By Paul Rieger
In this month’s Manager’s Corner Update, we have Incline Investment Management, LLC answer our “25 Questions Every Investor Should Ask”. Plus get the latest rankings from Barclay Hedge and sign up to receive our Managed Futures Kit.
Incline Investment Management, LLC utilizes the Systematic Hybrid trend following program across individual stocks and global futures markets. The strategy provides investors with an opportunity to capture trends that many models do not. The fund’s objective is to achieve exceptional absolute risk adjusted returns irrespective of the broad global equity indices. The systematic strategy employed makes no effort to forecast future market trends, but instead attempts to capture profits in these trends when and where they develop.
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25 Questions Every Investor Should Ask
1.) What is the name of the program/programs and who are the listed Principals?
The Systematic Hybrid is the primary program managed by Incline Investment Management. Essentially the program applies a systematic approach to trading individual equities and futures. The Principals of the firm are Ted Parkhill and Todd E. Hurlbut, CMT. Ted is the Chief Executive Officer and Todd is the Chief Investment Officer.
2.) Can you provide us with some details of your corporate background?
Ted and Todd have spent their entire careers in the investment industry. Ted was a senior executive in the mutual fund business prior to joining John W. Henry & Company (“JWH”) back in 2001. JWH, as many know, was one of the original CTAs and John personally was a pioneer in the space. Today John is better known for his ownership of the Boston Red Sox. Ted is one of only a few to leave JWH and start and successfully manage an investment firm (Ken Tropin of Graham Capital being another notable JWH alum).
Todd started his career in private client services at Salomon Smith Barney. Early on he realized that having a disciplined approach to investment management was much more prudent than the conventional wisdom that prevails to this day, where so-called experts are expected to ‘know’ where markets are headed. In 2006, Todd founded Everett Capital Management (“ECM”) where he launched Everett Capital Partners, LP (“ECP”). ECP was a systematic fund that also traded individual equities and futures. Todd merged ECM with Incline Investment Management in June of 2012.
3.) Who are the Principals with trading authority?
Both Principals of Incline Investment Management have trading authority. Todd has primary responsibility for managing the portfolio on a day-to-day basis. However, Ted has oversight from a risk management perspective and also serves as a back up to ensure there is trading continuity.
4.) Can you provide details on the principal and/or managers’ education, career and trading background?
Early in Ted’s career he traded oil option which helped pay for one year of his university education. Because of his interest in the futures markets he earned his Canadian Futures Exam (the Canadian equivalent of the Series 3) when he was just 22. He has an undergraduate degree in Economics and Business Admin. He went on to earn his MBA in marketing and finance from Cornell University. He also earned his CFP designation while working as an executive in the mutual fund industry. He has held the Series 7 and currently holds the Series 3 and 30.
Todd as well has been interested in the dynamic of markets since university. A competitive athlete (he attended the University of Virginia on a swimming scholarship) he was fascinated by the similarities of trading and competing. Upon graduation he embarked on a career with Salomon Smith Barney. He recognized that his interests and skill set lay in designing portfolios for private clients. He also realized that the majority of portfolio managers had great theories for investment management decisions but at best that was what they were; theories. It dawned on Todd that a practical, effective, and prudent approach to investing was one that was highly systematic in nature; where one wasn’t fighting the direction of a market but instead followed the direction. He realized that through experience he had become a trend follower. Along the way he earned his Chartered Market Technician designation (“CMT”) in 2005.
5.) Which firm calculates your performance numbers?
It is critical in today’s market place for an outside firm to perform the fund accounting and overall fund administration.
We selected a firm with a great deal of experience with CTAs and systematic investment managers. NAV Consulting Inc. is the firm that calculates our performance numbers.
6.) What is the minimum investment for your program?
The Fund, that utilizes the Systematic Hybrid, requires a minimum of $100,000 US. However, we do require $500,000 for a separately managed account.
7.) Do you accept notional funding?
We do accept notional funding. We do require about 40% of the capital in order to sufficiently build (and employ) the strategy as designed. This is primarily because of our equity component which is slightly more capital intensive than the typical managed futures strategy.
8.) What is your management and incentive fee structure?
The Fund is priced similarly to most funds of its kind. We charge a 2% management fee and a 20% incentive fee.
9.) What is your program’s capacity?
We have a great deal of room to grow. But most significantly we do not expect the strategy to change at all during our growth. The most important point is that the strategy is highly scalable. This is partly because we only trade exchange-traded instruments that are very liquid. Therefore, we estimate our capacity in the $1 billion range.
10.) When did you start trading this program?
The Systematic Hybrid was introduced in July of 2012. When ECM and IIM amalgamated, the Principals spent May and June of 2012 designing the combined approach. Both firms coincidentally were trading systems where individual equities and futures were being utilized. The best of the two firm’s trading systems were adopted and combined into one approach which is now called the Systematic Hybrid. This approach has been used since.
11.) What type of accounts do you manage?
The primary focus for the firm is the Systematic Hybrid. It is available in a domestic Limited Partnership structure (the Fund) and it is also available in a Separately Managed Account format.
12.) Can you give a brief description of your program?
IIM utilizes the Systematic Hybrid trend following program across individual stocks and global futures markets. The strategy provides investors with an opportunity to capture trends that many trend following models do not. The fund’s objective is to achieve exceptional absolute risk adjusted returns irrespective of the broad global equity indices. The strategy employed makes no effort to forecast future market trends, but instead attempts to capture profits in these trends when and where they develop. Half of the portfolio is dedicated to investing in individual equities and half to what could be described as traditional managed futures where we trade over 55 futures markets. The equity component utilizes a short stock index futures position to create a ‘hedge’. Ultimately, it is possible for the equity component to be in a market neutral position (depending on the long exposure and the size of the hedge) and then eventually a net short position. To the layman we explain it as a long/short equity approach but it is not your typical L/S Equity methodology. Most L/S Equity funds are net long. We don’t suffer the same issue because we apply our short exposure at the market level.
13.) Do you have a systematic or discretionary approach to the market and what are your program goals?
We are systematic. A key lesson learned over the years by both Principals, is that discipline is critical. Both partners have seen examples where managers either start to doubt and then start tinkering so there is what today is called style shift or worse where a manager dramatically changes the approach to what could be called style ‘flip’.
Ted and Todd both emphatically agree that the long term success of any systematic approach is to rely on the firm’s extensive research and then to adhere to the approach over the long term. They recognize there will be short term periods where markets do not cooperate but the key is to remain steadfast over time.
14.) What is the average holding period for each trade?
The average holding period depends greatly on the current market conditions. However, for the equity component profitable trades are held for a few weeks to a few months while unprofitable trades are exited within a few days. Similarly for the futures component, profitable positions are held for days to weeks and possibly up to several months while unprofitable trades are exited rapidly.
15.) Do you trade options within your program? If yes, please describe the types of options traded and how options risk is monitored.
Yes, the program is designed to include options trading but it is on a limited basis within the equity component of the portfolio. Options can be used to gain exposure on a highly calculated basis in equities on the long side and act as a hedge on an individual position.
16.) Are there any liquidity constraints in the markets you trade?
One of the key factors for including a market in the portfolio is that it needs to be quite liquid. Currently, the portfolio is not constrained in any of the markets in which it trades.
17.) In what types of market environments does your trading program do well and /or struggle?
The Systematic Hybrid does particularly well in rising or falling markets. The program is designed to take advantage of markets that move. The program tends to struggle when there are choppy or markets that remain horizontal for any period of time. As well, in periods of short term high volatility it is possible for the program to get chopped up by taking a number of small losses. Thankfully, these types of markets do not tend to prevail for long periods of time.
Because of our stop loss methodology we tend to lose money on about 60% of our trades. Unless investors are familiar with managed futures in general this may at first seem like it is less than impressive. However, the simple math we use to explain our success is that by effectively using our stops we will lose about $1 on 60 of our trades. The objective is to make about $2 on the remaining 40 trades (thereby grossing $80, losing $60 and netting $20). When we are flat it does not mean we necessarily lost more money or our risk controls do not work. Instead it could mean we just didn’t capture as many profitable trades as required. For example, if those 40 trades only capture $1.50 in profit the strategy theoretically will be flat (grossing $60, losing $60, netting $0).
As well, the strategy may be down but again not necessarily because the risk controls failed. It could mean that we only made $1.25 on our 40 profitable trades (grossing $50, losing $60, netting -$10). Historically, our research has demonstrated favorable market conditions prevail which is why the Systematic Hybrid is expected to make money in the long run.
18.) What is the standard range of margin to equity usage for the program and how long do you hold the average trade?
The standard margin to equity used on the futures component of the Systematic Hybrid is 15%. On the equities component it is much more significant because equities require cash. It would be in the 60% range for the 50% of the portfolio dedicated to equity trading.
19.) How do you manage risk/reward and what metrics are employed?
Risk Management is a core focus for IIM. The strategy combines a diversified systematic equities model with a globally diversified systematic futures model each of which employs its own built in risk management disciplines. Stop loss orders are utilized on every trade and no single futures position can exceed 80 basis points of initial risk capital and no single equities position can exceed 50 basis points of initial risk capital. The equities model mitigates risk exposure by utilizing a stock index hedge and individual put options. Volatility-based exits are also used to decrease positions in volatile market environments.
20.) What are the optimal market conditions for your strategy?
As mentioned earlier, we are looking for movement in the equity and futures markets. Given that we trade over 55 global futures markets the system is looking for directional moves or trends as they are often called. We need movement in order to make money. We are directionally agnostic. That is the beautiful part about having exposure to a strategy like ours. In our business, investors are often concerned about risk. To us it is extremely risky to invest on a long only basis (like most of real estate, mutual funds, etc.). With an investment in the Systematic Hybrid, you get more than downside protection. You also get the potential to earn returns when markets head south!
21.) Describe your worst drawdown to date, how did it happen and what actions have been taken (if any) to prevent similar drawdown’s?
The worst drawdown for the Systematic Hybrid took place in the fall of 2012 when we saw a continuation of a negative environments (lack of significant trends) in the futures markets and an artificial extension of the equity rally through continued quantitative easing from the Fed. Following three years of this environment we do not anticipate these conditions to persist indefinitely and in 2013 we started to see a return to more historical conditions which was favorable to our approach. In 2014 we have seen this positive environment continue.
22.) What are your investment goals?
The investment goals are straightforward. We are looking to provide investors with positive non-correlated returns in the mid teens while delivering it with equity-like volatility. We believe that most investors have risk tolerance to own equities and therefore should not be able to say, “Our strategy is too risky”! We believe it is important to deliver one of the key benefits of investing in managed futures; non-correlated returns. Many investors learned the hard way in 2007-2008 when many believed they were sufficiently diversified by owning equities and real estate. By adding non-correlated investments investors can potentially increase portfolio return while decreasing overall portfolio risk. What many investors wonder is how we are able to achieve this. It becomes possible by trading a wide range of markets (i.e. diversification) that most investors eschew or probably should not be investing directly in the first place! That is one of the reasons they call it managed futures. It makes sense to hire a professional manager to invest in a diversified portfolio that most investors would not typically have exposure.
23.) What makes your program unique and different from other managers in your sector?
We consider ourselves a systematic macro manager. We are different than the typical global macro manager in that we are not placing thematic ‘bets’ on global markets. Instead, we are employing a disciplined systematic approach. Most managed futures managers are systematic. What differentiates us from the typical managed futures manager is that we have built in the individual equity component to our strategy. We have effectively applied a managed futures philosophy to building our equity trading approach, including the application of our short stock index ‘hedge’. We believe this gives us a distinct advantage because the Systematic Hybrid is designed to perform in a greater variety of market conditions.
24.) Do you feel you have an edge if so what is it?
We believe that our ‘edge’ is the composition of our portfolio; that we have built a combined systematic approach to individual equities and futures. As well, our unique risk controls are also critical where we limit initial position risk to a pre-defined level (again it is a maximum of 80 basis points of risk on a futures position and only 50 basis points of risk on an equities position). This prevents a build-up of the ‘big trade’ (which some managers use but to us it could mean ‘big risk’). And just as important we are able to deliver non-correlated results.
25.) What is the one piece of advice that you would give to a new start-up CTA?
Ask as many people as you can in the business for advice. The beautiful part of the CTA space is that there is a general feeling we are all in this together. Therefore, there exists a collegiate atmosphere amongst competitors. Most managers remember what it is like to get started (we are all started small) and therefore there is a willingness to share advice and ideas that we believe doesn’t necessarily exist in other areas of the investment world. We believe that most managers realize that the pie is very large and that we aren’t really competing as we are just trying to increase our share of what has over the long term been a growing category within the greater investment universe.