New York (HedgeCo.Net) Lake Austin Advisors is an alternative investment manager located in Austin, Texas. Founded and seeded by successful technology entrepreneur Joel Trammel, the firm runs actively managed trading strategies available to both institutional, family office and high net worth investors. Their trading strategies are focused on quantitative investment techniques actively applied to individual equities and exchange traded funds (ETFs) with the goal of offering investors attractive risk-adjusted returns. Their diversified management team draws upon disciplines including algorithmic trading, financial modeling, and computer science. HedgeCoVest recently sat down with Ron Breitigam, the managing director of Lake Austin Advisors.

HedgeCoVest: Thank you for joining us today Ron.

Ron Breitigam: Thank you, happy to be able to do this.

HCV: On your overview page on HedgeCoVest, your strategy is described as a hedged equity strategy, if you would, please explain how a hedged equity strategy is different from a long/short strategy or a market neutral strategy.

RB: We have taken a slightly different approach to the traditional long/short strategies in that we take long positions in S&P 500 stocks, usually about 75 names, categorized as momentum plays or mean reversion candidates. On the short side, we do not short individual stocks, instead we use a dynamic hedging mechanism to short index ETFs against the long portfolio. Our view is that our long portfolio will provide the greatest portion of the alpha, but we can reduce excess market beta by shorting these index ETFs creating a more attractive risk-reward profile.

HCV: Are you shorting the ETFs or are you using inverse ETFs?

RB: We feel the least expensive, more pure play is to short the actual index ETF rather than using inverse funds. This dynamic hedging mechanism has traditionally been able to protect the portfolio during market downturns, but it has also been able to do that with minimal impact on upside gains.

HCV: In terms of the investment philosophy, when you say you look for momentum stocks or stocks that might be a candidate for a mean reversion, are you using technical analysis to determine this, or is it a combination of technical, fundamental and sentiment analysis?

RB: We don’t use technical analysis in the traditional sense of looking for price patterns or things like that. We are more quantitative and statistical in our approach. We believe there are numerous behavioral biases that are present in financial markets due to irrational investor behavior. Academic research supports this philosophy and suggests that investor biases create inefficient markets. So we use a quantitative approach in identifying these biases and then we systematically apply trading models to capitalize on those pricing anomalies.
HCV: This is quite different from a traditional approach.

RB: Yes it is. Unlike our colleagues, we are fundamentally agnostic and don’t use fundamental analysis at all. We believe in looking at the price action and that everything we need to know is embedded in the price. Nothing against fundamental analysis, in fact we believe that our quantitative approach is complementary to a fundamental approach.

HCV: What type of biases are you looking for?

RB: Some of the biases that we look for are the herding effect which creates sustainable momentum and the anchoring effect which means investors are slow to react to news. But probably the most effective, and one of the newest in behavioral finance theory, we subscribe to prospect theory where investors react quite differently to losses than they do gains. The Efficient Market Hypothesis says these opportunities should not exist, but Efficient Market Theory does not take irrational investor behavior into account.

HCV: How do you incorporate that into the selection process for long positions and how does that help with hedging the portfolio?

RB: For the long positions, we essentially look for top momentum candidates measured in different time frames. The hedging algorithm is a bit more unusual. If you rank all of the S&P 500 names by our proprietary momentum score, the behavior of the list dictates our hedge weights and timing. We have a term we call “List Stretch” If the top momentum names are exhibiting increased upside volatility compared to the majority of S&P500 names, we view that list as being stretched on the upside and that activates more hedge weight. Conversely, if the lower part of the list is dropping faster than the top ranked momentum stocks, we categorize that as lower list stretch. We dynamically apply that rule to our portfolio by varying the degree of short position in index ETFs.

HCV: After you apply the trading models, how many positions do you usually end up holding at any time?

RB: We normally have 75-80 long positions in the portfolio, but these positions are divided in to momentum plays as well as mean reversion plays.

HCV: Do you have limits on position sizing?

RB: Yes, no one position will ever exceed 5% of the portfolio. With that being said, we rebalance and reallocate each day. Because the momentum rankings can change from day to day and because we are always looking for mean reversion candidates, our automated platform applies our trading models each day in real-time and creates trade lists to adjust the portfolio.

HCV: What is the average holding period for these trades?

RB: That depends on the type of trade it is. The momentum trades can last anywhere from one month out to 12 months with the average being in the three to four month range. The mean reversion trades are short-term in nature and usually only last three to seven days.

HCV: Do you find that there is market environment where your strategy works better than other strategies or better than the overall market?

RB: Because of the mean reversion trades and the hedging mechanism, our models seem to work better in a higher volatility environment and because the strategy has a long bias, the best environment seems to be a highly volatile market with an upward bias to it. Conversely, the strategy tends to lag the overall market when the market goes straight up, but that is due to the hedging aspect.

HCV: I know you were established in 2013, but I assume the models were back-tested for a market like the bear market we saw in 2008. Is that the case?

RB: That is correct and the back-testing showed good gains in both 2007 and 2008. Between the shorter-term mean reversion trades and the hedging mechanism, the models still managed to show profitability despite the S&P 500 losing half of its value.

HCV: Thank you so much for taking the time to speak with us today teaching us more about Lake Austin Advisors. I do have one last question for you before we go. What was it about the HedgeCoVest platform that made you want to sign up?

RB: We view the HedgeCoVest platform as an extension of liquid alternatives without unnecessary compromises or modification of the trading strategy. It no doubt opens doors to investors who would not normally have access to hedge fund strategies. For the investor, the managed account option coupled with the efficiency of HedgeCoVest’s Replicazor technology creates a win-win for efficient access to hedge fund managers.

HCV: Ron, thank you so much for your time.

Rick Pendergraft
Research Analyst
HedgeCoVest