as a way to measure the persistence in skill that the manager exhibits when someone follows their holdings using the disclosures. So it’s a persistence of returns score. We score everybody in our universe and we track about 500 funds. We pick the managers with the highest score and then aggregate their high conviction ideas into our strategies.
Also, importantly, I will say that, in terms of clone scoring, one of the pitfalls of investing in managers who are seeking to outperform the market, or active managers, is that you fall in love with the managers that you select. You boil the ocean, you do all of this due diligence around these managers, and then you select them and if they start to underperform, you really have this bias against going away from them. So we don’t suffer that at AlphaClone because our approach is completely quantitative. In order to avoid it, we rescore every manager in our universe every six months. That gives us the ability to continuously evaluate managers on an ongoing basis and really solve the problem of manager selection for long-term investors who are looking to access active strategies.
ETFdb: So would you say that, basically, the attributes based on which you evaluate managers are more quantitative?
MJ: Absolutely quantitative. Our approach, in a lot of ways, combines the best of man and machine. We use machines to score our managers, but really, we’re scoring human beings and their ability to pick stocks. So it’s the best of man and machine.
ETFdb: Expanding on that, could you describe how rules-based and self-adjusting combines the best of active and passive investing?
MJ: Everything that we do is rules-based. And everything that we do is continuously adjusting on an ongoing basis. We update the holdings in our strategies based on new form 13Fs that are filed quarterly. We rescore managers every six months. In doing so, we’re able to identify managers who continue to perform well or are now performing well because of some macro shift in the environment. Not every strategy does well in every environment, so it’s important to reevaluate managers so you can capture those strategies that are performing well. And this continuous, automated, adjusting nature of our strategies, I think, is an important element that gives a lot of potential value to the investor. So that’s what we mean by self-adjusting.
When we say the best of active and passive, our strategies are alpha-seeking. They’re looking to outperform the overall market, they’re looking to generate return in excess of that. And so in that sense, they’re active because they’re alpha seeking. But in another sense, they’re 100% rules-based. And we’ve created indexes that underlie exchange-traded funds, which, in the form that we offer them, are considered passive vehicles. Passive vehicles, and ETFs generally, have a lot of benefits: they’re transparent, they’re relatively low cost, they’re very tax efficient, they’re much more accessible to investors. By developing rules-based, alpha-seeking strategies and putting them in passive vehicles, we seek to give investors the best of both active and passive investing in one product.
ETFdb: What type of investor should invest in AlphaClone ETFs?
MJ: That’s a good question. Before I answer that, I neglected to also mention another important aspect of how our strategies are self-adjusting: they’re dynamic-hedged – we don’t believe in being long only all the time, and we certainly don’t believe in being long-short all the time. So most of the core indexes and strategies that we offer vary their market exposure based on a simple rule. Again, very rules-based and it allows the strategies to vary from being long only to market-hedged. And we’ve written a lot about this, but we used the 200-day moving average at the end of the month to decide whether for the S&P 500 our strategies remain long only or move into a market-hedged posture. For what it’s worth, using that rule, our strategies have been hedged in September and again in October for the first time in three years. So, I think that’s an important point to make about self-adjusting.
So the fact that we’re self-adjusting, the fact that we’re alpha-seeking, the fact that we give investors the best of both active and passive, and machine-mediated, we’re not really targeting investors who are short-term. The typical ETF investor has been investing using ETFs as trading tools, as they expect a particular outcome. But we’re using ETFs in order to give long-term investors our strategies. So the right investor for us is the long-term investor who’s looking to outperform the market or have the potential to outperform the market over a long period of time, yet still have downside protection in their strategy, so it can make it more easily held during difficult times in the market. One of the biggest risks that long-term investors have is behavioural risk. It’s one thing to say, “I’m a long-term investor and I’m going to hold for 10 years,” and it’s another thing entirely to live through, say, a 40% drawdown event and to still hold your investments. So by including an automatic downside hedge in our core strategies, we’re seeking to give investors the strength to make the vehicles that we offer more easily held during difficult times in the market.
ETFdb: AlphaClone offers Hedge Fund exposure as well as an ETF, with different strategies. Would you say that this is the main factor that differentiates AlphaClone from other issuers?
MJ: We’ve been happy to see other ETFs following strategies from other providers being offered. It’s generally positive for investors because it means there are multiple companies in the market trying to educate investors on the efficacy of form 13F and using it. Having said that, we think we’re differentiated in that space largely because this is all we do and we’ve being doing it for the longest period of time. We were the first to offer investable strategies using form 13F, whether it was in separate accounts or via ETF. We’re experts at it. And in this business, research matters and quality does really make a difference.
ETFdb: Currently, you have the AlphaClone Alternative Alpha ETF (ALFA). What future opportunities do you see for AlphaClone ETF launches, and is there anything else you want to mention?
MJ: AlphaClone has now been approved by the SEC to issue new ETFs as of last week. We have four new funds in registration, so you should see at least one launch later on this year.
The Bottom Line
If you want to follow smart money (a.k.a. institutional investors) using 13F forms, this is the perfect way of doing just that. This is exactly what the Alpha ETF utilizes as part of its strategy, and it’s part of how it rates portfolio managers without bias. This approach combines human investing abilities with quantitative techniques that pick the best-performing managers. In conclusion, you can always do your own research on form 13Fs and follow your favorite managers, or you could leave that job to the AlphaClone Alternative Alpha ETF (ALFA).