Cole Asset Management (CAM) was formed in 2004 as an investment advisor, and its first proprietary product, Tellus Natural Resources Fund, a fund of funds dedicated to the commodities and natural resources sector, was launched in February 2005. Brad Cole has more than 20 years of industry experience, including ten years on the floor of the CME trading futures and options, then as part of a successful Chicago-based CTA. Developing and dissecting trading approaches has been at the heart of Cole’s investment career since 1980. Rian Akey, COO, has been working with CAM for more than seven years, primarily in a research and due diligence capacity.
CAMS shares portfolio management responsibilities with a sub-advisor, Chicago-based AlphaMetrix Investment Advisers. AlphaMetrix is an alternative investment advisory firm that specialises in trading manager research, due diligence and developing technology for risk management and quantitative analysis purposes. They advise over US$350 million in assets.
From AlphaMetrix, Aleks Kins has asset management experience as a member of the alternatives group at Carr/Indosuez and Ramsey Quantitative Systems Inc, where he helped to build the Emerging CTA Index, a multi-advisor product that focused on emerging commodity trading advisors. Jon Stein was previously the chairman of the investment committee for Efficient Capital Management, one of the largest multi-advisor CTA managers in the world, and before that he was with Rotella Capital Management.
The Tellus portfolio gained 11.21% net of fees for the period from February 2005 to December 2005. In 2006, the portfolio is up an estimated 17.39% year-to-date through July. The compound annual rate of return from inception through July 2006 is 19.61%, with annualised volatility of 8.07%.
- Could you outline the key features of the Tellus Fund of Natural Resources Funds, such as terms of liquidity and redemption, incentive fees charged etc?
Tellus is set up in a master/feeder structure, with a Delaware LP entity serving as an onshore feeder and a Bahamian corporation as the offshore feeder. Tellus Master Fund Ltd is a Bahamas-domiciled entity. The funds provide for quarterly liquidity with 90 days’ notice, a 1.5% management fee and a 10% incentive fee.
- One of your stated investment guidelines is to diversify and cap your exposure to any specific commodities sector at 40%. Could you elaborate on your allocation methodology and the rationale behind it? How frequent and dynamic are changes to these allocations?
In developing the portfolio – and this goes back more than two years now – we made a very concerted decision that we wanted this to be a commodity fund and not an energy fund. It was clear to us that within this space there is an abundance of energy managers, many of whom have institutional quality infrastructure and capacity to manage a significant volume of assets. Our view is that the supply/demand drivers that are getting so much attention and focusing interest on the natural resource space are not energy-specific. That is, the macroeconomic story is much broader than being merely an energy story, and creates opportunities in everything from metals and grains, to soft commodities and exotics. By forcing diversification through sector constraints we are attempting to provide broad exposure to a diversified mix of these opportunities. We feel that there are actually more ways for an investor to gain pure energy exposure, if that’s what he wants, than there are ways for an investor to gain diversified resource exposure, especially via actively managed strategies.
The idea here is not to be making large-scale sector calls, but to provide ongoing exposure to a diversified mix of resource strategies. We do review our sector exposure on an ongoing basis in relation to our views on market fundamentals, but the changes are more subtle and likened to tilting than outright re-balancing. The goal here is to provide ongoing access to a diversified opportunity set, with the best managers and traders from each sector.
- Do you foresee any significant shift in your sector exposure in the near term? Why or why not? What are the typical holding period of an investment and turnover of the portfolio?
We have taken a strong interest in agricultural and soft commodities, particularly insofar as markets like corn and sugar are linking more than ever to what is happening in the energy markets. We have broadened our exposure here to managers we feel are well-positioned to digest and act on these types of fundamentals. Ideally, we would anticipate low turnover and long holding periods; we are not involved in this space to trade managers or chase returns based on near-term sector views.
- It is also stated in the mandate that Tellus has a half-and-half exposure to directional and relative-value/pair-trading plays. In your experience, was there any discernible pattern between performance and the style employed? What other factors go into making the style allocation decision?
Along with the sector diversification mandates, this is another key to portfolio structure that we feel is unique to Tellus. Within each sector and even each market, it is clear to us that directional market timing is only one source of alpha. The number of relative value type trades is voluminous, whether you are looking at trading along the futures curve, arbitraging the future to the physical, inter-market spreads, etc. Because of all of the attention to the long-term supply/demand issues in the resources space, we have felt like there is so much focus on the directional side of the equation. We believe in many of these long-term macroeconomic factors about commodity prices increasing, but we also don’t want to be reliant upon gold hitting us $900/ounce to have a profitable portfolio. This is where the relative value portion of the portfolio contributes. From May-June 2006, when metals markets like copper and gold were selling off, our metals positions were profitable in the aggregate, largely due to relative value positions. We see months where there is a very clear pattern between directional and relative value strategies in the portfolio, and the balance in our portfolio has absolutely smoothed our return stream.
- Is the fund as diversified geographically as well? What is the current regional breakdown of Tellus’ assets?
The great majority of assets are deployed in North America and Europe, with small pockets of exposure coming outside of those regions. We are interested in broadening exposure outside of these areas, but find that the real core of activity in the space is coming from these parts of the world.
- What is the Tellus fund’s competitive edge over other funds of funds allocating to natural resources?
We touched on these a bit previously.
The first is coverage. We are not an energy fund. That particular sector is well-known and well covered. There are a handful of well-known, pedigreed groups and they are not a mystery to anyone in the space. We do not think we are setting ourselves apart in the energy sector (nor is anyone else). We have sector limits that mandate a diversified portfolio of broad commodities exposure. That limits the amount of assets we can ultimately manage, but it increases our focus on the other sectors in a commodity portfolio – and these are places where we feel we can get a real edge: finding good, solid, professional grain traders, softs traders, metals groups, and managers covering peripheral markets. These are the managers who are not always widely known or accessible.
We don't have asset level minimums in terms of a manager having a certain amount of assets to be considered – you just can't do that here when you are looking at trading only in the livestock or grains. The managed account platform that AlphaMetrix brings to the table is a huge advantage in terms of mitigating much of the business risk of looking at these smaller managers. Also, everyone on our investment committee has substantial experience looking at small and emerging managers, so that is a clear specialty for us.
We also consider ourselves a natural resources fund, as opposed to commodity only in terms of futures-only. There are other managers in the space who won't go into managers in the securities markets. We know that adding long/short managers into the portfolio can add some equity exposure, but feel that the trade-off in terms of an expanded opportunity set is worth that relatively small amount of exposure. We can get involved in peripheral markets like water, forestry products, utilities, shipping, infrastructure – there are all kinds of additional ways to get involved in resources that aren't really available in a futures-only strategy.
- Would you contend that, from an investor’s standpoint, a fund of funds such as yours is a better proposition than a multi-strategy hedge fund targeting similar opportunities in the commodities markets? Why? What factors, other than lower incentive fees and diversification of key man risk, do you think would go into the investment decision?
A multi-strategy hedge fund in the commodities markets is an interesting concept, but we think that in some ways it’s something that might look better in theory than in practice. Once again I think we have to look at it from the standpoint of the energy groups, and the non-energy groups. I think on the energy side you have a situation where the coverage has always been mainstream, and the traders have been working through and with the infrastructure of large banks and financial institutions. But if you get outside of the energy markets and go back 20 years to when many of these same wirehouses were disbanding their commodity desks and research units, you see a dispersion of the talent into far more isolated, eccentric channels. That means, first, that there aren’t hundreds of pedigreed metals analysts or cotton traders out there to choose from, but also that the best and most experienced grain traders haven’t been sitting on a desk at Citibank for the last 20 years – they’ve been running small, independent operations out of Memphis or Little Rock. Luring that talent to a multi-strategy shop in Manhattan is a different endeavour than putting together a team of convertible traders or distressed debt specialists.
A fund of funds, on the other hand, is well positioned to take advantage of these kinds of idiosyncracies, particularly with a group like ours that can mitigate some of the manager risk in some of the smaller managers with limited infrastructure via a managed account platform.
- Could you shed some more light on your unique risk monitoring framework?
Through the sub-advisor, AlphaMetrix, the portfolio utilises a risk monitoring platform that provides 100% transparency on the underlying investments where we have managed accounts. This information is aggregated via state-of-the-art, proprietary systems that allow us to review manager positions on a trade-by-trade basis, but also to view that segment of the portfolio and our exposures on an aggregated basis.
- How has the fund performed vis-à-vis its investment objectives, over the months since its inception in February 2005?
Our objective was to put together a commodities portfolio that could achieve a rolling Sharpe ratio of 1.0 or higher. Since inception, the Sharpe Ratio is 1.94. The monthly performance has been in line with our expectations, based on some pro forma statistics we generated, but also in terms of some of the theoretical research we did on the space that has been published in white papers.
Rolling 12-month returns have been in the top quartile of expectations, while volatility and lack of correlation to commodity benchmarks has been consistent with expectations. We have been particularly pleased with performance during months like April and October 2005, as well as February 2006. These are periods when commodity markets have had dramatic pullbacks, even in the midst of a secular bull market. Some of the commodity indexes were down 10% or more in these months, while the most we lost in any of these periods was 1.09%, so the portfolio defended really well in some tough markets. So, in reality, most of the volatility we have seen has been to the upside. Over the long term we do expect to see volatility increase; our target is about 10% annualised volatility.
- And lastly, what is your take on the current volatility in the commodities markets? What is your macro view for the short term and what opportunities do you foresee?
We are long-term bullish on the commodities arena as a whole and expect to see high volatility continue. The main drivers here are long-term shifts in supply and demand to accommodate Asian mobilisation into global capitalism, increase corporate activity both in terms of re-investment into R&D and increased production capacity, but also in terms of an increase in M&A activity as valuations rise in the sector. Lastly is the idiosyncratic nature of commodity distribution which means more structural inefficiencies as opposed to the deeper capital markets. These fundamentals feed into our multi-strategy approach quite nicely.
As for commodity prices, we expect to see more range trading as far as individual commodity markets go, even if the range is fairly wide, but still with plenty of volatility for traders to find opportunities. It will be interesting to see how some of the emerging interest in bio-fuels affects the relationship between corn, sugar and the energy sector.