MutualFundWire.com: A Firm Uses Indices to Show Worth of Young Funds

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Friday, April 5, 2013

A Firm Uses Indices to Show Worth of Young Funds

How do you promote confidence in alternative funds too young to have three-year track-records, but still based on long-standing strategies that have been successful in other formats, like separately-managed accounts?

Well, one way is to publish indices based on the strategies and publish everything you can on the underlying methodologies so there are no mysteries regarding their success.

This is the strategy of David Moore, co-founder and chairman of the 17-year-old Nashville asset manager Compass Advisory Group, which currently markets 16 funds.

Many of the funds are too young to have three-year track records, since Compass has only been registered for '40 Act status since Fall 2008.

"One of the concerns from advisors was 'You don't have any track record,'" Moore recently told MFWire. "We had been doing these methodologies in our SMAs for years, but when you apply it into new funds, they technically have no track record."

The Indices

To address this issue, Compass created indices, "because everything we do in every one of our asset classes is a rule-based methodology."

When launching these indices, they hired Dow Jones's indexing business, which at the time was S&P before they merged. They hired them to publish the indices, which went back in history to 2003. Then Bloomberg backdated them from 2003 to 2000.

Compass then published everything related to the different indices, and their underlying methodologies, right on the company's website.

A few of the more notable relevant sites are as follows:

Main page for the indexes:
http://www.cempindex.com/
White paper explaining the weighting process:
http://www.compassempfunds.com/files/2115/File/CEMP%20Enhanced%20Index%20white%20paper%202013%2001.pdf
Examples of some of the indices.
Large Cap 500/Long Cash
http://www.compassempfunds.com/files/2115/File/CEMP%20U%20S%20%20Large%20Cap%20500%20Long-Cash%20Volatility%20Weighted%20Index%202012%2012%2031-%20FINAL.pdf
Large Cap 500
http://www.compassempfunds.com/files/2115/File/CEMP%20U_S_%20Large%20Cap%20500%20Volatility%20Weighted%20Index%202012%2012%2031-%20FINAL.pdf

Trust Via Clarity

Moore says he and his colleagues were inspired to take the ultra-transparent route after reading the book, A Simple Genius.

He explained the merits of this strategy in this way:

We do everything we can to make it simple for everyone to understand. To describe our methodology, we don't use big words to confuse people. We don't use quant. We've built our mutual funds based on these criteria. We've taken the risk of exposing our methodology, but we also patented it before we did. We do have a little bit of protection, of moat built around the castle. We think it is a better way to manage money. We think it is a better war to mitigate risk. We are just taking the story to as many advisors and advisory firms and broker deals that we can get to on a daily basis.

The Secret Sauce, Revealed

For example, here is Compass's process for the Large Cap 500 strategy, according to Moore:

We start with the entire universe of stocks (around 11,000) and screen them for companies that have had positive earnings poet share for the last 4 quarters (which narrows it down to around 2,500 to 3,000). Then we identify the largest 500 common stocks by market cap.

After we have narrowed them down to the 500, we throw out the size figures. We don't care about the relative size, we just wanted to ID these 500.

We take these 500 and look at the average volatility of these 500 stocks.

We rate them based on the daily standard deviation of the past 180 days compared to the aggregate mean, i.e. if the mean is a 15 percent standard deviation and say Company A has a standard deviation of 3 and Company B has a deviation of 20, we are going to have more Company A and less of Company B so they contribute equal amounts of risk to the portfolio.

That's the hardest part to understand, but it is actually pretty simple. We also reconstitute every March and September.

We apply the same methodology to every one of our indices.

The Importance of Inspiration

Moore, a pilot who owns two of his own aircraft, is an executive comfortable taking inspiration from anywhere.

For example, when Moore established Compass in 1996 with co-founder Stephen Hammers, he came up with the name for the firm while watching the film Mr. Holland's Opus.

He describes his thought processes in this way:

As I was watching the movie, the principal had told Mr. Holland that he wasn't a good teacher. After he had been there for 30-years, all of the people from his history came to attend his retirement part in the Gymnasium. The principal was there as well and handed him a gift-- a compass.

She told him that "I'll still say you aren't the world's best teacher, but you are wonderful at pointing people in the right direction."

I saw that and thought, that has to be the name of our company: We are pointing people in the right direction.

It was also random inspiration that led Moore of the idea of launching his firm's mutual fund business back in 2008. This time it came in the form of a high school reunion.

In 2008, I went to my high school reunion and saw a bunch of kids I went to school with 40 years ago, and they were scared of the market.

"What can we do," they asked me.

They were all very concerned. "What can we do? How can we manage our money?"

We manage money in many different asset classes, currency, commodity, hedging vehicles, fixed income, all in order to reduce risk and normalize or level out a client's return.

"Can you help us," they asked, but at the time, I couldn't. We had a published minimum of $5 minimum for SMAs.

I came back from the reunion and my partner asked me how it went.

I told him:"It went great, but I'm a little frustrated. I feel dirty. I couldn't help my friends."