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Interview with Jesse Liu, Cofounder & CIO of Urania Capital Management

Jesse is co-founder and chief investment officer of Urania Capital Management Ltd. He has 30 years of stock market research and investing experience including studying entire fundamental and technical history of tens of thousands of public companies, as well as experience of starting and managing businesses in various growth stages and functional capacities including as public company CFO. He has deep understanding of corporate finance, accounting, and business fundamentals, and extensive knowledge and experience of mathematical and statistical models. Connecting these dots, Jesse has over time developed and refined Urania Capital’s unique strategy, system and tools for picking stocks and building portfolio for profitable investing. Jesse holds an MBA from Columbia University and a MS in Engineering from Iowa State University.

Urania Capital Ltd was launched in 2014 as a Cayman Islands standalone fund for non-US and US tax exempt investors, and was restructured in 2019 into Cayman Islands master feeder funds to accommodate non tax exempt US investors as well. Both the master fund and the feeder fund follow the same proprietary market neutral strategy, which seeks long term above­market return at below­market risk without market correlation from investing in US and global stock markets. To achieve the objective, the funds employ proprietary algorithm and exhaustive process to build and hold a portfolio of equal weighted market neutral long­short pairs that produce absolute return uncorrelated with the market. Urania Capital returned 27.64% for the first five months of 2020, significantly outperforming the global equity market and ranking in the top 1% of 12,000 plus hedge funds Eurekahedge tracks worldwide.

  1. Please share with our readers a bit of background to Urania Capital, including details about the key personnel in your team.
  2. Urania Capital was launched in 2014. The founding investors are a few of my partners and investors in our prior business Hurray and they have all been extremely trusting and supportive since inception. I am especially grateful to have Tina Ju as anchor investor and key partner of the fund. Tina is founding managing partner of KPCB China and TDF Capital, and a very accomplished venture capitalist also with extensive knowledge and hands-on investing experience in hedge funds. Over the years Tina has been a trusted advisor on key business decisions and pushed me to further refine and improve our investment strategy.

    Since inception Urania Capital has been supported by many third-party service providers such as Conyers for fund legal and regulatory compliance, DBS Bank for fund administration and custody, and E&Y for fund performance audit. We have also been exploring to potentially outsource fund marketing, operations and reporting. As we grow, we intend to build institution grade fund management infrastructure while focus on our core competence: research and investing.

  3. Do walk our readers through the highlights of the Fund’s investment processes and how the team distinguishes themselves apart from other long/short equities funds.
  4. Urania Capital’s investment objective is to achieve long term above market return at below market risk without market correlation. We benchmark against the S&P500 index which consistently leads all other major market indexes worldwide, with 9% average annual return and 18% standard deviation of return over the past 15 years. Our investment objective is clear: average annual return higher than 9% and standard deviation lower than 18% and correlation near zero. Our solution is a portfolio of uncorrelated equal weighted Beta neutral long short pairs, which generates Alpha along all three dimensions of our investment objective.

    Most long/short or market neutral equity funds today rely on some combination of traditional fundamental and technical analyses and discretional investment decisions. Urania Capital distinguishes itself by employing proprietary algorithm and exhaustive process that rejects 99.9% of all stocks. We use quantitative models and tools, instead of fundamental and technical analyses, to sift out long and short candidates via historical price, qualify long and short candidates via historical financials, match long and short candidates to create perfectly hedged pairs, and monitor each pair and the whole portfolio for margin of safety, correlation, entry, exit, and rebalance. We start with a database of 50,000 stocks worldwide and end up with a portfolio of 25 to 30 long short pairs.

  5. From an investor’s portfolio management perspective, how does exposure to beta-neutral strategies complement other traditional and alternative asset classes, and what are the main benefits offered by the Fund’s strategy?
  6. From an investor’s portfolio management perspective, low cost passive investing in index ETFs already provides easy Beta return, high fee active investing has to deliver Alpha return to add value. Beta neutral strategies can eliminate Beta return and produce pure Alpha return hence demonstrate an active manager’s value unambiguously. An investor can add pure Alpha return from a Beta neutral strategy to existing portfolio so to reduce market correlation and enhance resilience of the portfolio, or use pure Alpha returns from different Beta neutral strategies to construct a portfolio of uncorrelated Alpha returns and eliminate the portfolio’s market risk altogether.

    The main benefits offered by Urania proprietary market neutral strategy are stated in our investment objective: long term above market return at below market risk without market correlation. We seek to insulate our investors from market uncertainties and produce pure Alpha return regardless of market conditions. Recent market crisis proves once again the distinct value of such absolute return.

  7. What is the scalability of Urania Capital’s investment strategy? Are there plans to raise capital for new fund offerings which would complement the existing strategy?
  8. By design our strategy can scale up to US$1 billion AUM without problem. Our minimum market cap threshold for stock picking is US$1 billion, average market cap for stocks in our portfolio is over US$10 billion, and there are 40 to 50 long and short positions combined in our portfolio at any given time. Furthermore, we rely on algorithm and quantitative tools instead of human endeavour for our research, and we trade infrequently and hold our positions for years. All these make our strategy and execution highly scalable. Nonetheless, we believe true capacity to manage more capital only comes from our mental and physical experience growing with our fund over time. We will pace for marathon instead of a 100 metre race to ensure long term sustainable growth.

    In 2014 Urania Capital started out as a Cayman Islands standalone fund for non-US and US tax exempt investors. In 2019 we restructured into Cayman Islands master feeder funds to accommodate US taxed investors as well. Both the master and feeder funds employ the same proprietary market neutral strategy.

  9. Risk management remains as one of the major concerns for investors interested in alternative strategies, as downside risk could be extremely idiosyncratic given the nature of the strategy and asset class. Please provide some insights on how you identify opportunities within the equity market and manage downside risk.
  10. Stock investors face two primary risks: the first is individual stock failure when a stock crashes due to limitation of our cognitive ability; the second is market failure when whole market crashes with all stocks good and bad due to events beyond our control, like what happened in March due to global pandemic. A well-constructed long portfolio of diversified stocks can eliminate individual stock risk effectively and even reduce market risk significantly. Picking a suitable short stock for each long stock in the same long portfolio to eliminate each pair’s correlation with the market, the entire portfolio can eliminate market risk and minimize downside risk. This is the essence of Urania proprietary market neutral strategy. The result is since 2017 implementation our investors have had positive return and positive Alpha over any 12-month period.

    Compared with traditional long/short strategy or portfolio hedging via market or volatility index instruments, we believe our approach is more precise and complete as we seek to eliminate market risk not only from the portfolio but also from each position in the portfolio via quantitative models.

  11. Since the inception of Urania Capital back in 2014, what have been the greatest challenges the team has faced, and what were the steps taken by the team to better prepare itself against similar challenges which may occur in the future?
  12. Urania Capital started out in 2014 with long biased strategy based on proprietary algorithm. Back testing showed our well-constructed long portfolio of diversified stocks would eliminate single stock failure risk effectively and even reduce market risk significantly. For the remaining market risk, we were confident to handle with discretion given our experience managing personal portfolios through the 1998, 2000 and 2008 market crisis. When oil prices suddenly dropped 70% from mid 2015 to early 2016, we became concerned with potential market failure risk, as historically an oil price collapse always correlated with recession and major market downturn. Managing investors’ money, as opposed to personal money, yet knowing our long-biased portfolio is not completely insulated from market risk created unusual mental pressure. As a result, we deviated from our strategy and made discretional portfolio adjustments that hurt our performance. We finished 2016 with -5.9% return, our first and only down year since inception. Upon revisiting our transactions, we realised that we would be profitable for the year If we did nothing but simply sit through the volatility.

    That was the greatest challenge we faced so far. We learned that ease of mind is important to investment performance and managing market risk by discretion is not good enough. Instead we need a system approach to manage or even eliminate market risk altogether from our portfolio. Soon after we conceived and implemented our proprietary market neutral strategy in 2017 which proved remarkably effective during recent market crisis. When the crisis struck, we had ease of mind and did minimum trading with our portfolio. Our strategy took care of the situation by itself.

  13. Despite the advantages offered by beta-neutral portfolios, market-neutral hedge funds still account for a relatively small portion of the hedge fund industry vis a vis long-biased equity hedge funds. What are the primary challenges faced by investors interested in gaining exposure to this strategic mandate, and how do you expect the hedge fund industry to transform in the face of these challenges?
  14. Traditional market neutral strategies generate mid-single digit return with low volatility and are perceived as ultra conservative and unexciting. That is probably why market neutral funds only account for a small portion of the hedge fund industry. Somehow most investors do not look at investment return from risk adjusted perspective, do not distinguish between Beta and Alpha returns, and do not recognise that market neutral strategy is of lowest risk when returns are equal and of highest return when risks are equal.

    Market neutral strategies do not have to be unexciting either. Armed with quantitative models and tools, Urania’s strategy is in essence statistical arbitrage of growth disparity between businesses and expected to significantly outperform traditional ones. We think a market neutral fund that delivers above market return at below market risk without market correlation can be ultra conservative yet exciting to investors seeking solid pure Alpha returns.

  15. Given the volatile market situation over the recent months, the global hedge fund industry has witnessed substantial performance-driven losses and investor redemptions. What is the team’s expectation on the level of investor interest in market-neutral strategies in near future?
  16. Prior to the March market crisis, we had had an 11-year bull run since the 2008 global financial crisis, the longest in history. Throughout the time, most investors and fund managers knew that market risk is inherent and the next crisis was bound to happen. Yet they were complacent about not hedging against the system risk properly or sufficiently. As the famous saying goes, only when the tide goes out do you discover who has been swimming naked. It is amazing to see how many of us, including many established hedge funds, were swimming naked.

    Current market crisis should have reminded investors that market risk is inherent yet unpredictable and effective hedging is imperative. We anticipate investor interest in hedging strategies including equity market neutral to rise in near future. We would like to emphasise that comparing all hedging strategies, market neutral stands out with highest average return over standard deviation ratio and highest average return over maximum drawdown ratio. It has lowest risk when returns are equal and highest return when risks are equal. It is a strategy that produces best risk adjusted return.

  17. Urania Capital has returned 27.64% throughout the first five months of 2020, significantly outperforming both the global equity market and many other long/short equities funds which have struggled amidst the COVID-19 pandemic. What were the key factors which enabled the Fund to achieve such a remarkable performance?
  18. We appreciate Eurekahedge for telling us that Urania Capital’s return for the first five months of 2020 and for the 3-year annualised ranked in the top 1% of 12,000 plus hedge funds it tracks worldwide. It is intellectually gratifying to know that our proprietary market neutral strategy has not only withstood its first real world market crisis unscathed, but also profited from the crisis with outlier performance.

    Even though we had said in every monthly investor letter since October 2019 that the market was approaching an imminent major top, we could not have foreseen a market crash this steep this fast. Likely no one could possibly have. The market reacted rapidly and violently each day as investors’ consensus on the epidemic and its economic impact evolved. Nonetheless Urania market neutral strategy is made for this kind of environment and proved remarkably effective during the treacherous 33-day 33.9% free fall from February 19 to March 23. By the time the S&P500 reached the trough down 24.3% month-to-date on March 23, Urania was up 5.6% for the same period. And for first quarter 2020, S&P500 was down 20.0% while Urania was up 19.8%.

    Compared with traditional long/short strategy or portfolio hedging via market or volatility index instruments, we believe our approach is more precise and complete as we seek to eliminate market risk not only from the portfolio but also from each position in the portfolio via quantitative tools.

    Nonetheless, investing in stock market and growing wealth via slow and long compounding process is marathon instead of a 100-metre race. Attaining the top 1% performance and industry recognition for one year is merely a small step forward. We wish to continue this journey with our investors for many more years to come.

  19. Following on from the previous question, what is the portfolio manager’s outlook for the rest of the year, and how well-positioned is Urania Capital to take advantage of the development?
  20. By now the debate on whether the market is staging V or W shaped recovery has become pointless, as the market is displaying multiple shades. Of nine S&P500 sectors, consumer discretionary and healthcare are in V shape, energy and financials seem inclined to W shape, and technology keeps hitting a new high. Meanwhile, major central banks worldwide all followed US Fed in bringing out monetary and fiscal stimulus packages. Global pandemic and economic devastation are unprecedented, so are money printing and stock market momentum. Is the market foreseeing a rapid economic recovery or just too distorted by all the liquidity? Regardless, our strategy is to care not about market direction but focus on a niche where it can profit with high probability from growth disparity of selected individual stocks.

    In short, we will maintain our market neutral strategy and avoid attempting to time the market. By design our strategy should consistently outperform the market in mid to long term even though it may underperform the market in short term at major market inflection points, i.e. right before major top or after major bottom. We think it is an acceptable cost for the asymmetrical benefit of insulating investors from market uncertainties and delivering absolute return during this very troubled time.

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Contact Details
Jesse Liu
Urania Capital Management Ltd.
+1 415 991 9354