Australian early-stage investor Scout Global Funds’s roots lie with its original backers, a family office, but it now classes itself as an investment firm run on a co-operative basis. Oliver Alliker, director at Scout Global, explains that all investments in emerging managers are made through managed accounts. “We’re centred around investing through managed accounts rather than a fund because we find it a more effective way of deploying capital.”
Key strengths of the managed account route that Allikerlists include flexibility, which allows the investor to negotiate terms directly with the manager, whereas with the fund everyone gets the same rates. “Also, fundamentally, as the investor you own the assets so the assets will be in the investor’s name,” he says. “We invest in 20-plus managers and all those futures contracts, forex and equity positions are in Scout’s name whereas if you are in a fund, the fund owns the assets, you are releasing control of the assets. In other words, investing via managed account provides custodial security.”
Other advantages listed by Alliker include the fact that managed accounts offer daily liquidity terms rather than the usual monthly, and the investor is freed up to achieve more effective use of cash.
“When you invest in a fund you have to invest 100% of the trading level, whereas when you are in a managed account, you’re only required to cover margin and can also achieve cross-margin benefits across the accounts. So a large proportion of the notional amount you are investing is available to be used elsewhere rather than sitting in cash with the manager taking a performance fee on the cash return,” says Alliker.
Scout does not disclose how much money it has under management with those 20-plus aforementioned managers. There was a time when the firm looked at opening a public fund but realised that investment partners would benefit from having extra flexibility associated with a custom solution.
“We like the co-op methodology where Scout groups together with other investors with the goal of achieving economies of scale rather than making money off other investors’ investments,” Alliker says. “Rather than opening a fund structure, what we’ve decided to do is offer tailored solutions, taking our proven framework and due diligence methodology and offering it to other investors in a format that suits them.”
The other definitive difference in Scout’s approach is that they only consider fully systematic trading managers, a sector that has broadly struggled to find performance over the last few years.
Alliker says: “We’re having a good start to 2014. Part of the reason is that we’ve specialised in emerging managers who tend to look at different trading methodologies, different trading holding periods and perhaps more niche-type strategies.”
Alliker believes that when a senior researcher leaves a large established fund they often do so with a different methodology in mind. “It might be something that they may have thought about in their research career or ideas that they wanted to implement but never had the opportunity to implement,” he says. “The reason Scout is so committed to systematic trading is that we have built tools to evaluate systematic strategies. Our process logically works better with systematic managers.”
The firm uses quantitative and qualitative analysis but tends to focus more on the quant side. “We aim to evaluate a large number of managers quite effectively,” he says, “with the goal of investing in higher probability prospects.” Last year, Scout invested in a range of strategies worldwide. This included a seeding of the Aquantum Commodity Spread programme and the Degraves Capital programme, both of which have had good risk-adjusted performance since inception.
Despite the tough time the systematic and CTA community generally has been experiencing, Alliker reports that good new managers keep arriving. They haven’t invested in any high-frequency emerging managers to date. “HFT is dominated by well-funded established organisations,” he says. “It’s a little bit of an arms race amongst who has the better connectivity and technology which possibly gives the strategy an edge.”
The firm’s co-op methodology or logic is that economies of scale matter and if youcan offer a sizeable initial investment, it helps negotiate better terms with the manager, service providers, brokers and clearers. The firm invests with systematic trading managers worldwide, including Australia, UK, USA, Germany and Sweden. For emerging systematic traders, Scout will do a lot of due diligence on the manager’s testing methodology and the assumptions used in modelling.
“Rather than having something that perfectly trades the past but not the future, we are looking for strategies with disciplined and objective testing methods that have identified genuine market characteristics,” says Alliker.
The firm often looks for managers with a mix of a theoretical scientific background combined with a practical, logical approach as well. “We believe one foot in each world is important.”
The firm can be the first dollars under management with a systematic trader but it does need to be a regulated entity and operationally sound. Alliker says, “We like to see outsourced operations in emerging managers because the operations providers tend to use state-of-the-art operational infrastructure that is prohibitively expensive for an emerging manager and on top of this, operations can sometimes become too much of a burden and distraction for a small group.”
“We are often asked why we have a focus on emerging managers when an established manager may have an extended track record of strong performance. While this is of course a valid point, markets are evolving over time and we believe that in order to maintain performance, ongoing research and innovation is important,” Alliker says. “Often an emerging manager we invest with has a long track record of successful research and development at an established firm yet when he or she decides to leave and start their own firm, investors are often nowhere to be seen. We believe that the researcher will also have an advantage in that they are usually trading with a far smaller amount of capital than they have used in the past, potentially making trade execution more efficient and less of a drag on performance than the larger manager may face.”
Alliker finds that slippage resulting from large assets under management can result in several percentage points’ deterioration in performance each year: he says, “In some cases, managers experiencing large capital inflows are forced to add systems or markets with a lower expected return in order to absorb the increased assets under management. When investing with an emerging manager, we can have some confidence that they are applying the strategy in the optimal, most efficient manner.”
Another important consideration for Scout, when investing with emerging managers via managed accounts, is the ability to closely monitor positions and risk. “With a fund structure, the transparency is often limited to a monthly snapshot or even just a performance number, which may disguise the actual risk being taken. The extreme example is a Madoff-type scenario where investors are completely ignorant of a fraud that might be committed. When investing via managed account, we are able to monitor positions as they come in and out of the account, giving us a good insight into the risk being taken as well as the expenses being incurred on a trade-by-trade basis.”
From a business perspective, investing in emerging managers via managed account also offers a compelling deal, Alliker believes. “We are able to negotiate investment terms directly with the manager and insert clauses into the agreement that we think are appropriate. Over time, the Scout agreements have evolved to identify and mitigate many of the risks that an emerging manager investor may face. We conduct thorough quantitative and qualitative due diligence. However, at the end of this process, like most investment decisions, there is still the reality that you are handing over funds for someone to take calculated risks.”
Scout’s agreements allow them to retake control of the positions and account immediately in the event that they discover the funds are not being managed as agreed. Bespoke agreements also allow Scout to negotiate significant capacity at attractive fee terms which provide for compounding performance over many years.
“Although we are investing with emerging managers to take advantage of the benefits described already, we also believe it is important to provide for a long-term relationship at favourable fees in return for taking the early-stage risk that others are not willing or able to take,” Alliker says.