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Martingale asset management 130/30 investing

martingale asset management 130/30 investing

Today's financial system offers both investors and fund managers enormous opportunity. "Martingale Asset Management LP in , /30 Funds. In early July of , William (Bill) Jacques, Chief Investment Officer at Martingale Asset Management, a quantitative value-oriented investment manager in. Short selling is much riskier than investing in long positions in securities; thus, in a investment strategy, a manager will put more emphasis on. WHAT DOES IT MEAN TO BE VESTED IN PENSION Citrix Virtual Apps Dhc online shop. Which you'll need increase the speed for Next. The two routers many remote assistance tools, various pricing new version is.

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Another example, presented by Patrick M. Parkinson, former Deputy Director of the Division of Research and Statistics at the Federal Reserve, refers to the stress in the fixed income markets during the summer of Parkinson stated, "The willingness of hedge funds to sell options following a spike in options prices helped restore market liquidity and limit losses to derivatives dealers and investors in fixed-rate mortgages and mortgage-backed securities".

In contrast, Cao and Petrasek quote the Wall Street Journal from November 7, "Hedge funds are selling billions of dollars of securities to meet demands for cash from their investors and their lenders, contributing to the stock market's nearly 10 percent drop over the past two days". The paper goes on to argue that because of the 1. The empirical results of the study confirm the model presented by Brunnermeier and Pedersen where asset ownership by levered hedge funds magnifies liquidity risk.

Supporting evidence is presented by their findings that on days with large adverse shocks to market liquidity, there is a negative relationship between abnormal stock returns and the fraction of shares held by hedge funds in the preceding quarter. The debate of hedge fund liquidity provision versus consumption has no clear answer.

Regardless of what the truth may be, it is important to understand the factors that contribute to both sides of the discussion. In doing so, one acquires a perspective on how the introduction of a new fund and the associated strategy, leverage ratios, lockup terms etc. Broadgates Capital Management: Strategy Thoughts and Theory Some may argue that an active manager's ability to mitigate risk generally relies upon the ability to time down markets; this is an extremely rare ability.

For long-only equity managers, this may be true as they have to rely on moving assets into defensive securities at precisely the right time. Additionally, active mutual fund managers that aspire to beat a benchmark are further pressured to hold the right stocks at the right time. Taking a defensive posture too soon could result in underperforming the index and subsequent outflows from the fund.

In theory, this strategy would be structured with an initial fundamental value screen for potential investments. Then, the fund would use a quantitatively driven approach to sort portfolios based on factors that have been identified as critical in maximizing return and controlling risk. These general principles will serve as important strategy guidelines while also illuminating key observations that Broadgates Capital Management would rely upon when creating its investment prospectus.

Controlling Market Exposure Part of BCM's strategy would be to ensure that the fund is able to fully express its views on the stocks it analyzes while also pursuing specific beta exposure targets. The fund would achieve this objective is two ways. First, both long and short positions would be taken in US equities. Second, the beta of each position would be analyzed in order to control for overall portfolio risk.

From a long-term perspective, BCM would like to offer multiple funds that would allow investors to achieve specific goals based on their individual investment mandates. Initially, such strategies were utilized to increase the return of typical long-only funds by introducing a short element while also keeping beta exposure at 1.

Assuming that the fund's talent for identifying alpha opportunities is significant, the ability to efficiently execute BCM's strategy would rely on maintaining a high transfer coefficient. Implementing a strategy that includes a short component allows a fund to increase both its transfer and information coefficients "TC", "IC".

Even when holding the IC constant among funds, short-selling dramatically increases the TC and, therefore, increases actively managed returns. De Silva explains that active managers begin their process by forecasting alphas. These forecasts would then be used to determine the weights of these holdings within the larger portfolio, eventually resulting in the relative return of that portfolio.

Performance can be measured, in part, by using an information coefficient. This tool serves as a type of correlation coefficient which measures the linear relationship between the predicted and actual alphas; in other words, how good that manager is at predicting stock returns. This gap is measured by what is known as the transfer coefficient. Essentially, this coefficient measures how efficient a fund manager is able to translate information into actual weights within a portfolio through a calculation of the correlation between a stock's attractiveness and its weight within a given portfolio.

As mentioned, certain strategy constraints can have a significant effect on the TC. Harvard Business School published a case that clearly demonstrates this idea in practice considering the passive weights associated with a broad market index. For an index such as the Russell , typically a small number of stocks accounted for a large percentage of the index value.

For example, at the time of the case, 91 percent of the stocks in the index had a weight less than 50 basis points. A long-only manager, therefore, could only express an intensely bearish view by not owning the stock, which equated to an underweight position equal to the stock's very small benchmark weight. Consequently, although this manager may have strong conviction about the troubled security, the TC is quite small which will put measurable pressure on returns and as an extension on the IC.

As not to belabor the point, Clarke demonstrated that active investment strategies that use a shorting ratio between 20 - 30 percent are able to optimize these coefficients while controlling for things like tracking error. That being said, the fund would reserve the right to vary the short ratio over time while also introducing a ceiling on the percentage of short positions in order to control risk. Clearly, an investor must consider how confident they are in the manager's ability to structure such a portfolio.

Therefore, if looking for additional long exposure through leverage, avoiding "acquisition indebtedness" associated with traditionally borrowed funds is an important thing to consider when evaluating the appropriateness of this strategy. As quoted in the above referenced HBS case, this is typically 50 to 75 bps on the value of the short sale proceeds.

When short selling, there is the possibility of unlimited loss. Therefore, an investor should consider whether the fund has certain mitigation procedures in place to hedge against the price of a short position moving dramatically higher. The strategy may also be a bit more volatile in the short-term and a higher tracking error should be expected. Using short positions to more completely express market views can also be applied to a market neutral strategy.

Thinking about the Capital Asset Pricing Model, systemic risk should be the primary concern of investors because it cannot be diversified away. From a risk perspective, the strategy attempts to achieve beta exposure of zero and a correlation coefficient with the market that is not significant. The result is a fund with exposure to a select group of stocks with little need to time macro market factors that drive systemic portfolio risk. From a mathematical model perspective see Figure 2.

By going long the higher alpha portfolio and short the lower alpha portfolio, exposure to systemic market risk is-reduced to zero and the expected return is driven purely by the alpha factors. Hedge Funds' Ability to Achieve Alpha: An Empirical Study Much of the above strategy discussion is predicated on the assumption that BCM will have the ability to add real alpha to the portfolios it constructs while also effectively controlling market risk. As the answer to this question cannot yet be determined for BCM specifically, it is important to acquire a perspective as it relates to the overall hedge fund industry's track record for adding alpha and controlling beta.

The risk free rate used was the corresponding 1 month US Treasury Bill for each month in the time series. The resulting regression output provides for the following data: Regression Statistics Multiple R 0. Beta of. Therefore, hedge fund returns are not greatly affected by market movements assuming the single factor CAPM model. This is important for investors because risk associated with the market cannot be diversified away.

Alpha of. The higher this number, the more additional value an investment is adding. Overall: with low market exposure and 30 bps of alpha per month, these numbers suggest that hedge funds are capable of generating alpha within low beta constructions.

Additionally, it should be noted that the market premium t-stat is quite high representing the significant nature of the results. For comparison purposes, the same methodology was used to contrast hedge fund monthly returns with mutual fund monthly returns. Mutual funds are much more sensitive to market risk and movements with a very high R Square of. Researchers have also documented systematic market biases that are certainly worth discussing at this stage. Adding three additional factors to the single factor CAPM is a way to discover what efficient market theorists would call "hidden beta".

Therefore, hedge fund beta exposure is larger than the single factor model suggests. An R Square of. From this analysis, I would conclude that, on average, hedge funds are able to capture alpha while also limiting systematic risk exposure.

Additionally, it is important to note the significance of the additional three factors of the Carhart Model. I believe these factors to be significant, in that persistence over the mid-term is likely. Although these factors are said to reduce true alpha, the embedded impact on returns is a phenomenon that should not be ignored.

Therefore, within the framework of BCM's overall strategy implementation, establishing exposure to these factors particularly HML would be a consideration when constructing the fund's portfolios. Additional Market Anomaly In addition to the Carhart factors, one additional market anomaly is of interest when considering the most efficient implementation of BCM's strategy.

Clarke identifies a risk anomaly in the US equity market associated with minimum-variance portfolio constructions. Basic portfolio optimization theory suggests that riskier asset classes, such as stocks, experience greater returns than less risky asset classes, such as bonds, in order to compensate investors for bearing additional risk.

However, at the individual equity level, the traditional risk-reward paradox may not be operating as expected. Clarke's study of the 1, largest market capitalization weighted stocks in the US from to revealed that minimum variance portfolios achieved the same return as a market weighted portfolio with approximately 75 percent of the risk.

By comparison, the market had an average excess return over T-bills of 5. A disadvantage associated with this strategy is the high turnover necessitated by monthly rebalancing percent annual turnover. However, by reducing the rebalancing to annually 56 percent annual turnover , monthly volatility only increases 14 basis points and monthly returns fall by a relatively small 12 basis points.

Thus, reducing portfolio cost by reducing the rebalancing frequency still outperforms the market. BCM would like to consider investing in low beta stocks low volatility when constructing its strategy. Martingale Asset Management in Boston is presently championing a similar approach, although they currently do not have any outside money in the strategy.

Fundamental Valuation Considerations and Strategy Execution Ideas Within the scope of this general, more theoretical strategy discussion, considerations of fundamental value can be thought about in two ways. By including these key value driven elements, select stocks can then be sorted by factors like low-beta or momentum to create more quantitatively driven portfolios.

This, however, is not the only potential application of fundamental research. If deemed appropriate, BCM could construct portfolios driven purely by fundamental value analysis. The basic value principles for each approach are similar, with divergences in the final execution of the portfolio constructions.

Quant-Value Approach a low-beta portfolio : The application of this idea would include a combined value screen on the universe of all US equities. Using such an approach would open up the strategy to stocks of different capitalizations and sectors, while systematically exposing the portfolio to the value HML factor. The scoring methodology could resemble that of the multiple discriminant analysis "MDA" used in the Altman Z-Score model.

MDA models were initially introduced to compare firms that had gone into bankruptcy with healthy firms. A large number of ratios would be calculated for each group and the model would select a small subset of ratios that best discriminate between the two groups.

The MDA output would also pair each discriminant ratio with a coefficient based on its signal strength. The final result would be a single score calculated by weighting each ratio by its coefficient and summing the results. A single "value-score" could be calculated in a similar fashion by using historical data to separate US equities into "high outperformance" and "high underperformance" stocks. The resulting MDA model could help determine both the most critical ratios and the associated coefficients needed to calculate a single score.

The stocks would then be ranked based on their value scores. At this stage of the execution process, the top decile or quartile could then be re-sorted based on volatility low-beta , for example. Finally, long and short positions could be constructed based on the outcome of the value screen and the low-beta sort, creating a quantitatively assembled portfolio that includes a rigorous value screen. Additionally, there are no rules against running multiple funds with very different approaches.

Therefore, it is worth discussing how BCM would think about the execution of a purely fundamental-based strategy. Other useful financial statement ratios that could be used can be found in Figure 2. These figures would be calculated over a 3 year period and compared to a selected group of company peers. Amount of sales generated per dollar of assets Receivable Turnover used to quantify a firm's effectiveness in extending credit as well as collecting debts.

Higher is better Days Receivable ave length of time a firm waits to get paid. Is this increasing in an effor to stimulate sales? The larger this ratio the greater the liabilities CF from ops. For this fund, BCM would strive to acquire a detailed understanding of each business, the industry in which it operates, and the associated risks to long-term growth potential.

The following is an abridged example of how Broadgates Capital Management would try to think about such a fundamentally driven analysis for Goldman Sachs "GS" : Company Overview: Goldman Sachs is a global financial services company that works with corporations, financial institutions, governments and high-net-worth individuals. Goldman Sachs is run by chairman and chief executive officer Lloyd C.

Strengths of the Company: Best in Class Franchise: Goldman Sachs has positioned its brand as the top provider of investment banking, investment management, market-making, trading execution, and investing in the industry. As such, the company is extremely well positioned to capitalize on improvements in capital markets activity. Therefore, I believe that if the outlook on the investment banking and brokerage industry is positive, Goldman Sachs will have the ability to use this industry recovery to drive future revenue growth.

As investor confidence begins to strengthen, Goldman Sachs is one of the most attractive companies in the sector because of its position as a market leader. Diversity of Business and Revenue Streams: I believe Goldman Sachs has a competitive advantage over some of the more specialized players in this industry. Additionally, as the markets continue to globalize at a rapid pace, Goldman Sachs' worldwide footprint allows the company to compete internationally and provide clients with the type of global financial services that are becoming increasingly more critical.

Prudent management has the ability to set the proper strategic course, and the execution of these strategies is driven by the employees. Goldman Sachs has the advantage of being able to attract the best talent available. In the face of challenging financial regulation and efforts to cut expenses, the ability to hire talented individuals is a clear advantage when trying to maintain strong client relationships. Weaknesses of the Company: Strong Reliance on Economic Recovery: Goldman Sachs' profitability and ability to drive revenue growth is directly linked to a sustained economic recovery.

If capital markets activity softens and investor risk appetite wanes, Goldman Sachs' core business will be immediately impacted. Although an extreme example, one can see the sensitivity of Goldman Sachs' business to economic conditions when looking at the impact of the financial crisis.

In Goldman Sachs Q3 earnings report, expense reductions were in part offset by fees associated with regulatory proceedings. Additionally, as reported by Credit Suisse, the Fed stated that Goldman Sachs exhibited weakness in their capital planning process. Scrutiny such as this has the potential to drag on the ability of the company to focus on its primary business objective of servicing its clients and creating shareholder value. Revenue Stagnation: Linked to the first weakness mentioned, it is worth specifically targeting overall revenue stagnation as a primary weakness of Goldman Sachs' current business.

More worrisome is the fact that this drop is more than double the declines experienced by JP Morgan and Citi. Of course, the quality of earnings would be greatly improved with revenues serving as the main driver. As stated above, Goldman Sachs will depend on overall economic growth to propel revenues forward.

Headwinds such as continued high unemployment, waning consumer confidence, fiscal discord in Washington, and an uneven European recovery will weigh on global growth and dampen capital markets activity to a degree. Investors have shown a propensity for skittishness and a dependence on accommodative Fed policy. For example, perceived hawkish language has, in the recent past, driven dramatic market sell-offs in both equities and fixed income. Real economic growth is needed to sustain a strong market.

Additionally, cash and cash equivalents have grown dramatically on the company's balance sheet. Although capital must be preserved under new government regulations, share buybacks may also drive EPS growth during and beyond, especially as revenue begins to accelerate. Investment Recommendations: In valuing the company I would start by looking at certain ratio measurements and then evaluate those statistics based on comparable companies.

This ratio has been 2. Using the language of a Credit Suisse analyst report, these valuation levels suggest low future return expectations. For these reasons, I believe that Goldman Sachs is a buy. Accommodative monetary policy will provide for an environment that supports earnings even though revenue growth may be slower to recover.

As conditions improve, Goldman Sachs will be on the strong end of the industry in terms of earnings strength and stock price appreciation. For a more detailed example of such an analysis, refer to Appendix A for a fundamental review of VF Corp.

This type of valuation is time intensive and should result in high conviction ideas for a relatively small number of companies. This fund would have very low turnover as the strategy would seek to identify businesses that would outperform over longer time horizons. Benefits of a long-term approach include lower trading costs and the fact that trading less means having to make fewer good decisions.

Risk Controls Whether applying a quantitative or fundamental based strategy, maintaining an appropriate level of risk relative to the fund's return expectations is critical. From a fundamental perspective, potential downside should be assessed starting at the security level all the way to the firm level. Within a fundamental value based strategy, the risk associated with each portfolio company should be analyzed by considering factors such as operational risks, competitive pressure, product demand risk, currency risk, and potential changes in the regulatory environment.

These are the most basic factors that will contribute to the overall risk of such a fund, and they should be monitored on an ongoing basis. To ensure a baseline level of systematic risk diversification, Broadgates Capital Management would consider instituting controls such that no one stock could make up more than 5 percent of the overall portfolio holdings.

Therefore, the idiosyncratic risk associated with each company is relegated to a reasonably small portion of the fund. Moving to the portfolio level, risk controls apply to both quantitative and fundamental based strategies. Broadgates Capital Management would implement a daily review of sector, geographic, and industry exposures.

This review would analyze the changing conditions of the market within each of these categories in order to understand how these elements are affecting the risk of the overall portfolio. At the firm level, there would be regular, process driven, compliance reviews to ensure adherence to client investment mandates and regulatory guidelines.

The process would include trade reviews, analysis of the investment decisions process, and profit and loss reviews for all portfolio managers. Risk associated with the fund's investment portfolio warrants further discussion.

Managing portfolio risk is a complex endeavor and BCM would suggest employing specific tools when thinking about systematizing risk controls. First, tracking Value at Risk "VaR" would allow the fund to continuously quantify the probability of losing a specified amount of portfolio value within a certain confidence interval over a specified time horizon. Broadgates Capital Management would use VaR calculations at different levels of aggregation in order to compile a complete picture of portfolio risk.

After identifying the market risks that affect the securities in the portfolio, probability distributions and risk co-movements would be estimated and assigned to each risk variable. One advantage of this method is that the probability distributions don't necessarily have to be normal so appropriate adjustments can be made if necessary. After thousands of simulations, different values of the market risk variables will begin to paint a picture of portfolio value based on the outcome of different scenarios.

The example given in the NYU paper supposes 10, simulations. These values can be ranked from highest to lowest, and the 95th percentile Value at Risk would correspond to the th lowest value and the 99th percentile to the th lowest value.

Broadgates Capital Management would be most concerned with VaR time-series data. Identifying patterns in VaR overtime can produce key insights into how exposed the fund is to varying environments. Finally, incremental VaR could be used to understand how individual positions are affecting overall fund risk. Monte Carlo VaR calculations are not without their shortfalls. As with most predictive models, Monte Carlo VaR outputs are only as good as the market risk distribution assumptions.

The model necessitates probability distribution estimates for each additional risk and the number of simulations needed to generate an accurate picture of VaR grows exponentially with each additional variable. Without the proper computing power, running these simulations can be a painfully slow process.

However, when compared to other VaR calculation methods, like the variance-covariance approach, the Monte Carlo method does not require the sometimes inaccurate assumption of normal returns. Consequently, the Monte Carlo approach is more adaptable in calculating VaR across different assets and portfolio constructions that may not lend themselves to the simplifying assumptions of normally distributed returns.

According to Dr. Jaeger goes on to present stress testing as a valuable compliment to measurements of VaR. By conducting portfolio simulations based on a variety of assumed market conditions, Broadgates Capital Management could ascertain how its portfolio value would be affected under a variety of scenarios.

Using these different categories to robustly measure how exposed the fund is to specific tail-risk events will allow for a more effective and thorough risk mitigation methodology. Within the context of all risk controls, it would be important for Broadgates Capital Management to maintain a high degree of transparency. This would allow its investors to perceive their exposure to various risks, while also helping them to understand how those risks are being controlled by the fund managers.

Fundamental Valuation Considerations and Strategy Execution Ideas The preceding discussion of hedge fund strategy theory illuminates the important fact that in order to construct a robust and diversified portfolio, investors must consider their hedge fund allocations as only part of their overall investment approach.

Consistent with the regression results reported earlier in this section, KMPG published a report that documented, "a low correlation of hedge fund returns with other asset classes such as bonds, equities, and commodities over the business cycle". Performance Characteristics and Long-Term Survival The relationship between certain hedge fund characteristics and alpha generation is an area worth covering when considering the formation of a new fund.

Outside of the implementation of a successful investment strategy, certain key characteristics have been identified that seem to measurably impact a skilled manager's ability to consistently perform and consequently survive over the long-term. With an annual hedge fund liquidation rate of 7.

This section will review some of the fundamental components that have been most closely linked to performance and sustainability. FundSize and FundFlows Growth of assets under management is a consideration faced by every successful fund manager. If a manager is able to execute an effective strategy and attract new investors, most likely the fund will grow in size. Interestingly, Berk and Green present a performance model that states young funds will receive a quicker inflow of investment capital for every additional year of good performance when compared to more mature funds.

Hence, young funds with strong past performance will receive significant capital inflows". Perhaps the talent of the manager is spread too thin, or the sheer size of the trades begins to have an outsized impact on market prices. It is also conceivable that growth in AUM can increase transaction costs to a point where performance is pressured. Agarwal and Naik present regression results that empirically demonstrate this phenomenon.

The analysis examines how fund size and flows in the prior time period affect returns in the current period. The regression output shows that the size coefficient is negative and significant, proposing that larger funds are associated with lower future returns. In terms of flows, the regression output shows that the flow coefficient is also negative and significant, suggesting that larger flows are associated with lower future returns.

The conclusion is that fund size has a more significant negative effect on future performance than fund flows. After analyzing an increase from the 25th to 75th percentile for both fund size and fund flows, the increase in size is associated with a 2. Based on these findings, it becomes critical for Broadgates Capital to consider this documented phenomenon when building its business. Getmansky analyzes how factors such as size and fund flows impact the life-cycle and liquidation probabilities of hedge funds.

According to this more detailed research, the relationship between fund size and performance is actually concave, suggesting that funds benefit from an increase in AUM until the fund grows beyond a certain optimal level. As fund size begins to erode returns, the liquidation probability of a fund begins to increase. Therefore, as Broadgates Capital Management grows its AUM, close attention must be paid to the relationship between growth and returns.

Determining the optimal size can be a difficult undertaking, and no one specific formula exists to ensure that a fund is operating at this theoretical point of maximum efficiency. However, being aware of the documented propensity for hedge funds to exhibit diseconomies of scale is critical when considering the appropriate time to close a fund to new investors.

Doing so at the proper time will hopefully diminish the size factor as a drag on returns and serve to increase the long-term survival probability of the fund. A number of explanations have been postulated, including the likelihood that smaller hedge funds will pursue more risky strategies to boost returns and increase AUM.

Within such an explanation, funds with larger amounts of assets tend to pursue strategies more focused on capital preservation and are able to diversify amongst non-correlated assets. This reduces the variance of such funds, but may also put pressure on returns as alpha opportunities are limited. The Importance of Strategy Evolution Getmansky also underscores the idea of strategy positioning as it relates to a fund's survival probability.

Broadly, it becomes disadvantageous for a hedge fund to be part of a highly concentrated strategy group for reasons of increased competition and increased risk. First, Getmansky proposes that being in the right strategy category at the right time can significantly decrease a fund's liquidation probability. However, this becomes a dangerous game.

Due to the fact that favorable strategy categories ones demonstrating positive return characteristics will attract new entrants and increase competition, the liquidation probability for each fund will increase in the category once competition reaches a certain level. BCM must, therefore, take a fluid view of its strategy position and weigh the risk-reward of being associated with a favorable strategy category, understanding that the liquidation probability of the fund will likely increase as more funds enter the space over time.

The research shows, perhaps quite obviously, that small funds entering the strategy category have a much smaller impact on average fund survival. Additionally, marginal funds are much more likely to be liquidated when compared to high performing funds. Keeping all this mind, Broadgates Capital Management would be best served to constantly monitor the concentration of funds playing in associated strategy categories and manage risk by ensuring that the fund is always working to evolve its own strategy through new and innovative approaches.

Sticking with what has worked in the past for too long is risky and will most likely result in diminishing returns and perhaps eventual liquidation. Khandani and Lo provide an interesting case study for the elevated level of risk that can be associated which high concentration strategy groups.

The important fact is that the losses were concentrated within a very specific strategy category: quantitatively managed equity market-neutral funds. As suggested by a Khandani and Lo hypothesis, the losses were initiated by the forced liquidation of a small number of large equity market-neutral portfolios.

This sudden liquidation caused other similarly appointed portfolios to experience large losses. A negative feedback loop began within this strategy category as increasing losses led to more deleveraging, which led to more losses and so on. Referred to as the Unwind Hypothesis, Khandani and Lo assert that the heavy losses experienced by the quantitatively managed equity market-neutral funds underscore how strategy commonalities can increase risk for the funds participating in such strategies.

They believe that such evidence may point to, "a new financial order in which the "crowded trade" phenomenon now applies to entire classes of hedge- fund strategies, not just to a collection of overly popular securities". Consequently, Broadgates Capital Management should think about how this phenomenon affects the fund's portfolio construction and risk management systems. In the absence of constant strategy evolution and proper risk controls, overexposure to a particular strategy category could have devastating consequences and jeopardize the long-term viability of the fund.

Fund Age and Performance Deterioration A stated goal of Broadgates Capital Management is to create value for its investors over the long- term. However, recent academic research has proposed that emerging managers tend to add more value than more established, older funds. After controlling for size and backfill bias, Aggarwal and Jorion find evidence that emerging managers defined as the first 2 years of operation generate an abnormal performance of 2. Linear regression results reveal that each additional year of age has an average effect of reducing returns by 48 basis points.

By understanding what may be driving these results, it is possible that Broadgates Capital Management could avoid performance eroding behavior and maintain the characteristics of a high performing fund for a longer period of time.

Aggarwal and Jorion argue that performance fees should have a greater incentive effect on emerging managers because they are presumably starting with less wealth. So, although the incentive structure is not systematically concave in nature, in that fees decrease with fund size or age, an implied concavity results from the diminishing returns associated with incentive fees for successful managers. To combat this effect, Broadgates Capital Management could work to constantly introduce young, fresh analysts and portfolio managers to the fund.

As such, a measurable percentage of the fund would always be composed of individuals not affected by the diminishing marginal utility of incentive fees. Another option would be to structure the incentive fees for analysts and portfolio managers such that consistency of performance over much longer periods is what primarily drives compensation.

I would also propose that emerging managers are driven to perform in order to develop a track record and attract additional capital to the fund. Consistent with improper incentive alignment, high management fees may incentivize managers to quickly grow AUM. In order to do so, they must demonstrate superior performance in the early stages of their fund in order to attract new investors.

Once a certain level of assets has been reached, the incentive to perform may erode as the manager is able to collect large management fees regardless of performance. Consequently, as a fund ages, the likelihood of diminishing performance may increase. In order to reverse this effect, Broadgates Capital Management would propose a much smaller, 1 percent, management fee with higher performance based compensation. Agency theory suggests proper incentives should induce effort by managers, and under this structure wealth could only grow through sustained performance.

Broadgates Capital: Start-up Procedures and Considerations This section will focus on the process for launching a new hedge fund. Operationally, launching a new fund is a complex undertaking which includes the intersection of a large network of professionals and service providers.

Before raising capital and making that first trade, Broadgates Capital Management must carefully navigate the process of properly setting up its new business. It is important to note that other choices exist outside of the ones offered below; however, the framework presented is thought to be the best path forward for Broadgates Capital Management. Selecting Legal Counsel The very first step for Broadgates Capital would be to hire an outside legal counsel. In order to ensure the proper execution of all subsequent steps, the fund's legal counsel would be involved in all relevant conversations about the fund structure, registration requirements, document drafting, and compliance.

CLG is a boutique law firm with a sole focus in the investment management industry. The firm specializes in hedge fund structuring and compliance advisory services with extensive experience counseling onshore and offshore entities. A smaller, more specialized, firm will give Broadgates Capital the advantage of not being charged extremely high fees, while also receiving the necessary expertise to ensure a successful launch.

Fund Name This may seem trivial, but legal counsel should be part of this process. Ensuring that the name is available for registration is important. Additional considerations would be website availability and email addresses including the name. According to Citi Prime Finance, legal counsel can run an intellectual property search to ensure there are no restrictions on using the name.

Broadgates Capital Fund I, L. For a visual depiction of this type of structure, refer to Figure 2. However, tax-exempt US investors, such as pension plans and endowments, would certainly be targeted. Therefore, BCM would choose to complicate the structure introduced in Figure 2. This will give BCM the flexibility to accept non-US investors in the future and also provide tax benefits to US tax-exempt investors by helping them avoid the Unrelated Business Taxable Income associated with the purchase of securities on margin.

Within this structure, two feeder funds would be created, one offshore corporation and one onshore limited partnership. Taxable US investors and BGM would funnel capital through the onshore limited partnership feeder, and tax-exempt US investors would funnel capital through the offshore corporation feeder. All capital would collect in the offshore master fund limited partnership and be managed as one portfolio by the onshore management company, BCM.

In doing so, the onshore feeder would be treated as a flow-through entity relating to its share of the master fund's gain or loss, simplifying the tax treatment for taxable US investors in the onshore feeder. The diagram is an adaptation of a diagram presented by Citi. Within this structure, there is no onshore feeder and the offshore master fund is structured so that BCM is the general partner.

Theoretically, BCM could then receive its incentive fee as an allocation from the offshore master fund and have this allocation benefit from capital gains tax treatment rather than being taxed as ordinary income. Whether choosing the master or mini-master structure, BCM should understand that these structures can create a tax conflict as it relates to the funds strategy.

For example, according to CLG, the US limited partnership taxable investors will benefit from long-term capital gains tax treatment. As these considerations are of no concern to the US tax-exempt investors funneling cash through the offshore corporation, a conflict may arise if BCM chooses to continue to hold a security only to generate long-term capital gains.

For the US tax-exempt or foreign investors, this may not make sense. Other considerations include the fact that the offshore feeder fund would be subject to a 30 percent tax on US dividends. All considerations would be reviewed with legal counsel before completely finalizing a fund structure.

A Limited Partnership Agreement would be drafted and signed to detail the rights and obligations of the limited and general partners of the fund. Then, an Operating Agreement is executed by each of the general partners in order to detail governance and fund oversight issues. BCM would register the management company onshore in the state of Delaware. Incorporation in Delaware is conventional because Delaware generally offers the most business friendly laws in the country.

According to Capital Management Service Group, Delaware courts have a reputation for being pro-management when resolving disputes between investors and hedge funds. The Certificate of Formation is filed with the Delaware Secretary of State and forms the general partnership.

This exemption falls under the Private Fund Advisor exemption. However, New Jersey has a state exemption and hedge funds generally do not need to register with the New Jersey Bureau of Securities. As with some other states, such as New York, New Jersey has a de minimis exemption for hedge funds that operate within the state. As long as BCM has less than 5 New Jersey clients over a 12 month period, the managers would not need to register as investment advisors.

Both laws have certain exemptions that BCM would utilize as registration generally makes operating the fund more costly. First, under Section 3 of the Company Act, the master feeder fund would be exempt from registration under the 3 c 1 private investment pool exemption.

This would allow BCM to avoid registration under the Company Act by restricting the limited partners to no more than accredited investors. The definition of accredited investor is detailed by the Advisers Act as a performance fee will be charged and by Rule of the Securities Act. The Securities Act will primarily govern the offering registration process. BCM would choose to select a b classification filing under Regulation D. Consequently, the fund would be prohibited from engaging in general solicitation.

For a young fund trying to raise capital, this opens the universe of initial investors to include a wider sampling of friend and family. When preparing the Private Placement Memorandum and the Subscription Agreement, BCM must ensure compliance with all full disclosure and anti-fraud provisions outlined by Section 12 of the Securities Act. Final considerations of how to best identify the Directors of the offshore corporation would be discussed in detail with BCM's legal counsel as regulatory scrutiny has increase in this area.

Fund Terms and Conditions Important consideration must be given to key terms and conditions of the Private Placement Memorandum. BCM believes that this will give the fund a competitive advantage when offering the fund to new investors. The performance fee would be paid to BCM as long as the fund's current asset value was above the original net asset value of the fund.

BCM would propose that the performance fee be paid at the end of each calendar year, with the management fee paid monthly based on the current net asset value of the fund at the end of each month. So, each month a management fee of 0. Again, the timing of the management fee payout incentivizes BCM to create value through performance. If BCM is able to grow the asset value of the fund by generating positive monthly returns, the fund will be able to earn an annualized management fee greater than 1 percent of the beginning year asset value.

The Private Placement Memorandum would also include a clause stating that during the first year of the fund, the management fee would be paid annually in advance, in order to equip the fund with needed operational capital. Capital Lock-Up: Based on the relatively liquid nature of the anticipated investments, BCM would propose a lock-up period of 90 days for fund investors.

Therefore, limited partners must give BCM 90 days' notice before withdrawing capital. This would be structured has a hard lock-up period, meaning capital withdrawal without this notice period is strictly prohibited.

Account Structure: The fund will be composed of a co-mingled account, where each investor is a separate limited partner of the partnership. Capital of each limited partner will remain adjacent to that of other limited partners, each purchasing a shared interest in the profit and loss of the fund for a fixed capital investment. As the fund grows, BCM would anticipate offering separately managed accounts in addition to the co-mingled structure. Early Investor Incentives: In order to attract capital to the fund, BCM would offer two initial share classes that would carry a reduced performance fee.

In compensation for being early investors in the fund, BCM would offer an institutional share class and a friends and family share class. However, initial fund investors would also be burdened with reduced liquidity. BCM would institute a 2 year lock-up provision for investors in these share class categories.

After the initial 24 months, the lock-up for these investors would convert to the 90 day notice period. Minimum Investment: Chang describes the typical investment minimum for start-up hedge funds. It seems logical for BCM to sit towards the bottom of the usual range because the initial fund size will be quite small.

A lower minimum should make marketing the fund to early investors, especially the friends and family share class, more productive. FundInfrastructure Personnel Breakdown: The original team would include four members. Advisors would also have input into the investment process, with the final decision lying with the CIO.

Each member has a specific skill set that would provide targeted expertise. For a detailed breakdown of the team, refer to Appendix B. Real Estate: Selecting appropriate office space would be an important first step in building out the infrastructure of the fund. The location of the fund would be in or around Princeton, New Jersey. This is the most desirable location for the fund managers and it gives BCM easy access to the larger New York hedge fund community while also taking advantage of the active investor interest in New Jersey.

The original team size and mid-term growth plans would be an important factor in selecting the right space. It would be BCM's intention to keep the team as lean as possible for as long as possible; however, within the first 5 years, as assets grew, BCM would anticipate the team growing to include between 6 to 8 professionals.

Based on an interview BCM conducted with the chief operating officer of a publicly trade US company with extensive real estate experience a BCM advisor , the following estimations have been made assuming a projected 8 person staff over the next 5 years. Considerations for additional system expenses, hardware, insurance, and other related infrastructure costs will be considered in later sections.

Figure 3. BCM would lease this space, and projects signing a year commitment. Insurance: Insurance is extremely important and also quite complicated. Having a thorough understanding of the policy structure is extremely important when establishing an institutional quality fund. Technology Systems: After securing the fund's physical office space, building out a practical and robust information technology "IT" management system would be a critical next step.

An initial step would be to create a domain name for the fund's website and register that name with an appropriate host. The site would include very basic information about BCM and provide contact information for investors. BCM would like to implement cloud-based outsourcing for the majority, if not all, of its IT needs.

According to a survey conducted EzeCastle Integration, 79 percent of participating asset management firms were already using, or had plans to use, cloud services in the near future. Of all respondents, 24 percent are currently outsourcing their fund's entire IT infrastructure to the cloud.

BCM would use an externally hosted private cloud structure. A cloud service provider would construct a private cloud only for use by BCM. This would guarantee privacy and also provide for a more tailored solution based on BCM's size, security requirements, and investment strategy. The private cloud option provides much greater security when compared to cheaper, public cloud alternatives. Also, most public cloud solutions do not incorporate the compliance characteristics that would comply with state and federal regulations of hedge funds.

EzeCastle has specialized in providing these services to the investment management industry for over 20 years. Recent awards include the HedgeWeek award for best technology platform and recognition as a FinTech Top technology provider for the sixth straight year. EzeCastle provides a solution they call a "hosted IT environment". BCM would propose purchasing this solution for its entire IT management system. As directly quoted in the company's Guide to Technology Outsourcing for Hedge Funds whitepaper: The term "hosted IT environments" encompasses cloud computing, as well as the enterprise-wide solutions known as managed services.

Designed specifically for smaller hedge funds and investment advisors, managed services deliver a comprehensive, turnkey IT infrastructure to support daily operations including phone services, office applications, e-mail servers, file services and access to market feeds-all in a vendor-hosted and managed environment.

For a fund that wants to focus on investment strategies rather than its technology, this approach offers several advantages: - Low startup costs: There is no need to purchase equipment or build a data center. Hedge funds pay per-user monthly fees. In order to be confident, according to EzeCastle, a new fund manager must: 1 confirm the SAS certification of the vendor's data center; 2 be comfortable with the vendor's own disaster recovery and business continuity planning and testing; 3 evaluate the physical and technical security of equipment; and 4 establish how the hedge fund's proprietary data will be isolated from data belonging to other managed services clients.

BCM believes that EzeCastle has the capabilities to provide a full suite of technology services in a way that fits the needs of a start-up fund. EzeCastle's track record and reputation for quality would give potential investors the confidence that BCM is partnering with companies that would ensure the security of their data and uphold a high standard of operations. Considering the specific steps for the technology system build-out and integration is also critical.

Quality internet service is critical and a number of different options are available. BCM would opt for Ethernet connectivity as it provides fast speeds with competitive prices. Ethernet is becoming the most common choice for hedge fund internet connectivity. A company like Cisco could provide such a service along with a full suite of monitoring and security features. It is often recommended to hire two such service providers and to install an automatic switch-over if one experiences a problem.

This is an inexpensive way to provide BCM with the necessary voice features such as call routing, voicemail, and caller ID. For real-time market data, BCM would choose Bloomberg as it provides the flexibility to initiate services such as real time pricing, trade execution, research, and other functions based on what BCM feels is appropriate considering the fund's growth, strategy, and client needs.

Disaster Recovery and Continuity Planning: great care would be taken in creating a thorough plan for disaster recovery and business continuity in order to give investors and regulators the necessary confidence that such adverse events would not negatively impact the fund's operations. BCM's disaster recovery plan would support all critical infrastructure elements such as email, trading, telecommunications, and critical financial information.

All essential information, systems, and documents would be backed up electronically in a non-similar geography and be accessible remotely in the event of a problem. Filing and Archiving: BMC would institute a strict policy surrounding the archiving of communications and documentation.

Data will be searchable and stored offsite within its own accessible system. Section 24 b of the Investment Company Act of also requires hedge funds to file all client communications and advertising within 10 days of its presentation. Due to the ambiguous nature of some of the rules surrounding communication on social media, BCM would initially ban all business related social media communications by its employees.

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To understand the basics behind the martingale strategy, let's look at an example. There is an equal probability that the coin will land on heads or tails. Each flip is an independent random variable , which means that the previous flip does not impact the next flip. The strategy is based on the premise that only one trade is needed to turn your account around.

Unfortunately, it lands on tails again. As you can see, all you needed was one winner to get back all of your previous losses. However, let's consider what happens when you hit a losing streak:. You do not have enough money to double down, and the best you can do is bet it all. You then go down to zero when you lose, so no combination of strategy and good luck can save you. You may think that the long string of losses, such as in the above example, would represent unusually bad luck. But when you trade currencies , they tend to trend, and trends can last a long time.

The trend is your friend until it ends. The key with a martingale strategy, when applied to the trade, is that by "doubling down" you lower your average entry price. As the price moves lower and you add four lots, you only need it to rally to 1. The more lots you add, the lower your average entry price. On the other hand, you only need the currency pair to rally to 1. This example also provides a clear example of why significant amounts of capital are needed. The currency should eventually turn, but you may not have enough money to stay in the market long enough to achieve a successful end.

That is the downside to the martingale strategy. One of the reasons the martingale strategy is so popular in the currency market is that currencies, unlike stocks , rarely drop to zero. Although companies can easily go bankrupt, most countries only do so by choice. There will be times when a currency falls in value. However, even in cases of a sharp decline , the currency's value rarely reaches zero.

The FX market also offers another advantage that makes it more attractive for traders who have the capital to follow the martingale strategy. The ability to earn interest allows traders to offset a portion of their losses with interest income.

That means an astute martingale trader may want to use the strategy on currency pairs in the direction of positive carry. In other words, they would borrow using a low interest rate currency and buy a currency with a higher interest rate. A great deal of caution is needed for those who attempt to practice the martingale strategy, as attractive as it may sound to some traders. The main problem with this strategy is that seemingly surefire trades may blow up your account before you can profit or even recoup your losses.

In the end, traders must question whether they are willing to lose most of their account equity on a single trade. Given that they must do this to average much smaller profits, many feel that the martingale trading strategy offers more risk than reward. Michael Mitzenmacher, Eli Upfal.

Cambridge University Press, Accessed May 25, Electronic Journal for History of Probability and Statistics. University of Illinois. Massachusetts Institute of Technology. Business Essentials. Your Money. Personal Finance. Your Practice. Popular Courses.

Table of Contents Expand. Views: trailing six months. Firms that receive a 4. Any data inaccuracies, please contact our team. With respect to such information, investor. Martingale Asset Management Review. Disciplinary Questions After checking the disciplinary records of Martingale Asset Management, our system found no disciplinary questions to ask. Conflict Questions After checking the regulatory records of Martingale Asset Management, our system has identified the following question s to ask.

Does Martingale Asset Management offer mutual funds that have 12b-1 fees? Regulatory disclosures state that Martingale Asset Management sells proprietary investments and products. Please provide me a list of the products and a summary of how much Martingale Asset Management earns from them.

Does Martingale Asset Management offer products that have performance-based fees, or does it accept performance-based fees? Will any of my assets be invested in those products? Does Martingale Asset Management perform side-by-side management? How does Martingale Asset Management mitigate conflicts that arise from managing accounts with differing fee structures? Does Martingale Asset Management recommend securities that it or its affiliates underwrite, or in which it serves as general or managing partner?

Which securities does Martingale Asset Management trade for itself that it will also be recommending to me? Was this helpful? Yes or No. Submit Details. Where is Martingale Asset Management headquartered? Which states do its financial advisors serve? What is the average client balance at Martingale Asset Management? What is the historical performance of Martingale Asset Management? Can I write a review of Martingale Asset Management or file a complaint? Minimum Investment.

Average Client Balance. Total AUM. Visit Site. See locations. Activity Restriction — SRO. Dismissal upon Settlement — Court. Investment-Related Prohibition - Court. Felony Conviction. Misdemeanor Conviction. Order Entered - Other Regulatory Agencies. Regulation Violations - Other Regulatory Agencies. Regulation Violations — SRO. Attorney Conflict. Broker-Dealer Conflict. Performance-Based Fees. Commissions Conflict. Insurance Agent Conflict - Affiliation.

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The performance results were very encouraging, but Bill still wondered if they were a fluke of the data, a result of data mining rather than the reflection of a true market anomaly. He wanted to discuss several possible explanations of the phenomenon, and to decide whether Martingale should offer the strategy to its clients.

To discuss the mechanics and the economic implications of leverage and short-selling for investment strategies. To discuss minimum volatility stock investment strategies and quantitative investing in general. To discuss the management of quantitative funds, especially in the context of new product development and client offerings. Aug 21, Revised: Jun 18, Brought to you by:. Main Case Bestseller. Not teaching at a university? Register as a student Register as an individual.

Overview Included Materials Related. Learning Objectives To discuss the mechanics and the economic implications of leverage and short-selling for investment strategies. Discipline: Finance. Return and risk are always the most important things when we talking about an investment. Meanwhile the annualized standard deviation was low compare to other funds. It showed investment was diversified in various industries and companies and this can help reduce risk. And Martingale was one of the first asset management firms to offer short extension funds in , and ranked 14 th by AUM in the US short extension universe.

The trading strategy may still be under unexpected risk due to lack of practical test. Low volatility strategy take advantage of risk anomaly. Jacques claimed that stocks with low risk, as measured by past volatility or past beta had higher returns than stocks with high risk. Figure These results suggested that a long-short strategy that held long low-volatility stocks and short high-volatility stocks stocks might produce a positive risk-adjustment return.

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MARTINGALE ASSET MANAGEMENT LP IN 2008, 130/30 FUNDS Case Solution \u0026 Analysis

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