Thales Fund Management is an investment management firm focused on developing quantitative trading strategies to generate alpha in global equity markets. Thales offers three funds:
- Its flagship stat-arb hedge fund, which was launched in 1999
- Temujin, a hybrid long/short strategy blending the best of quantitative and fundamental investment approaches, which began trading in 2002
- Leros, a 130/30 fund, which was launched in February 2006
Thales was founded by Dr Marek Fludzinski. Dr Fludzinski has a PhD in theoretical physics from Princeton and worked for DE Shaw, Swiss Bank and Hull Trading prior to founding Thales. Thales’ senior investment team has over 13 years’ experience working together. The firm manages approximately US$1 billion in assets and employs approximately 50 people, half of whom are devoted to research.
- With regards to the fund and fund manager, how is their approach different from others and what is the overall proposition for investors?
The main differences between Leros and other short extension strategies begin with the objective of the fund. Leros’ objective is to maximise the Sharpe ratio while being 100% net long equities. Said differently, we expect to beat the S&P 500 with much less volatility and downside risk. Most managers are focused on beating the market, but few are focused on minimising volatility and risk. Risk reduction is a critical source of value-added that most managers ignore. Institutions particularly appreciate risk reduction in environments like the current one, where the outlook for equities is uncertain. Leros allows investors to maintain their allocation to equities with much less exposure to the significant draw-downs to which equities are prone in times of market stress. One of the ways that we achieve this investment objective is by taking a holistic approach to constructing the portfolio. While many 130/30 strategies merely overlay a 30/30 portfolio onto the index against which they are measured, Leros explicitly considers every position in the portfolio rather than just the overlay positions. The size of Leros’ portfolio also varies from 130/30 to 160/60 depending on the strength of our signals for both alpha generation and risk reduction.
These differences allow Leros to enhance return while also minimising the volatility and downside risk of the portfolio much more effectively than a traditional 130/30 fund.
- What sort of fundamental/technical analyses would you put into your pre-stock selection research? Could you elaborate on your investment philosophy and strategy?
Leros employs a quantitative investment approach that is focused on holding stocks that have both high alpha potential and low risk impact on the portfolio. We short stocks that have little/negative alpha potential and that contribute significant risk to the portfolio. While most managers are focused on the alpha potential of the positions they hold, few consider the risk impact on the entire portfolio level. This explicit consideration of risk gives us an edge in constructing a higher Sharpe ratio portfolio fund.
- How frequently are your allocations revised? How liquid is your portfolio and what is the typical holding period of an investment?
Our typical holding period for a stock is 7-8 months. We revise our allocations regularly based on changing conditions in the market. The portfolio is extremely liquid, and we estimate the capacity of Leros to be at least US$10 billion.
- The structure complies with a net exposure of 100% and gross exposure of 1X0%. How rigidly is this followed and how often is the optimal exposure reviewed? What metrics are used to determine these weights?
Leros is always 100% net long, however the total portfolio size will range from 130/30 to 160/60 (1.6-2.2x gross exposure). The actual leverage employed at a given time is a function of the strength of our signals. One important note is that we often increase our leverage in order to reduce risk; ie if we assess that the volatility of the Leros portfolio will be less than that of the market, we will increase leverage with the objective of reducing the volatility of our portfolio.
- Fundamental, quantitative, all of the above? What is your take on the various approaches available in the 130/30 space and what advantage do you offer compared to your peers?
Leros employs a quantitative investment approach built on Thales’ senior investment team’s 13 years of experience developing quantitative investment strategies. Because of the uniqueness of Leros’ investment approach, Leros has been uncorrelated to other quantitative managers. For example, Leros outperformed the S&P 500 in August 2007, November 2007 and January 2008, months which were challenging for many other active management strategies.
- Mutual fund, hedge fund or hybrid? How would you best define your offering and where does it fit in an institutional portfolio (conventional, alternative allocation)? How influential is this “identity” in the marketability of the strategy?
In general, 130/30 funds are attempting to generate alpha in public equity markets, and the idea behind them is that by removing the long-only restriction, they can generate more consistent excess returns than managers subject to a long-only constraint. Since they are always 100% net long, however, they likely belong in the conventional equity allocation of an institutional portfolio.
Having said that, Thales has approached the development of Leros from a hedge fund perspective. We leverage our experience generating alpha, managing risk and shorting securities, and apply that knowledge in the 100% net long framework of Leros. We feel that this gives us an edge vs a manager coming at the 130/30 space from the long-only side.
- How do you benchmark your performance? How critical is the choice of benchmark and are peer comparisons valid as well (vis-a-vis long-only funds, 1X0/X0funds, etc)?
Since we are trading large-cap US equities, we benchmark our performance against the S&P 500. In general, for funds that are 100% net long, a long-only benchmark is the appropriate point of reference.
- The 130/30 universe is estimated to have more than 200 strategies, from at least 110 management companies and upwards of US$60 billion in assets. Where do you see these products in one, three, five years time?
We expect that the market will continue to grow rapidly, and that the market share will come at the expense of long-only managers. Institutional investors are seeking more alpha in their portfolios to enhance returns and to increase diversification. 130/30 strategies offer a structural advantage that enables a manager with a given level of skill to generate more consistent alpha than if she were subject to a long-only constraint.
130/30 funds are not a panacea though. The structure doesn’t magically give a manager that couldn’t generate alpha in the long-only world the ability to do so in the 130/30 world. As a result, many of the newly launched 130/30 funds will likely not be around in a few years.
Some perceive 130/30 strategies as inflexible – being fully invested and having rigid exposures. As investors seek to balance capital preservation with above-average returns, what are the advantages and disadvantages of a 130/30 fund over long-only funds, index trackers and other long/short funds?
We would agree that limiting a short extension strategy to a fixed exposure of 130/30 does not make sense. For example, if a manager has weaker-than-average conviction at a point in time, she should not be forced to take the same risk as if she has stronger-than-average conviction. This is why Leros employs a variable exposure that is based on the strength of our signals at a given point in time. Having said that, 130/30 funds have a structural advantage over long-only funds. A 130/30 managers has the ability to implement underweight positions more effectively and is able to construct a more diversified portfolio of active bets.
- Overall, what have been the key challenges in developing this product and what else is in the pipeline? Do you foresee extending your offerings beyond 130/30 into long/short, market neutral, etc?
Thales has been managing a market neutral hedge fund for nine years, so development of Leros was a fairly straight-forward application of principles similar to those used in Thales flagship fund in a 100% net long framework. We are currently researching Japan and Europe versions of Leros as well as portable alpha/beta 0 versions of Leros.