About the only time you’ll see an otherwise laid-back Tom Florence get animated is when you mention fees in the liquid alts space, and the general impression that they’re too high.
“Love it, love it; love that question,” says the CEO of Denver-based liquid alternative investment firm 361 Capital, gamely rising to the challenge. “The early entrants into the world of alternative investments were hedge funds into ‘40 Act funds, and they dragged along the performance-based fee structure. So you’d have to pay the manager 150 basis points and then there were all these performance-based fees. It’s evolved to where it’s now really just a management fee, as there is in a traditional mutual fund, without any incentive fees.”
For instance, he points to the firm’s managed futures fund, which he says is 180 basis points “all in,” with 150 basis points as a management fee.
“They are going to come down,” he says pointedly. “We’re constantly looking at fees in the industry relative to where the assets are going. Now you’re seeing multimanager funds that, rather than hiring hedge fund managers to manage the assets in the traditional sense, they’re able to lure those managers for a flat fee. So they’re becoming much more investor friendly, which is a good thing and what should happen.”
The firm, founded in 2001 by president and CIO Brian Cunningham, has a sole focus of taking its “experience and knowledge in the alternative space ‘post-Bernie,’ and all that nastiness with illiquidity, high fees and a lack of transparency, and put these strategies into something usable,” according to Florence.
“All lot of these strategies are good strategies and have a place in the portfolio, and why shouldn’t everybody have access to them?” he rhetorically asks. “So we see a ’40 Act mutual fund as the perfect vehicle for something like that. Our view is to take the strategies that make the most sense in mutual funds and then put them in mutual funds. Our mission as a firm is to create alternative investment vehicles that have weekly liquidity or better, and then teach our advisors who we work through how to best use them in portfolios.”
So is the alternative investment story an easy story to tell at this point? Yes and no, Florence responds.
“There was a lot of interest around alternative investments in 2008 and 2009. Since then we’ve had this tremendous bull market, so it’s hard to get excited about anything other than the S&P 500. However, what is starting to draw people to it is the question of what will happen with fixed income and rising interest rates.”
That concern, coupled with more education among advisors on the topic of alternatives, are driving interest beyond the “tip of the pyramid,” a theme the firm is currently discussing. “The tip is the people that really get it, they’ve been using [alternative investments] in the asset allocation of their portfolios and they’ve been subbing out the illiquid stuff for the liquid stuff. They’ve been the ones that have been really driving assets in the space over the last three years. And when you read about the asset growth, which has been pretty tremendous, it’s some of the more astute advisors that haven’t been using alternative assets that are now beginning to use them. And that will continue down through the rest of the pyramid, and it represents tremendous opportunity.”
The impression among many advisors is that in 2008, too many of the supposedly noncorrelated assets sure were correlated, and about the only asset class that performed to expectations during that time was managed futures. The story since then with managed futures hasn’t been pretty, so how does the firm tell the alternative investment story if there isn’t the track record to back it up? Florence doesn’t hesitate.
“One of the things that make us so effective is that we have counter-trend strategies, which is different than the trend followers,” he says.
“Managed futures have predominantly been a trend following strategy,” Cunningham adds. “That has suffered over the last few years because, ex. the equity markets which have been choppy at times, there really hasn’t been a clear trend, say, with commodities and things of that nature. So we’re in a 26-month or 27-month drawdown on the managed futures industry as a whole. I think that I’d rather have a strategy that’s consistent over time, rather than one that gives me a 30% return in 2008 and then nothing for the next four or five years.”
This is one reason 361 Capital (“a degree beyond” is its tagline, in case you were wondering) “latched on” to the whole idea of short-term countertrend strategies; because they tend to be more consistent and tend to trade less often.
“I think one of the things that’s been a major driver of our growth and something we emphasize here is simplicity and transparency in the strategy,” Cunningham continues. “It’s one thing to have underlying transparency to the position, but show me the typical hedge fund with the thousands of positions and I couldn’t really tell you what the strategy is. If you keep it simple as to why the strategy works and when it will do well and when will it struggle, that’s what has been resonating with advisors.”
The result is that the firm has been able to get positive returns in a bad market environment for managed futures, something few others were able to do. Cunningham says the managed futures fund is up 9.43% over the last 12 months, while the average fund in the industry was down 6%.
“If I can earn 9.43% every year, hey, I’ll take it,” he says, before conceding the S&P 500 was up 19% over the past 18 months, “but those are really outlier years. We’ve focused on this niche specifically for that consistency, and that’s really what’s resonated with advisors. Simple process, simple story. It’s not a black box; around here we call it a transparent box.”