AMG / River Road Long-Short (ARLSX), February 2014

By David Snowball

At the time of publication, this fund was named ASTON / River Road Long-Short.
This fund was previously profiled in June 2012. You can find that profile here.

Objective and Strategy

ARLSX seeks to provide absolute returns (“equity-like returns,” they say) while minimizing volatility over a full market cycle. The fund invests, long and short, mostly in US common stocks but can also take positions in foreign stock, preferred stock, convertible securities, REITs, ETFs, MLPs and various derivatives. The fund is not “market neutral” and will generally be “net long,” which is to say it will have more long exposure than short exposure. The managers have a strict, quantitative risk-management discipline that will force them to reduce equity exposure under certain market conditions.

Adviser

Aston Asset Management, LP, which is based in Chicago. Aston’s primary task is designing funds, then selecting and monitoring outside management teams for those funds. As of December 31, 2013, Aston is the adviser to 23 mutual funds with total net assets of approximately $15.9 billion. Affiliated Managers Group (AMG) has owned a “substantial majority” of Aston for years. In January 2014 they exercised their right to purchase the remainder of the company. AMG’s funds will be reorganized under Aston, but Aston’s funds will maintain their own identity. AMG, including Aston, has approximately $73 billion in assets across 62 mutual funds and sub-advised products.

Managers

Matt Moran and Daniel Johnson. Both work for River Road Asset Management, which is based in Louisville. They manage $10 billion for a variety of private clients (cities, unions, corporations and foundations) and sub-advise six funds for Aston, including the splendid (and closed) Aston/River Road Independent Value (ARIVX). River Road employs 19 investment professionals. Mr. Moran, the lead manager, joined River Road in 2007, has about a decade’s worth of experience and is a CFA. Before joining River Road, he was an equity analyst for Morningstar (2005-06), an associate at Citigroup (2001-05), and an analyst at Goldman Sachs (2000-2001). His MBA is from the University of Chicago. Mr. Johnson is a CPA and a CFA. Before joining River Road in 2006, he worked at PricewaterhouseCoopers.

Strategy capacity and closure

Between $1 and $1.5 billion.

Management’s Stake in the Fund

Mr. Moran and Mr. Johnson had between $100,000 and $500,000 as of the last-filed Statement of Additional Information (October 30, 2012). Those investments represent a significant portion of the managers’ liquid net worth.

Opening date

May 4, 2011.

Minimum investment

$2,500 for regular accounts and $500 for retirement accounts.

Expense ratio

1.70%, after waivers, on assets of $220 million. The fund’s operating expenses are capped at 1.70%, but expenses related to shorting add another 1.46%. Expenses of operating the fund, before waivers, are 5.08%.

Comments

When we first wrote about ARLSX eighteen months ago, it had a short public record and just $5.5 million in assets. Nonetheless, after a careful review of the managers’ strategy and a long conversation with them, we concluded:

[F]ew long-short funds are more sensibly-constructed or carefully managed than ARLSX seems to be.  It deserves attention. 

We were right. 

River Road’s long-short equity strategy is manifested both in ARLSX and in a variety of institutional accounts. Here are the key metrics of that strategy’s performance, from inception through December 30, 2013.

 

River Road

Long-short category

Annualized return

13.96

5.88

% of positive months

74

64

Upside capture

58

39

Downside capture

32

52

Maximum one-month drawdown

(3.5)

(4.2)

Maximum drawdown

(7.6)

(11.8)

Sharpe ratio

2.3

1.0

Sortino ratio

3.9

0.9

How do you read that chart? Easy. The first three measure how the managers perform on the upside; higher values are better. The second three reveal how they perform on the downside; lower values are better. The final two ratios reflect an assessment of the balance of risks and returns; again, higher is better.

Uhhh … more upside, less downside, far better overall.

The Sharpe and Sortino ratios bear special attention. The Sharpe ratio is the standard measure of a risk/return profile and its design helped William Sharpe win a Nobel Prize for economics. As of December 31, 2013, River Road had the highest Sharpe ratio of any long-short strategy. The Sortino ratio refines Sharpe, to put less emphasis on overall volatility and more on downside volatility. The higher the Sortino ratio, the lower the prospects for a substantial loss.

After nearly three years, ARLSX seems to be getting it right and its managers have a pretty cogent explanation for why that will continue to be the case.

In long stock selection, their mantra is “excellent companies trading at compelling prices.” Between 50% and 100% of the portfolio is invested long in 15-30 stocks. They look for fundamentally attractive companies (those with understandable businesses, good management, clean balance sheets and so on) priced at a discount to their absolute value. 

In short stock selection, they target “challenged business models with high valuations and low momentum.” In this, they differ sharply from many of their competitors. They are looking to bet against fundamentally bad companies, not against good companies whose stock is temporarily overpriced. They can be short with 10-90% of the portfolio and typically have 20-40 short positions.

Their short universe is the mirror of the long universe: lousy businesses (unattractive business models, dunderheaded management, a history of poor capital allocation, and favorites of Wall Street analysts) priced at a premium to absolute value.

Finally, they control net market exposure, that is, the extent to which they are exposed to the stock market’s gyrations. Normally the fund is 50-70% net long, though exposure could range from 10-90%. The extent of their exposure is determined by their drawdown plan, which forces them to react to reduce exposure by preset amounts based on the portfolio’s performance; for example, a 4% decline requires them to reduce exposure to no more than 50. They cannot increase their exposure again until the Russell 3000’s 50 day moving average is positive. 

This sort of portfolio strategy is expensive. A long-short fund’s expenses come in the form of those it can control (fees paid to management) and those it cannot (expenses such as repayment of dividends generated by its short positions). At 3.1%, the fund is not cheap but the controllable fee, 1.7% after waivers, is well below the charges set by its average peer. With changing market conditions, it’s possible for the cost of shorting to drop well below 1% (and perhaps even become an income generator). With the adviser absorbing another 2% in expenses as a result of waivers, it’s probably unreasonable to ask for lower.

Bottom Line

Messrs. Moran and Johnson embrace Benjamin Graham’s argument that “The essence of investment management is the management of risks, not the management of returns.” With the stock market up 280% from its March 2009 lows, there’s rarely been a better time to hedge your gains and there’s rarely been a better team to hedge them with.

Fund website

ASTON / River Road Long-Short Fund

Disclosure

By way of disclosure, while the Observer has no financial relationship with or interest in Aston or River Road, I do own shares of ARLSX in my own accounts.

© Mutual Fund Observer, 2014. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.
This entry was posted in Stars in the shadows on by .

About David Snowball

David Snowball, PhD (Massachusetts). Cofounder, lead writer. David is a Professor of Communication Studies at Augustana College, Rock Island, Illinois, a nationally-recognized college of the liberal arts and sciences, founded in 1860. For a quarter century, David competed in academic debate and coached college debate teams to over 1500 individual victories and 50 tournament championships. When he retired from that research-intensive endeavor, his interest turned to researching fund investing and fund communication strategies. He served as the closing moderator of Brill’s Mutual Funds Interactive (a Forbes “Best of the Web” site), was the Senior Fund Analyst at FundAlarm and author of over 120 fund profiles. David lives in Davenport, Iowa, and spends an amazing amount of time ferrying his son, Will, to baseball tryouts, baseball lessons, baseball practices, baseball games … and social gatherings with young ladies who seem unnervingly interested in him.