Brad Lamensdorf is a hedge fund guy. He invests with an absolute-return sensibility, looking for gains with a keen eye on downside protection. The two ETFs he’s involved with—and the firm he’s created, Active Alts—have a contrarian flavor, looking at stocks that are heavily shorted or out of favor. These aren’t your vanilla ETFs; rather, they are hedge-fundlike active alternatives that offer investors a different way to approach the market. Lamensdorf tells us why the AdvisorShares Ranger Equity Bear ETF (HDGE) and the Active Alts Contrarian ETF (SQZZ) are worth a look.
ETF.com: Give me the big picture of how you got involved with HDGE and SQZZ.
Brad Lamensdorf: I'm a hedge fund guy, and I ran my own long/short hedge fund for quite a while. That’s my background. With HDGE, we’re making huge inroads in the marketplace. We all know the inverse community and the products they're producing don’t work. They’re meant to be held for a day, but do you know what's going to happen if a financial advisor starts buying it and selling it every day to hold that position? Churning. Churning the account.
The alternative is to short indexes. But when you're shorting indexes, you're shorting Apple, you're shorting Johnson & Johnson, you're shorting the companies that are the biggest, best companies in America, because their notional value is the biggest within the index.
When a correction comes, is that really what you want to be—short these companies? Or do you want to be short extremely weak fundamental companies that don't have near the cash flow or the balance sheet or the momentum to be able to handle the downdraft? That’s what we look for.
We feel that, for active management, we've done a super job. We made alpha in most corrections in the market since we started. We're an alpha generator when the markets go down, and that's when you need it most.
HDGE has a 1.6 beta to the S&P 500, and we're kind of even with what's going on; we're actually one or two points ahead this year. When you're mathematically looking at something that's higher beta, we should be down much more than the market. Obviously, the key is stock selection.
ETF.com: Does playing the short side give you more alpha opportunity than if you were long? Why this focus?
Lamensdorf: I'm a long/short manager. I can trade both sides of the market. You can call me a nut, but I've seen this cycle play out millions of times, where the indexes are beating the active managers, and then the active managers come and destroy the indexes.
The problem is that when you think about everybody shoving all this money into these indexes, it becomes an extremely crowded trade. The good part for us is that there are many stocks that aren't in the indexes that are perfectly good. And they're being starved of capital because they're just not getting the same flows.
There's lots of opportunity in stocks that aren't in these indexes, and I can capitalize on that because they're starting to get cheap relative to other stocks in the indexes. So there's value being created in stocks that are outside the indexes.
The price-to-sales ratio on the S&P 500 is as high as it was in 2000. Everybody's telling me this market isn't expensive, but earnings can be manipulated. That's why we short stocks; people get conned into thinking that companies can produce earnings.
But I can tell you one thing that can't be manipulated, and that's sales. Sales cannot be manipulated unless you're an outright fraud. We analyze sales very aggressively in HDGE to see the quality of earnings that are coming from the sales.
ETF.com: On HDGE, you short companies that have low earnings quality or use aggressive accounting policies. On SQZZ, you own companies you believe are about to face a short squeeze, but the majority of the portfolio is in cash. Why?
Lamensdorf: SQZZ, which is an actively managed fund, is going to be running much more like a hedge fund than an index. Right now, we have 60% cash, because I think nobody wants to own cash, and I think cash actually can be a very nice hedging-oriented feature for somebody who doesn't want to get annihilated in these market corrections.
The way to make a lot of money is to be a contrarian in the market. In my opinion, right now, everybody is on one side of the game. Everybody's indexing, and everybody's fully invested. But everything is very rich when everything couldn't look worse. Insider selling is at a seven-year high.
ETF.com: How do you make money out of that huge cash allocation in SQZZ? Is it about securities lending? And why would investors want to pay 1.95% in fees to own a portfolio that’s mostly in cash?
Lamensdorf: There are two things here: first, the SEC’s rule that no fund can lend over 33% of its notional value. So if I'm at 75%, it doesn't matter; I'm maxed out at 33%. So even if I were 33% invested, that's the maximum utilization I can do for the lending program. The investor's never going to get hurt by me being around 33% or more, because that's my max.
Secondly, if I'm expecting a 10-20% correction in stocks, I could certainly ratchet up my position sizes. And if I were looking for the market to get hit 10% or 20%, we'd probably be 100% invested, because at that point, sentiment would be very low, insider selling would have subsided, valuations would have gotten compressed some, and that’s where our investors actually can get some stocks at some good prices.
Unfortunately for me, the SEC held SQZZ up so long, I got to list it when I got to list it. Timing wasn’t great, but there's nothing really I can do about that. We've backtested a lot of different ways to run this program quantitatively. Every two or three years, this group of highly sorted stocks gets absolutely taken apart—down 20%, 30%. It's a complete whipping.
Again, I'm more of an absolute-return-oriented thinker. And that's why the fee is higher, because it's going to be run much more like a hedge fund and much less like some kind of index-oriented fund. Hedge fund managers think much differently than “plain vanilla” people who just put things to work and just slam it into the market. We're very delicate in the way that we move around. We don't like big losses.
ETF.com: I’d argue that “plain vanilla” investors index because they don’t believe anyone can consistently time the market. You pitch actively stock picking and timing the market. How can you reliably time the market?
Lamensdorf: Some people may have a tough time doing it. But I have shown over and over and over through my entire career that it can be done.
But the fact that people think you have to be 100% invested to make money is just not so. HDGE stays 80-100% invested, and frankly, that wouldn't have been my choice. But we're competing against the inverse products, and it's a hedge-fund-oriented product, but it’s a dedicated short-only. So when we do get corrections, we raise about 10-15% cash, and we’ve done that several times.
For SQZZ, and where it is now, you can easily make money off this. Just the fact that I'm loaning out, say, 30% of the book and making, let's call it an average of 5% annually—I don't know exactly what it is, but I'm just kind of giving you an idea—that's an extra 150 basis points to the shareholder every year.
ETF.com: How has investor reception of SQZZ been?
Lamensdorf: It's been mixed. We're almost out of our seed in the first month, so we've been working on that. Every ETF is going to take a few months to get approved at certain brokerage firms and go through that process, just as HDGE did.
But I think some people are very concerned that the fee is very high. My response to that is that I'm giving you 100% of the securities lending business back, which will more than cover the entire fee. So I think I'm actually being very generous. Other asset managers would probably charge 1% and then take a large portion of securities lending and be making 2%-plus a year on the money. But I'm not doing that.
Obviously, if we had launched last fall, when things were looking shakier and people were more concerned, we would’ve been 60% or 80% invested, and we wouldn't even be having this conversation. Our indicators were bullishly positioned last fall due to sentiment gauges. Therefore, we would have been much more invested. And people would have been happy with it, and they wouldn't have even focused on the cash allocation.
Because I start with a lot of cash, everyone's saying, “Why would I pay for this?” You're paying for a manager with a focus on beating the market.
ETF.com: Should we expect more of these types of products from you?
Lamensdorf: At Active Alts, my new company, all we're going to be focused on is alternative investments in the active space. We're going to be, later in the year, coming out with some long/short-oriented products as well.
Contact Cinthia Murphy at [email protected]