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Hedge Fund Exploits Changing Political Climate

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David Coggins, principal of Coral Gables Asset Management (CGAM), was always keen on launching his own fund. But differentiating oneself in a crowded marketplace is not easy, and it wasn’t until he did his MBA at the University of Miami in Coral Gables, Florida, that he hit upon a unique idea for an investment vehicle that he knew would work.  

His firm launched a behaviorally based long-short hedge fund in June that seeks to exploit short- and medium-term trading opportunities in the U.S. equities space — opportunities that arise, Coggins said, largely from the slow pace at which market participants (investors as well as analysts) incorporate new information into stock prices. 

Coggins, who studied under Alok Kumar, Gabelli Asset Management Professor of Finance at the University of Miami and a leading researcher in behavioral finance, was greatly impressed by the latter’s work in the field. 

“I thought his research was cutting-edge and different, and it could form the basis for a different product in the marketplace,” he said. 

Coggins tied up with Kumar, who serves as CGAM’s CIO, and their union resulted in the new fund.

The fund, which is managed by Jawad Addoum, employs three independent sources of predictable patterns in stock returns: geographic diffusion, momentum and sensitivity to the political climate. All of these factors generate opportunities, Coggins said, because Kumar’s research has shown that the way in which investors and analysts react to them creates mispricings in the market.

CGAM has built proprietary investment models based on these factors that allow the firm to rank stocks based on signal strength. 

“We develop and rigorously test our quantitative investment models in-house, with the goal of achieving superior returns exhibiting low correlation with market returns and economic conditions,” said Elizabeth Fugler, CGAM’s director of new business development and client services.

“When we talk of geographic diffusion, the main drivers of a firm’s returns are not typically concentrated around its corporate headquarters, and yet Alok’s research has shown that equity analysts do not fully incorporate firms’  geographically dispersed earnings-relevant information into their forecasts. Instead of using dispersed geographical information, they form their forecasts primarily based on lagged firm earnings. As a result, their earnings forecasts do not fully account for the earnings information of other firms headquartered in economically connected states,” Coggins said. 

Local macroeconomic conditions also affect the risk appetite of local investors, who tend to overweight local firms. CGAM has developed a new measure of state-level economic conditions that allows the fund to take advantage of other opportunities.

Finally, firms and industries are sensitive to the changing political climate, and through measuring this sensitivity systematically, CGAM has shown that market participants process this information slowly, thereby creating investment opportunities.

“You would think, for example, that a health care company might do well in a Democratic political environment while another type of company, perhaps something gun-related, would fare well in a Republican administration,” Fugler said. “Actually, that’s not always the case, and our research has shown that if we go back historically, we can see that companies that you think would perform one way in a particular political climate don’t actually do so.”

She added, “Obviously, there will be times — during elections, for instance — when that would more so be the case, but by and large, analysts are not accounting for this behavioral factor.”

The CGAM portfolio focuses on mid-cap stocks that are under-researched and less efficiently priced than large-caps. Portfolio security selection within CGAM is managed to be market neutral, Fugler said, and returns from stock selection are “pure alpha”. 

“We reduce volatility by achieving neutrality across factors such as style, market cap, geography, sector and industry, as well as risks originating from financial distress and liquidity,” she said. “We systematically rebalance positions at a frequency that balances the trade-off between realizing profits and minimizing transaction costs.”

“We have a dynamic strategy and continuously look for new ways to use Kumar’s cutting-edge research in behavioral finance to benefit our investors,” Coggins said.