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Robert Abbott
Robert Abbott
Articles (320)  | Author's Website |

Lee Ainslie Ventures Into Quant Funds

The former 'Tiger Cub' is heading into territory not known to the original Tiger Management group

Hedge fund founder and manager Lee Ainslie (Trades, Portfolio) has had a couple of rough years. At the same time, he has been testing quant investing strategies, a very different approach for this longtime value investor.

Although the fortunes of his two quant funds are still in the future, is it possible this expedition will help him generate better results with his conventional investing strategies?

Who is Ainslie?

In an interview with the Graham and Doddsville newsletter, Ainslie says he first became interested in investing while in school; he joined an investing club, started a paper portfolio and his interest developed from there.

He received an undergraduate degree from the University of Virginia and an MBA from the University of North Carolina at Chapel Hill.

His first job was as a management consultant at KPMG. Then it was on to Tiger Management, run by the legendary Julian Robertson (Trades, Portfolio). While at Tiger, the wealthy Sam Wyly family of Texas persistently asked him to manage their money for them. According to Investor Almanac, he eventually agreed and, after three and a half years at Tiger, left to start Maverick Capital.

Numerous “Tiger Cubs” emerged from Robertson’s tutelage; in addition to Ainslie, the group includes John Griffin (Trades, Portfolio), Chase Coleman (Trades, Portfolio) and Andreas Halvorsen (Trades, Portfolio).

What is Maverick Capital?

Dallas-based Maverick was formed in 1993 by Ainslie, who remains its portfolio manager and owner. The firm manages the assets of the three broad groups of funds, according to its Form ADV Part 2A:

The first group, under the umbrella of Maverick Funds, operates six funds:

  • Maverick Fund USA Ltd. (Maverick USA).
  • Maverick Fund L.D.C. (Maverick Fund).
  • Maverick Fund II Ltd. (Maverick Levered).
  • Maverick Long Fund Ltd. (Maverick Long).
  • Maverick Long Enhanced Fund Ltd. (Maverick Long Enhanced).
  • Maverick Select Fund Ltd. (Maverick Select).

The second group, Maverick Stable Funds, offers a fund-of-funds strategy.

The third group, Maverick Venture Funds, is the main vehicles through which Maverick invests in venture capital opportunities.

The Form ADV report, filed July 21, 2017, shows discretionary assets under management of $15.9 billion. GuruFocus puts its equity-only portfolio at $7.9 billion in November 2017, based on 13F filings. It charges clients the basic 2% and 20%, with discounts for longer-term holds.

Strategies

Leading off his description of Maverick’s investing strategy is Ainslie’s statement that the investment process is driven by intensive, bottom-up research. They curb economic risks by buying certain securities while shorting others. In addition, they take a top-down view of individual industries.

All of this produces a proprietary quantitative model that recommends position sizes on the back of factors correlated with wins and losses in different market environments.

Research is done by sector teams, up to six of them, that focus on different opportunity areas. The Form ADV Part 2A notes they currently operate five sector teams: Consumer, Healthcare, Cyclicals, Media & Telecom and Technology. These teams get support from two discipline research teams: private investments and quantitative.

Recently, the firm has added another strategy, quant investing. Quantitative typically uses very big and very complex models that digest large amounts of data. The goal is to develop a system that provides an edge through greater knowledge or speed. Quant strategies, for example, are used by day traders to try to take advantage of small arbitrage opportunities. The effectiveness of quant strategies is widely debated; skeptics point to their use by Long Term Capital Management and how its huge failure might have brought down the financial system in the 1990s.

In other words, quant funds are miles apart from value investing. Yet, Ainslie is taking his firm into that area, while maintaining his traditional business models.

In October, Business Insider reported Maverick had tested a quant strategy in two new funds, starting two years earlier. Citing an Oct. 20 letter to clients, the magazine quotes Ainslie as saying the strategy would produce insights that would prove “invaluable” to their core, fundamental effort. In other words, the new funds will likely continue as stand-alone entities, but should also help the firm do better fundamental research.

The magazine also reports seeing marketing documents with performance data for the two funds:

  • The Maverick Fundamental Quantitative Fund gained 16.9% between January and August 2017.
  • The MFQ Neutral Fund was up 22.1% over the same period.

Ainslie’s overall strategy is summed up in four lessons, in an article based on an interview he did with McKinsey & Company.

  1. The first lesson is to understand the business, to know what exactly a company does, what leads to growth, sustainability and use of capital. To reach their goal of knowing more than any non-insider does about the company, Maverick’s investing professionals normally have fewer than five positions at a time. Analysts also take a sector approach to develop their expertise further.
  2. A long-term perspective is essential, although Ainslie’s idea of long-term will be shorter than that of most value investors. His horizon is one to three years, which is said to be longer than most hedge funds, but many gurus would argue that three to five years, or one market cycle, would be their idea of long term. And, for devoted followers of Warren Buffett (Trades, Portfolio), long term will be 30 years or even forever.
  3. Valuation is a key pillar, but Ainslie takes a flexible approach. He argues diverse sectors such as financial, retail and technology cannot be approached in the same way. Overall, they look at “sustainable free cash flow” and stocks with the potential to beat a 20% annual hurdle rate.
  4. Getting to know management well is the fourth pillar. He speaks of spending an “inordinate” time with management, trying to understand their quality, ability and motivations. He considers investing to be a direct bet on managerial competence and motivation.

Although nominally a value investor, Ainslie’s focus is on the potential of stocks rather than a discount price. And his emphasis on managerial competence and motivation highlights the difference that good management makes for companies.

Holdings

This chart captures the diversity of Ainslie’s equity portfolio:

Lee Ainslie sectors

These are the top 10 holdings among his 177 stocks as of Sept. 30:

Performance

Over the past five years, Ainslie’s portfolio has suffered because of a losing 2016 and mediocre performance in the first half of 2017. This TipRanks’ chart shows the lead-up to 2016, and modest recovery:

Lee Ainslie 5 year performance

Referring to his underperformance in the first half of 2017, Ainslie wrote to clients: “The median stock in our investable universe was up 7.7% in the first half of the year, and our shorts were up 12.6% — outperforming (to our detriment) the median stock by almost 5%."

Despite the slump, the guru is confident his firm will get back on a winning track. In his October letter, he wrote: “Previous to this current period, Maverick had only suffered eleven five quarter periods with negative returns in our history, and Maverick has delivered positive returns in the following year every time.”

In response to the slump, Ainslie says he and his team did an exhaustive review of their portfolio, tweaked their team and improved their processes. That’s why he expects history to repeat itself.

This GuruFocus chart shows the value of equity holdings since mid-2002:

Lee Ainslie equity holdings

Note Ainslie’s claim that the firm has had only 11 five quarter periods with negative returns. That works out to 55 down quarters out of the 100 total quarters since inception (55%) over the past 25 years.

Conclusion

Unless I am badly mistaken in my assumptions or arithmetic, Ainslie has had more losing five quarter periods than winning. Still, equity holdings seem quite consistent across the past five years. And if we go by them alone, it suggests Ainslie is holding his own.

Forthcoming quant fund results may change his future. They have the potential to produce significant gains and losses, with the latter just as likely as the former. They may make a positive difference, though, if Ainslie can successfully integrate them with existing, traditional forms of fundamental research.

Value investors should note Ainslie’s insistence that his team members get to know the businesses in which they may invest. Anyone value investing for the long term is investing in a business, not in a stock market. It makes sense, therefore, to know as much as possible about it before making a major commitment.

A corollary of that is his insistence on getting to know management; investing in a business is synonymous with investing in the managers who envision, execute and run the business.

Disclosure: I do not own shares in any of the companies listed, nor I do not expect to buy any in the next 72 hours.

About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995, and in 2010 added options, mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the Unseen Revolution. In Big Macs & Our Pensions: Who Gets McDonald's Profits?, he looks at the ownership of McDonald’s and what that means for middle class retirement income.

In an eclectic career, Robert Abbott was a radio news writer and announcer, a newsletter writer and publisher, a farmer, a telephone operator, and a construction worker. When not working, he has been a busy volunteer, which includes more than a decade of leadership roles at the Airdrie Festival of Lights, one of North America’s leading holiday light displays. He lives in Airdrie, Alberta, Canada.

Visit Robert Abbott's Website


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