The Journey, Part VI: New Horizons

February 2, 2013
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With this installment, we conclude our series, “The Journey: From Floor Trader to Family Office Manager.” (If you haven’t read the whole thing, start here.)

In Part V, Global Opportunities, we discussed managing large amounts of capital… moving beyond conventional wisdom… and the search for, well, global opportunities.

In Part VI, New Horizons, we discuss the Family Office outlook… dig deeper into risk control… and finish with a view of the horizon — trading, investing and beyond.

This interview series is part of the Mercenary Vault, an archive of exclusive high quality materials available to Mercenary Dispatch subscribers.  

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And now to the finale…

Note: This interview segment is Part VI of a series. Also available:

JACK: If an up and coming hedge fund manager wanted to break into family office circles and get a meaningful allocation of capital, what advice would you give? What kind of approach would be recommended, what kind of pitch, and so on?

DEEP ALPHA: First, I would say be aware of some changes in the Family Office world.  The shifts have been occurring for some years, but since 2008 they have accelerated.

For one thing, there has been a migration from single family office structures to multi-family structures to help reduce costs. For another thing, family offices (like so many) are scarred from financial crisis losses and the lack of transparency post-disaster.

They are more savvy now, and some of the larger offices are plucking top-notch investment talent from hedge funds and private equity firms. That is the bigger scale.

But, whatever size a manager is dealing with, most Family Offices want to know immediately about your fee structure and how you manage risk. They want scenarios. They don’t want big surprises.

JACK: It keeps getting back to risk control.

DEEP ALPHA: Yes. In your interview with Peter Brandt, I was very impressed with the way he thoroughly goes over risk management: How he reviews trading performance, what he could have done differently, breaking it down and so forth.

That deep focus on risk management is what I would be asking for. Very specific parameters, broken down, laying out exactly what would happen under various scenarios. That and the profile of the sandbox the manager is playing in. What are the opportunities, how crowded is the space, is it saturated yet… how long has he been there, does he have people there… with emerging markets especially, having people there is key. Knowing the local markets, the local color and flavor of what’s happening.

Depth of expertise and depth of risk management – those are the two big ones. Then I want them to be aware enough to answer all my detailed questions. 

JACK: What is your opinion on some of the major hedge fund players out there today? Och Ziff, Moore, Paulson… just the big humongous players.  How do you view the big giant funds out there?

DEEP ALPHA: This may be a personal bias, but it just isn’t my style to go with asset managers that large. I would much rather hand pick some boutique, smaller shops –

JACK: You’d rather trust in your ability to find up-and-comer managers who can deliver real returns.

DEEP ALPHA: That’s me. And as I mentioned, since the big meltdown, fee structures are being questioned. Negotiating is much more common. Fees were just accepted before, but now it’s no longer the case.

JACK: The standard “2 and 20” is becoming “1 and 15” and so on?

DEEP ALPHA: It’s changing, absolutely. The fees are getting smaller.

JACK: Is there a place in this universe for aggressive risk-return type funds? Where there is still a risk management process, obviously, but the target might be 40 to 80 percent annual returns with acceptance of a larger drawdown –

DEEP ALPHA: I can tell you that family offices don’t look at that. Endowments wouldn’t look at that. I personally would look at it though…

JACK: They are more in the neighborhood of, say, 10-15 percent annualized and single-digit drawdowns.

DEEP ALPHA: Right.

JACK: Another question relating to allocation: In your own trading, how do you think about allocating capital to various time frames: Day trading positions, swing positions, long-term investments… how do you break that out?

DEEP ALPHA: I wish I had a scientific answer…

JACK: Just a general feel for how you approach it.

DEEP ALPHA: My short answer would be “Opportunistically.” Day trading is kind of a staple. Bread and butter.

JACK: By opportunistic, you mean that you see something and on the spot say “Hey this could be a good swing trade,” or “Hey this could evolve into a long-term position trade.”

DEEP ALPHA: Yes. And I would say the swing trades are much more frequent than the long-term trades. I can and have sat with gold for 10 years…but not in the futures market. I never would be able to hold it like that.

JACK: What is going to happen in your own trading as you get more and more involved from a family office perspective? The very definition of long-term capital allocation – deep digging, vetting the managers, finding the gems – how will you balance that with the demands of short-term trading? Just do a lot of delegating?

DEEP ALPHA: There will definitely be delegating, especially with the next move I’m contemplating to a much bigger family office structure. 

JACK: So your expertise is also shifting to becoming an evaluator of other traders, of other managers.

DEEP ALPHA: Exactly. I’m looking forward to that. I’ve been doing that on a small scale, but it’s going to start happening on a much larger scale.

JACK: Part of your ongoing evolution.

DEEP ALPHA: Yes. The reality is, I enjoy interviewing others amd learning what they know and how they implement their strategies. Time for changes…

JACK: Put short-term trading on the shelf and possibly come back to it later…

DEEP ALPHA: Yes, putting it on the shelf while I see how I like a far deeper commitment to the family office world. Will I still be swing trading and doing things of that nature? Maybe upon occasion. You certainly don’t want a conflict of interest when you are responsible for very large sums.

I need to focus my energies on becoming an experienced long-term investor – again, an evolution that I’m ready for. I am looking forward to traveling, meeting with managers, and talking with competent people.

JACK: How do you think about risk from an investment perspective? We’re talking just your investment portfolio, where everything in it has a minimum time horizon of twelve months, or a longer term 5 years, perpetual cash generation or whatever – how do you think about risk allocation to this pool of capital that you have? I mean, would you go on an individual investment basis? 5% of capital into this idea and whatnot? How would you mentally approach this?

DEEP ALPHA: Let me get back to you in deeper detail on that. This is an area I’m growing in and formulating right now.

JACK: I’ve always been curious about this. It’s the question of how value investors manage risk. Most of what they do is, “When you buy something make sure it can’t go to zero.” It’s strange in a sense that deep value still has serious embedded volatility risks. But as Buffett says, Volatility is not risk; you think about risk in terms of permanent loss of capital.

If you’re going to be a real deep value player, I guess you have to be willing to sit back and have these years where you are down 20% or whatnot… the whole question is very interesting to me, because value becomes more poignant the larger your capital base becomes.

DEEP ALPHA: Certainly. It’s going to be a learning process, no question.

JACK: What makes sense to me is: If you’re talking about a longer term pool  of capital, you have to establish a series of outlier cases and then work off of those. You have to say, “If we’re going to invest this capital with a 5, 10, 15 year time horizon, we’re going to have to endure drawdowns of X percent or more.” And even that is going to be fuzzy because, if you’re doing off-exchange type stuff, there aren’t going to be regular mark-to-market values. It’s very interesting, the complexities involved here.

DEEP ALPHA: Agree, and I will be diving headfirst into that.

JACK: What would you say is the ballpark capacity level for, say, daytrading vehicles like the e-minis and bonds, or swing-trading — say you’ve developed a great short to intermediate term system for trading equities and futures — what would you say is the upper limit for that type of strategy? 50 million? 100 million? At what point does the base get too large?

DEEP ALPHA: I would say $100 million… there are enough liquid assets and places to play for that to be a reasonable ceiling.

JACK: That makes sense to me too. So then here is another question, more of a personal one: Given that your short-term strategies give you the possibility to run as much as $100 million — the bulk of which could become your own money after a while — why choose to go into the longer term arena? It could be a great decision, of course, I’m just curious about your motivation. Are you just passionate about new vistas and new horizons, or…?

DEEP ALPHA: For me, one of my goals is to open up my time horizons. As human beings we are like monkey brains: We get trained in something, and then we keep going there and going there, and I want to open up my time horizon to get past that. And this is going to do it. This will also open up a whole range of opportunities to dig deep into risk management… all kinds of alternative investments… areas that I am very fascinated by.

JACK: Do you think it could actually be less stress, to run larger amounts of capital on a family office timeframe? 

DEEP ALPHA: I think so, for me personally. Again I wasn’t trained classically — it’s just been boots on the ground training, off we go. This whole concept of an enormous portfolio, and the world as your playground — I want to see how this goes, and what I’ll be learning from it. And if it works, the access to people and ideas I’ll have will be huge. I’ve had good access so far, but it will be even bigger. It will just give me this leap to learn – 

JACK: It sounds like a new adventure.

DEEP ALPHA: Yes. And like we were talking at dinner the other night — Mongolia. So many interesting places in the world…

JACK: Right, any economy that is growing 50% per year is likely to be intensely interesting. And it is such a wild time. I’ve said before there is as much exciting change going on now as there has been in the past 100 years. We’ve got industrial revolutions, global power shifts, breakthrough technologies on the cusp — craziness.

DEEP ALPHA: So much fun. I think too that giving up trading is an empty nest syndrome for me, so I really have to fill it up with something big.

JACK: And you are only partially walking away from trading because there is a new horizon of things that are even more interesting, at such a great time.

DEEP ALPHA: It’s a time of incredible opportunity and change. And of course, learning…


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