Absolute-return strategies that generate positive returns in up and down markets are the holy grail of Wall Street. But in a post-Madoff world, investment advisers that are seeking hedge fund-like long and short strategies are not keen on the lack of transparency and liquidity in the limited partnership model, which involves legal complexity, limitations on investor withdrawals and duplicative fees. In a limited partnership model the general partner is responsible for the investment decision making and day-to-day operations of the fund operations, while the limited partners serve as investors.
The waning interest in limited partnerships means heightened interest in ProfitScore Capital Management's Unified Hedge Account, a quantitative multimanager, long/short product that uses actively managed mutual funds to take positions against the indexes. ProfitScore claims it delivers the absolute return strategies associated with funds of funds.
John McClure, founder and president of Eagle, Idaho-based ProfitScore, an SEC-registered investment adviser with $30 million in assets, launched the multimanager structure in March 2007 after he pulled the plug on his own hedge fund. "Transparency and liquidity are everything these days," he says. "You've heard about the gates being up and no one can withdraw," he says, referring to hedge funds prohibiting investors form cashing out during the past year.
McClure learned first-hand about the problems with the hedge fund limited partnership structure when he launched the ProfitScore Platinum Fund in 2004. Though he raised $25 million, the fee charged by the hedge fund administrator to maintain separate accounts was cost prohibitive, forcing McClure to keep the assets in a single account. In addition, he notes, the subadvisor technology needed to enable a multimanager fund wasn't on the market at the time. "I couldn't get there with the technology at hand," says McClure, noting that he would have had to build his own order management systems, which was too big of a project for a firm ProfitScore's size.
He also didn't like the lack of liquidity and transparency for investors, redundant fees and the complex legal structure. "I wanted to deliver this multimanager product in a separately managed account. It's an account you own, and you can see the holdings every day," says McClure.
Ignore the Traders Behind the Curtain
"The only thing that you don't have transparency on is our trader," McClure continues. "You don't get to see those traders. That's the IP [intellectual property] in this process."
Essentially McClure has recruited 15 quantitative traders who provide him with exposures to benchmark indexes in U.S. and international stocks, commodities, high yield bonds, and the U.S. dollar. "It's unified -- when they hire ProfitScore, they're hiring 15 different managers, but we're able to unify all of that and do it inside a single account," McClure asserts.
Each trader, McClure explains, follows a quantitative model into which McClure has visibility and that he monitors for risk and style drift. Hiring them, he notes, is a key part of the fund's strategy. "We assemble all the specialists into the portfolio," McClure relates, adding that they represent different styles, including mean reversion, momentum and statistical arbitrage. And each trader is a specialist in a particular index.
"We're not hiring a team of generalists," McClure says. "I hire traders that trade a certain index for me. Once that hiring decision is made, that's all they're going to trade for me."
But it's the "non-correlation of downside risk" exhibited by a trader's style that is key, McClure reveals. "You want their volatility on the downside to be uncorrelated," he comments.
At the center of it all is an in-house developed trading platform that allows the outside traders to post their exposures for certain benchmarks -- such as the S&P 500, the Russell 3000, the U.S. dollar, high yield bonds, and various international and emerging market indexes. "The traders are giving me the percentage exposure that they would like me to achieve against the benchmark," explains McClure.
"When they log in, they tell me what they'll do for the day -- long or short positions," he continues. "I take their inputs and cross them with the other traders." For example, if a manager wants to be 50 percent long on the S&P 500 and another wants to be 50 percent short, "We net those positions down and we develop a trade file, and then we take that information and trade it in an individual managed account," McClure explains. In that case, the fund would hold cash, he relates. But other times one exposure will outweigh the other.
"They don't care how we get that exposure," McClure says of his traders. "They don't care if we use mutual funds or ETFs or swaps or futures. It's up to me to go out and get that exposure."Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio