Harindra de Silva, whose quantitative shop, Analytic Investors, pioneered the groundbreaking 120/20 strategy, is always on the lookout for more new and different ways to invest.
The president of Analytic Investors Inc. is keen on making sure the quantitative firm's innovative muscles never atrophy.
"Part of that is the people you hire, and thinking about new ways to do the same thing," Mr. de Silva said.
Mr. de Silva's proclivity to think outside the box is, in part, what prompted him to co-author a 2002 white paper, "Risk Allocation vs. Asset Allocation," which preached that shorting securities results in more efficient portfolios.
Analytic Investors has been managing its core-equity-plus product, a groundbreaking "120/20" product that invests 120% long and 20% short, since July 2002. Such strategies have been popping up from other investment managers recently as more institutional investors loosen constraints on managers.
In this vein, Analytic Investors is firmly focused on active management. So much so, that it recently outsourced a hedging program so it could concentrate on active management of clients' portfolios. Mr. de Silva recently discussed that outsourcing decision, his consulting background, and shed light on other innovations in the works, during a September interview from the firm's Los Angeles headquarters.
Describe Analytic Investors' approach. There are two characteristics of our approach. One is that we really focus on systematic investment strategies: strategies that are devoid of emotion, strategies we've designed to be model-based. We focus on that type of strategy with regard to investing in equities, as well as options, and broad asset classes like bonds, currencies, even commodities. The second is the notion that we take these systematic strategies and basically try to customize them to meet clients' needs. Most of the newer products we've come out with in the last three to five years have really been driven by clients coming to us saying, ‘Here is the problem. How can you help us solve it?' A lot of firms focus on systematic and quantitative strategies, but what makes us unique is the tendency to apply that same methodology to solve client problems.
How did you come to co-author the 2002 paper? People were starting to put money into alternatives, and some common questions I got asked at the time were ‘How much money, for example, should I put in a market-neutral strategy?' ‘What percent of the portfolio should they put in the strategy?' And we felt the right way to look at it was from a risk perspective. For example, you could have two market-neutral strategies, one with a volatility of 4%, the other with a volatility of 20%, but if you're doing the same thing, it's really the same strategy. So putting 10% in the one that has volatility of 20% is a lot riskier than putting it in the one that has a volatility of 4%. So the whole focus of the paper was to say, ‘Think about allocating your overall risk budget, as opposed to what percent of your allocation goes in a particular pie.' We were really trying to get people to think in that dimension. Four years after the paper I see increasing comfort with that type of approach.
Why do 120/20 strategies strike a chord with investors? With 120/20 strategies, you can get 80% to 90% of the benefit of being able to go long and short, removing your long-only constraint without all the complexity of a portable alpha strategy. In a portable alpha strategy, you got 100 long, 100 short, 100 in cash, and you need to have futures on top of it, so there's a lot of complexity.
How do you feel about other managers offering 120/20 or 130/30? It must have been less than a month after we converted a client from long only to 120/20 when they said to all their managers, ‘Analytic is doing this for us and we want you to have this flexibility as well.' A lot of those managers actually called us and said, ‘How are you doing this? How are you setting up the accounts? What are the logistics? What's the back office look like?' We were happy to help them, because from our perspective, it's a way to encourage more people to invest more efficiently. The fact that there are more people (offering 120/20 strategies) doesn't decrease our ability to add value. In some sense, I think if we had been doing it by ourselves and not sharing the ideas with others, it would be less accepted than it is today.
How much is Analytic Investors running in 120/20 strategies? Around $2 billion, (which is) probably a billion more than a year ago.
Is this the fastest-growing area of business? The word growth is hard to apply because a lot of people are migrating from traditional long only to 120/20 or 130/30-type strategies. But it is one of the fastest-growing areas for us. It's certainly the area where we are seeing the most amount of interest from investors and consultants.
What else is in the works? The products we are looking at now are low-volatility equity strategies. If you have a low-volatility equity portfolio, you can invest in that and add to that a fixed-income future. … We launched the strategy in 2004, and are running it for one client. It was recently discussed in the Journal of Portfolio Management.
Why did Analytic recently outsource the hedging program it was running for Old Mutual Financial Network? We started running the hedging program about four and a half years ago. (The goal was to hedge the equity market exposure with the equity-linked annuity insurance policies OMFN sold). The program had grown to about $6 billion. But we wanted to focus on actively driven strategies, as opposed to passive. And the fees associated with passive are so low; even though (the strategy) accounted for a substantial amount of assets, it did not account for a substantial amount of revenue. (Mr. de Silva declined to name the manager now running the strategy.)
What's the plan for building business now? We have three engines of growth: equity, global asset allocation and option-driven strategies. There are two areas we are focusing on. First, the 120/20 and 130/30 type, both in the U.S. and globally. Second, we are focusing on … where we combine one or more of these strategies — stock selection, global asset allocation and option driven — in one portfolio, and move the risk around from one strategy to another to capture the risk return trade-off that's most attractive. We are seeing … demand for multistrategy from both institutional and retail investors. That is a real change that occurred. Ten years ago, everyone was benchmark focused, and now we are moving to an environment where people are more outcome-oriented. They say, ‘I want a 10% return and I'm willing to tolerate 10% volatility.' They are leaving it up to managers.
What do you think about the separation of alpha and beta? Will investors be able to find all this alpha? The idea has been around for a long time. The important idea is not that you can separate alpha and beta, but that there is a variety of beta (sources). If you want to meet investment goals going forward, (you) need to be comfortable layering or combining different types of beta.
How has your pension consulting background helped in your current position? The biggest value (comes from) having sat on the other side of the table, realizing money managers come and talk to you, and it's hard to differentiate one from another. (At Analytic), we try to be clear about our value proposition.