ETF Expert Corner
Maz Jadallah Spotlights the AlphaClone International ETF (ALFI)
February 28th, 2017 by ETF Store Staff
You can listen to our interview with Maz Jadallah by using the above media player or enjoy a full transcription of the interview below.
Nate Geraci: The ETF we’re spotlighting this week is the AlphaClone International ETF. Ticker symbol ALFI. Joining us via phone from San Francisco to discuss this ETF is Maz Jadallah, CEO and Founder of AlphaClone. Maz, great to have you on the program today.
Maz Jadallah: Thanks, it's great to be here.
Nate Geraci: Maz, let's just jump right in here. The AlphaClone International ETF seeks to replicate the top international stock picks from some of the world’s best hedge fund managers. Just walk us through, how does this ETF work?
Maz Jadallah: As you know, my firm AlphaClone specializes in building active indexes using Form 13F which is a required filing with the SEC for institutional investors. It's a holdings disclosure. This fund, in short, aggregates the high conviction ideas. International high conviction ideas of institutional investors and hedge funds that we deem to have skill over long periods of time. It really just tries to give the investor access to managers, while at the same time forgoing the high fees that usually come with accessing really skilled managers.
Nate Geraci: I know the process you use is something you call cloning. You mentioned the 13F filings. Can you talk about this process and maybe how the different hedge fund managers are scored and selected?
Maz Jadallah: Every manager that manages a 100 million dollars or more has to file a Form 13F with the SEC. It discloses all of their long positions at the end of every quarter. We believe that form is arguably even better in accessing a manager's skill than looking at the manager's actual performance. That's because the manager's actual performance can stem from multiple sources. The manager could be using leverage, they could be timing the market, and they could have trading skill. Whereas, if you evaluate them using just their holdings disclosure Form 13F, the only thing you know about the manager is what they held at the end of every quarter. It can be a much better way to isolate managers who have true skill over long periods of time. That's what we call clone scoring. That's at the heart of how we build all of our active indexes. The reason Form 13F is essentially valuable is there's this perception that a hedge fund and its additional investors have a very short holding period when it comes to their holdings. The opposite is true, most hedge funds are fundamental bottom up managers. Their average holding period for high conviction ideas is over 40 months. If they file every three months there can be quite a bit of value in these filings. Of course, the trick is in scoring them and knowing which managers have true skill and which ones don't.
Nate Geraci: As you mentioned, this particular ETF holds international stock positions. How many holdings are in this ETF all together and can you give us an idea as to the top holdings right now?
Maz Jadallah: There are usually between 30 and 40 holdings. For a while now, and this is true in the latest rebalance for this fund, the China internet theme is probably the most dominant theme in the fund. Ctrip, Alibaba, JD.com are three of the largest holdings. There are other themes as well including basic materials and healthcare.
Nate Geraci: Are there any restrictions in terms of the size of companies that can be held in this ETF? In other words, can this ETF include smaller cap stocks?
Maz Jadallah: Yes it can. There's a 100 million dollar market cap floor on being included but that's it. Other than that, the fund will tend to tilt large cap but there can be mid cap and smaller cap holdings in there as well. There is also a limitation on size of the position. No position can be more than a 5% weight at rebalance.
Jason Lank: Maz, this is Jason Lank. On the subject of holdings, are there any capacity restraints in the universe that you’re looking at? Is there a maximum amount of dollars that can chase these great ideas or is the ceiling way out there?
Maz Jadallah: It's way out there. I mean especially with ALFI, the index that ALFI tracks tilts large cap. With active strategies, high active share strategies, there is always a ceiling but with our strategies - because they tilt large cap - it's obviously very, very large.
Nate Geraci: Again we're visiting with Maz Jadallah, CEO and Founder of AlphaClone. We’re spotlighting the AlphaClone International ETF, ticker symbol ALFI. Maz, as I understand it, this ETF also uses a downside hedge. Can you tell us more about that? What triggers this hedge and is this a full hedge on the ETF's holdings?
Maz Jadallah: It's a dynamic hedge which means it turns on and off. Our strategies are for long term investors. Of course, to be a long term investor it means you have to hold your positions for the long term. In volatile equity markets, that can be a very challenging thing. We don't believe in being long only for core strategies or statically where you are hedged all the time because you are not participating in run ups in the market. We have a dynamic hedge, it's very simple. It looks at the S&P 500 relative to its 200-day moving average at the end of every month. If the S&P 500 closes below its 200-day moving average, we’ll move the strategy from being long only to essentially EAFE neutral in the case of ALFI. That's the MSCI EAFE index which is a broad international index. It will be neutral that.
Nate Geraci: Is there a reason why you use the S&P 500 moving average as opposed to the MSCI EAFE? Is it just because they are so highly correlated?
Maz Jadallah: The way we express our international exposure is through American depository receipts or ADRs. We've looked at using other indexes for the trigger on the hedge and the S&P 500 hedges the least but still captures what we call the real deal events like 2008, 2000, 2001. With dynamic hedges, one of the risks is always that you can get whipsawed and we saw that in our strategies in Q4 of 2015 and Q1 of 2016 where you hedge and the market rally's. This particular rule has been very good at capturing the real deal events where you are seeing 30, 40% draw downs in the market. We think for long term investors, those are the events that they should really care about, not the whipsaw events.
Nate Geraci: Maz, more broadly speaking, obviously this ETF allows the average investor to easily access some of the best investment ideas from top hedge funds. Can you talk more about what makes the ETF structure so attractive verses just getting these stock picks directly through the hedge funds themselves?
Maz Jadallah: Hedge funds and mutual funds are some of the most inefficient investment vehicles around. They are packaged inefficient. There's often lock ups as you know with hedge funds, there's a high fee structure that comes with those things. An ETF does away with all that. It's liquid, it's transparent, it's very tax efficient, it's accessible and it's relatively lower cost than obviously a 2 and 20 hedge fund fee or mutual fund fees.
Jason Lank: Maz, obviously the ETF is designed to capture some of the best ideas from the best hedge fund managers out there. This is just right out of the headlines: Warren Buffett released his annual report, which is obviously coveted by investors around the world, and in it he kind of lambasted hedge funds and high expenses and fees. I also noted that he has some high conviction individual holdings. What do you make of that and is he talking out of both sides of his mouth?
Maz Jadallah: Not really. I wrote an article about this very thing just yesterday and published it on our website. I think basically what he is saying is that he is a believer in stock picking, but because he is a stock picker. For most investors, institutional and individual, the high fee structure and the inefficiency with which they have to go through in order to access skill renders the point mute. It's just better to sort of invest in the market. Of course, what we are trying to do is innovate on how investors are accessing skill. We're trying to do away with the high fees and the inefficient vehicles. We developed these active indexes and I think even Mr. Buffett would agree that the more resilient portfolios will have both very cheap passive market strategies that look like the market and cheaper, efficient high active share strategies combined. That way, they are a lot more resilient. We're trying to give investors the high active share strategies without the fees and the headaches.
Nate Geraci: Again our guest today is Maz Jadallah, CEO and Founder of AlphaClone. We’re spotlighting the AlphaClone International ETF, ticker symbol ALFI. Maz, high level, where does this ETF fit in an investor’s portfolio? Do you view this as a core holding for international stock exposure?
Maz Jadallah: Absolutely. The two funds that we've got out there, ALFA and ALFI - ALFA is US domestic and ALFI is international. They are core holdings. We like what we call a mirror portfolio construction. For example, if your asset allocation calls for a 40% allocation to international equities - just making this up - we believe you should put half of that in very cheap beta products and the other half in very efficient, relatively low cost, high active share products. We like AFLI for the high active share component of that allocation.
Nate Geraci: Alright Maz, we have just a few minutes left here. You began to talk about this just a few moments ago, but I did want to ask you about the age old active verses passive management debate because I know you do have some rather strong feelings on this. Obviously, the two ETFs that AlphaClone offers, they’re unique because they are essentially hybrids. They attempt to replicate the picks of active managers, but investors get those picks in the form of an index fund. You call this active indexing as you mentioned. Why do you think that this is a better way for investors to invest?
Maz Jadallah: Because I think accessing skill is important in realizing your ultimate investment objectives. Incorporating skill into your allocation helps investors achieve their goals quicker potentially. The problem has been that accessing that skill has been super expensive and inefficient. These active indexes try to give investors the best of both worlds: high active share strategies, but offered passively and efficiently. You know, it's hard to make the active argument when the S&P 500 has returned 15% per year over the last five years. Everyone knows that there will come a five year period or a seven year period where the S&P 500 returns 2%. Active strategies will do better than that. By incorporating both in your portfolio you're doing yourself a service because you are building resilience into your portfolio.
Nate Geraci: Maz, about one minute left, when you look at the proliferation of smart beta ETFs - I'm just curious, do you view that as the same in terms of accessing that manager skill that you speak of?
Maz Jadallah: No. Smart beta ETFs try to capitalize on known factors in the market. For example, small cap stocks can now outperform large cap stocks, high value stocks can now outperform growth stocks. Some of them just give you one factor, some of them try to give you a combination of factors. We don't consider ourselves as smart beta. We frankly consider ourselves smart alpha because we're trying to package these skills, i.e. alpha, that these managers exhibit and do it in a way that's efficient and low cost.
Nate Geraci: Maz, with that we'll have to leave it there. Fantastic spotlight today. As always, we appreciate you joining us on the program. Thank you.
Maz Jadallah: Thanks a lot guys.
Nate Geraci: That was Maz Jadallah, CEO and Founder of AlphaClone. Again the ETF is the AlphaClone International ETF, ticker symbol ALFI. You can learn more about this ETF by visiting alphaclonefunds.com. That's alphaclonefunds.com.