Market Folly's Custom Hedge Fund Portfolio Created With Alphaclone ~ market folly

Friday, April 17, 2009

Market Folly's Custom Hedge Fund Portfolio Created With Alphaclone

Today, we are proud to unveil our own Market Folly hedge fund portfolio. With Alphaclone (which by the way is currently 50% off) we have created our own "fund of funds" and have cloned a unique portfolio of equities. Two weeks ago, we introduced you to the ultimate hedge fund portfolio machine otherwise known as Alphaclone. In our introductory post, we told you about how it can clone the portfolios of individual hedge funds, which demonstrate some great market outperformance. Last week, we examined how you can combine multiple hedge funds into one cohesive "fund of funds" portfolio. In particular, we looked at the Tiger Cub clone, a portfolio consisting of all the various funds that have sprouted up since Tiger Management's dissolution. And, the performance metrics on that clone spoke for themselves: the Tiger Cub clone has beaten the S&P 500 by 15.5% annualized since 2000. What's awesome is that since the portfolio holdings are laid out for you and rebalanced each quarter, you can invest your own money based off these clones and pocket these gains. We're not even joking when we say that we use Alphaclone every. single. day.

The best part of Alphaclone is the extensive amount of customization available. This week, we want to further elaborate on that by creating our very own fund. You can create a fund of funds with as many or as few hedge funds as you like. For instance, the Tiger Cub clone we looked at last week contained 21 funds. Our Market Folly clone, on the other hand, only contains 3 funds. We have literally spent almost a month now testing out all sorts of portfolio combinations and strategies. We've mixed value funds with global macro funds, concentrated portfolios with activists, etc. You name it, we've tried it out. We went through the list of the hedge fund portfolios we typically cover here at Market Folly and mixed and matched them all over the place. Additionally, we also ran various strategies such as: top holdings, best ideas, and most popular holdings. Over the course of the month, we've literally created THOUSANDS of unique portfolios that are based off multiple hedge funds. But, we finally cloned the portfolio we were looking for.

The Market Folly Portfolio

Today, we are finally ready to unveil our Market Folly clone created with Alphaclone. And, as we mentioned earlier, we have only included 3 funds in the clone. Why, might you ask? Well, after running thousands of clones, we've found a great deal of performance in simplicity. We kept it simple and stuck to hedge funds that we know can outperform. The 3 hedge funds we selected are: Baupost Group, Eton Park Capital, and Shumway Capital Partners.

Here's the rationale behind our clone: We wanted to combine unique styles and managers while still keeping things from getting too complex. We found that if you added too many funds, it hurt performance. So, we simply took the best funds in three different categories: value, concentrated portfolio, and Tiger Cub. Then, we consulted the list of funds we track here on Market Folly and started to mix and match.

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- Our value fund is Seth Klarman's Baupost Group. If you're familiar with this fund, then you already know why we've selected it. They have unprecedented performance and define the essence of value investing.

- Our concentrated portfolio is Eric Mindich's Eton Park Capital. We wanted to pick a fund that ran a pretty concentrated portfolio because we've found that these types of funds can usually outperform due to their conviction in their picks. If they have high conviction in a portfolio holding, you can bet they've done extensive research on it and are confident. And, after comparing numerous concentrated-style hedge funds, we found that Eton Park kept putting up the best numbers.

- Lastly, our Tiger Cub portfolio is Shumway Capital Partners (Chris Shumway). Some will argue that selecting a Tiger Cub to be in the portfolio is basically like selecting another value fund. And, that's a completely valid point. But, we also want to point out that many Tiger Cubs often exhibit high conviction in their picks, and that was a characteristic we were looking for. So, we've essentially picked a fund that combines value with a concentrated portfolio. Plus, as you've seen above with the performance numbers the Tiger Cub clone kicks out, it's pretty self explanatory. The Tiger Cubs outperform and Shumway is a unique blend of value and high conviction.

The Strategy

Now to the good stuff. After creating our portfolio in Alphaclone, we started to mess around with strategy. As we've mentioned in our previous posts, you can chose numerous strategies with Alphaclone. You can choose the top 1, 2, 3, or 5 holdings from each hedge fund and combine them into one portfolio. Or, you can also take each fund's best ideas (the top 1, 2, 3, or 5 from each). Lastly, you can also take the most popular holdings (the positions most commonly held among the funds in your custom clone). The portfolio then runs equal weighted and rebalances each quarter. You also have the option to run the portfolio as long only, or you can hedge the portfolio with a 25%, 50%, 75%, or 100% hedge. To our surprise, we actually found two successful strategies. Below, we'll cover a 'top holding' strategy. Then, next week, we'll look at our 'best ideas' strategy.

The Market Folly Portfolio: 'Top Holding' Strategy Performance

Firstly, we'll focus on the Market Folly custom clone that runs the 5 top holdings from each of our 3 hedge funds all equal weighted, with a 50% portfolio hedge. The rules associated with this clone strategy are:
1. Buys the largest holding(s) for each manager(s) as determined by the market value of the holdings at the end of the quarter.
2. Sells when the holding is no longer ranked as being a top holding for that portfolio.

Remember, Alphaclone gives you all the historical performance metrics, your clone's current holdings, as well as which holdings were recently rebalanced from the last quarter. Here's what the performance looks like with the green being our portfolio and the blue as the S&P500:

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Simply put, this portfolio has performed quite well. Out of the eight years tracked, this Market Folly clone has outperformed in six of those years. And, year to date for 2009, this portfolio is up 15.7% when compared to the S&P500 -4.9%. You'll also notice that in the bear markets of 2002 and 2008, this portfolio also beat their benchmarks handsomely. With Alpha of 15.4, Beta of 0.7, and Index correlation at 0.8, we've found some solid alpha. Over a 3 year time frame, this portfolio has a total return of 28%, while the S&P500 has a total return of -29.3%. And, our portfolio has done so with less volatility, a higher Sharpe ratio, and less drawdown.

Here's the best part: Since August 2002, our Market Folly 'Top Holdings' portfolio has seen Alpha of 15.5 and a total return of 194.5% versus the S&P500 return of only 6.6% ... now that's outperformance!

The Market Folly Portfolio: Holdings

So, where does this great outperformance come from? Well, here's what the current portfolio looks like as broken down by Alphaclone. These are the holdings that have yielded the outperformance year to date in 2009 as mentioned above:

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Keep in mind that these positions are rebalanced each quarter and Alphaclone does everything for you by showing you which holdings to sell out of and which to buy (all under the 'Recent Trades' tab). And, you can see the holdings for each previous quarter as well. Also recall that our portfolio runs a 50% S&P500 hedge at all times as well. It's really easy to run a portfolio with your own money based off these outperforming clones.

Now that you've seen the Market Folly custom hedge fund portfolio, what do you think? Pretty impressive, right? What's crazy is that we literally came up with tons of outperforming portfolios that we could have shown you. This one simply generated some of the best numbers while holding true to our 'keeping it simple' mantra. Remember, this is just the first strategy of our Market Folly custom portfolio. We covered the 'Top Holding' strategy this time around, and next week be on the look out for our post when we implement the 'Best Ideas' strategy in our Market Folly custom hedge fund portfolio.


Now you know why we use Alphaclone on a daily basis. As you can see, it is highly customizable and gives you great backtesting, tons of performance metrics, and a current portfolio that rebalances automatically each quarter. Don't forget that Alphaclone currently has a 50% discount, so get it while it lasts. We have only illustrated a tiny amount of the capabilities, so check it out and explore it for yourself. And, if you've missed our other posts on this ultimate hedge fund portfolio tool, check out our introduction and also the Tiger Cub clone. Stay tuned next week for the other strategy in our custom Market Folly portfolio!

*Update: Here's part 2 of our custom clone.

*Please note that all our Market Folly portfolios have a filter set at the very beginning of the Alphaclone custom portfolio process where we exclude positions with a market cap greater than $50 billion. We still allow all sectors and all other market caps. If you wish to replicate our portfolio with Alphaclone, just make sure when you create your custom fund group that you 'uncheck' the "greater than $50 billion market cap" box at the beginning, so that those positions are excluded from the portfolio. We did this because we found that slightly better performance could be achieved when enabling this filter.

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