Q: What is the history of the company and the fund?

We have been involved in quantitative management and investment techniques for more than 30 years, since the dawn of its development on Wall Street.

As investors sought a more flexible strategy that adapted to changing market dynamics, their interest in alternative investments grew. We created the Quantitative Long/Short Fund in September 2008 as an alternative to complement traditional long-only investments. 

Launching a new fund in the midst of that market chaos was challenging. However, with our combination of fundamental, quantitative, and technical processes, we are better able to determine which stocks are likely to outperform or underperform in the long term. 

We believe adding an alternative element to a traditional long portfolio provides diversification that helps on the downside. There are times – maybe even lengthy intervals – where the ability to not be there when a significant bearish event occurs can be quite valuable. This fund allows us the opportunity to be tactical while also having defensive characteristics. 

Q: How would you define your investment philosophy?

The basic philosophy behind the fund is to be in tune with major market moves over time. We adjust asset allocation according to changing risk/reward parameters, remaining focused on longer-term valuation and technical market trends. 

Simply put, when value is good and market conditions are supportive, the fund will have a higher net long position. When the converse is true, it will have a smaller net long position and potentially higher cash and short positions. Outside of our shorting capability, this is basically what mutual fund managers used to do 50 to 60 years ago. 

Other long/short funds are market neutral, and some strategies carry a net short position. By and large, our net long position ranges between 45% and 115%, so there is a broad range we can operate within. This flexibility can help achieve equity-like returns with lower volatility on the downside, and the beta of the fund can actually change over time. 

Individual stock selection – whether it is focused on dividends, growth, value, small cap, or large cap – is largely determined by our quantitative process. One of the advantages of using quantitative techniques is that it provides for a disciplined systematic process that takes away the human emotion and behavioral bias when making buy-and-sell decisions.

Q: What is your investment strategy and process?

There are two aspects to our investment strategy: we take a top-down approach to determine allocation between longs and shorts, and marry it with bottom-up quantitative stock selection. 

The appropriate long/short allocation is decided based on a macro view that uses a dashboard of indicators related to the U.S. equity markets. 

Roughly half of these are valuation indicators that help us figure out how expensive the market is and give us a general idea about future expected longer-term returns. Because historically valuation has not always been the best timing tool in the short-term, momentum indicators are used as well to capture changes in the overall trend of the market. Using the combination of valuation and momentum helps to guide the fund’s positioning over time. 

Currently, the fund is approximately 50% net long, at the lower end of our positioning range, indicating we have become more cautious near term. 

The second aspect of our investment process is stock selection, which is more of a bottom-up process that uses quantitative analysis to rank stocks. For the long side, we start with an all-cap universe of stocks, primarily among the S&P 1500. The S&P is attractive because of its restrictions on quality and liquidity. 

For shorts, our universe tends to be broader. It can include not only the S&P 1500, but also all other U.S. stocks above $100 million in market cap. 

We start with over 3,000 stocks. Then a multifactor model ranks them based on the valuation, earnings, and momentum attributes for each stock. These underlying factors are tested routinely for their effectiveness. 

Focusing on the most attractively ranked stocks narrows the universe significantly. From there, we implement a fundamental or qualitative overlay which allows the portfolio management team to identify red flags – reasons to avoid certain stocks the model may not have picked up on. 

Such items include company-specific issues like litigation, corporate actions, or even insider trading activity. We also look at the external environments of companies and their industries, like regulation and economic policy that might affect a stock. 

Finally, during the composition stage, we perform additional technical analysis of each stock before its inclusion into the portfolio. For long positions, our goal here is avoiding value traps or catching that falling knife; we want to see evidence of price reflecting positive fundamentals. For short positions, we seek stocks with poor fundamentals whose price movement is in a weaker trend.

Q: What is your portfolio construction process?

Diversification plays an important role in our portfolio construction process – we want to own a large number of stocks. Typically, the fund holds 100 to 150 stocks on the long side and 30 to 100 names on the short side. 

For additional diversification, both long and short positions are equal weighted. Currently, positions are about 1% on the long side, while short positions are about a half a percent each. 

Not only is the fund tactical and flexible in its allocation between the longs and shorts, it is also relatively unconstrained in terms of market cap and sector weights. The market cap and sector weights are determined based on a bottom-up approach that is a byproduct of our quantitative process. For example, if we see that more stocks in healthcare are attractive, healthcare will increase as a weight within the portfolio.

Internally, we cap sector weights on the long side to 35% of the total portfolio. We do not want to end up being an all-technology or discretionary fund. 

Our quantitative process dictates our selling discipline, and again, the primary reason we use this discipline is to remove behavioral bias from stock selection. So regardless of any personal feeling, if a stock deteriorates to a certain level the investment team will sell it and replace it with one that looks better. The same applies to the short portfolio. 

We compare our fund to two benchmarks: the S&P 1500, and for peer comparison, the Lipper Long/Short Equity Index. However, the fund’s positioning can vary significantly from either benchmark. 

Q: How do you define and manage risk?

Particularly in periods of poor valuation, as we see now, we do not want to be overly exposed to an event that precipitates significant loss. Though there is a hedging element to this fund in the first place, a so-called black swan event could still come out of nowhere and have an impact. 

We manage risk in several ways. The fund’s overall risk is managed by adjusting the net long position of the portfolio based on a weight of evidence approach that looks at various valuation and momentum indicators for the market. In addition, we may also apply a low volatility or beta screen to help provide down side protection. The fund’s maximum short position is 35%, and we limit overall financial leverage in the fund to no more than 1.7 times the total portfolio. 

We monitor each stock’s liquidity by looking at average daily volumes and limiting the market-cap minimums to $100 million.