Hedge Fund ETFs vs. Hedge Funds, With Bob Elliott

Leading hedge funds have the capability to deliver enormous returns for investors, but their active management comes at a price.

Bob Elliott, CEO at Unlimited, joins the show to discuss HFND’s unique alternative strategy, and why he believes alternative ETFs have the potential to outperform hedge funds, net of fees.

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Episode Highlights

  • Bob’s educational background, and how he got his start in the hedge fund industry.
  • How a macro hedge fund works (and why the best hedge fund managers only “get it right” approximately 55% of the time).
  • How hedge funds performed in 2022 as a group, and whether they lived up to “the hype.”
  • Details on HFND (Unlimited HFND Multi-Strategy Return Tracker ETF), and the strategy behind it.
  • How Unlimited uses machine learning to implement an intelligent trading strategy, with a comparatively low cost structure.
  • Bob’s prediction on whether hedge fund replication ETFs (and similar alternative ETFs) may grab market share from traditional hedge funds over the coming decade.

Today’s Guest: Bob Elliott, Unlimited Funds

About The Alternative Investment Podcast

The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.

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Show Transcript

Andy: Welcome to the Alternative Investment Podcast. I am your host, Andy Hagans, and today we’re talking about hedge funds and hedge fund ETFs. So, this episode, I believe it’s wrapping up our mini-series that we’ve done on alternative ETFs and liquid alts. So, a lot of insights that we’ve covered on liquid alts in these past few weeks, and very excited that joining me today is Bob Elliott, who is CEO at Unlimited. Bob, welcome to the show.

Bob: Thanks so much for having me, Andy. Really appreciate it.

Andy: And I love talking about hedge funds and hedge funds ETFs. I mean, with hedge funds, I feel like even just the word hedge fund, if you’re not in that industry, it like has this connotation of like a secret club or whatever. So, Bob, I’m gonna ask you to, you know, give us access into this secret club, but I wanna start with your background because I know you’ve worked with some very interesting people in our space. You’ve done some very impressive things in your career. So, how did you get your start?

Bob: Well, I actually started off at Bridgewater Associates right out of college, which is you know, many years ago when Bridgewater was a bit of, you know, a challenger asset manager at the time. The thought was at the time that systematic or that macro investing really was for the savants of the world, the Soroses, the people who could sort of infer how exactly the macro economy was gonna work. And, you know, Bridgewater’s real innovation in that space was bringing the sort of rigorous and systematic approaches that had existed for a long time in things like equity long-short, and areas like that, and bringing that understanding into the macro space. And so, when I showed up at Bridgewater, it was a few billion under management and a pretty small team.

And you know, over the course of almost 15 years, you know, developed a deep, rich understanding of the macroeconomy, how it works, and then also built, you know, a wide variety of systematic investment strategies, many of which were used in the flagship pure alpha fund, you know, across all the different asset classes. So, it was really a great place to start a career because it got a great sense of all the different major asset classes, the strategies, as well as sort of foundational understanding of how to use systematic strategies to basically give edge in investing.

Andy: So, Bob, how do you get that job right outta college? I’m like, were you valedictorian or?

Bob: Oh, far from it. Far from it. You know, I had done a wide variety of different things. My academic background is actually in the pure sciences in botany. And I recognized… I’ve done a lot of botany research in my career realized I wasn’t gonna be a research scientist for my career. And, you know, recognized how important…I always had an interest in investing and the macroeconomy and really recognized how important it is to driving darn near everything that’s going on in the world. And so, I showed up actually with the expectation of, you know, going for a few years, kind of getting like a paid master’s degree type idea. And almost 15 years later, I was still there. So, you know, that’s how I started. As I said, you know, at the time, you know, it was a challenger organization. And so, you know, was part of the small handful of investors that took it from being that challenger to being, you know, now considered the incumbent.

Andy: Right. Yeah. No, that’s amazing. And so, you were there in the early days. You mentioned learning how the macroeconomy works. So, I think the Federal Reserve and a lot of economists are also wondering how does the macroeconomy work?

Bob: Well, first of all, the macroeconomy works very differently than what you’d learn in a college, you know, macroeconomics class or what a traditional academic finance education would give you. A big part of developing that understanding was sort of understanding and thinking about the intuitive cause-effect drivers of the macroeconomy in asset classes. And then from there, taking that intuition about those linkages, right? You know, if inflation comes in above expectations, you would then expect bond yields to rise. That’s a simple linkage, which you can then quantify what are the pressures on, you know, inflation to rise relative to what’s priced into the bond market. And you can start to quantify those linkages.

And then really, all systemization is, is the quantification and using that understanding in a repeated way over and over and over again, right, in a way that is disciplined, which is a very… You know, the biggest benefit of systemization is quantification and discipline. So, often investors can challenge. If you’re a discretionary investor, it can be very challenging to basically pursue, keep true to your investment strategy because you’re always being influenced by the incremental information that’s out there. And you may overreact or underreact, for instance, to that incremental information.

And the beauty of systemization is bringing that discipline, helping synthesize a wide variety of information, bring the discipline to execute the strategy as designed. And so, you know, that really is the core of it. If you could do that, you know, I think the important thing to recognize is in macro, at least like your odds, even the best macro investors in the world are wrong…about 55% are wrong about 45% of their bets in any one month. But if you do that, if you, you know, have the coin on your side, 55, 45, and you flip it, you know, you trade 100 markets, that gives you a little bit of edge. And if you can trade that over time, you know, at a 55, 45 ratio, you actually end up being, you know, one of the best investors in the world. And so it’s all about…

Andy: You’re the best blackjack player that’s ever walked into the casino.

Bob: That’s right.

Andy: When you mentioned, you know, inflation, printing higher, and then, you know, bond yields going up or, you know, these kind of linkages, spotting patterns, so to speak, kind of reminds me of like Jurassic Park, you know, the chaos theory, a butterfly flaps its wings in Peking or what, because you can see those effects, right? I can say that…And did I mix that up by the way? Did I get the bond yield thing right? I always mix that, but…

Bob: No, you got it right. You got it.

Andy: Okay. Okay, good, good. You can see those effects. But here’s what I’m thinking is, and I’m not a trader, you know, I’m a long-term investor, but as a trader or whatever, there will be that linkage, but then there might be the Federal Reserve might do X, Y or Z in response, or there might be a response from a policy standpoint, or the market might price this in. And I’m thinking, so then there’s every reaction to the initial action. I’m like, there has to be like an order of magnitude less certainty in the reaction to the reaction. You know what I mean?

Bob: Yeah. I think what… You know, the goal of bringing a systematic understanding to the world is not to have a perfect description of everything that happens because there’s a lot you don’t necessarily know and a lot you can’t predict. The idea of bringing a systematic approach to the world is to say, let me get edge in predicting what the various people involved in the markets will do. And so, you know…

Andy: And is that short-term, though? I guess my point was is that kind of like game theory like 90 days ahead or 6 months ahead. It seems like that’d be really challenging to do it like five years ahead, for instance.

Bob: Right, I think I agree that something like five years ahead is probably not really the best way to think about it. But I think the idea of saying that, you know, various folks’ actions are driven by, you know, a set of not necessarily cost effect rules. They’re not rules, but there are motivations. There is, you know, whether they have access to resources or don’t have access to resources, their motivations, those are all things that you can think about. I mean, just recently, I was talking about how the Fed, you know, people often will look at what the Fed says, particularly around what they say they will do in the future. And don’t recognize that the motivations of the Fed, how the Fed reacts is simply a function of how the data that they’re seeing happens.

You know, what’s coming in terms of that incoming data. And then they have an almost relatively constrained, you know, set of decisions, decision rules that they use based upon that information. And then they make their decision, right? And so often, you know, I think this is where you get edge, often people will focus on either their own view of what the central bank should do, or what the central bankers are saying, or what they’re predicting will happen, rather than just saying, “Hey, look, if I take the basic inputs of growth and inflation, I understand, you know, the central bank has a set of levers, whether it’s QE or interest rates. And I could basically solve for and predict how exactly they’re going to behave…

Andy: So wait, are you telling me that…

Bob: …given that set of inputs and that set of response function.

Andy: You’re telling me that then the chairperson of the Federal Reserve could essentially be a robot or an algorithm in the sense that their proposed action in the set of circumstances is very constrained. It’s almost like a rule set. And our experience from the past 36 months, I would say, you know, the rule set may need adjusted, or we may need better data or faster ways to react to the data or something. But we’re not here to talk about the Federal Reserve or just only the Federal Reserve.

Bob: I can talk about the Federal Reserve all day.

Andy: Well, I wanna ask you, because, you know, in alternative investments, and this is my world, right? The show, the Alternative Investment podcast, there are so many products, asset classes, strategies kind of underneath that umbrella. But broadly speaking, you have the whole liquid versus illiquid alts. That’s kind of one way to categorize all alts. And then another way to categorize them really top level, you have alternative assets, and you have alternative strategies. So what you’re talking about, I think, is alternative strategies when we’re talking about hedge funds and we’re talking about hedge fund ETFs mostly fall in that alternative strategies bucket. And when I look at your career and just even hear you talk, I can tell you, you have a passion for this stuff, for the alternative strategies, I guess. What is it about alternative strategies that you find so, you know, compelling or so interesting or such an intellectual riddle?

Bob: Yeah, I find that at its core, you know, what folks who are often pursuing these alternative strategies, and I’d say in particular in macro, is this understanding of how the whole system works. And, you know, it’s not surprising. I come from a pure sciences background, which is really focused on how do you understand the totality of, you know, a biological system. You could think about markets and economies as just a different type of system, and one that I think, you know, frankly, is pretty neat because we operate inside it. So, we’re both actors within it and can understand our own behaviors as well as abilities to step back and see how the whole system works. And so, you know, that’s what I think is really interesting about understanding the macroeconomy and developing investment strategies.

In a lot of ways, what investment strategies are, are ways in which you can express your understanding relative to how the rest of the market understands the world because that’s essentially what’s priced in. And if you get it right, you’ve demonstrated that you have incrementally more understanding. And if you get it wrong, you know, you demonstrate that you have an imperfect understanding of what’s likely to transpire. And that sows the seeds of new learning, right?

The best thing about investing in a macro sense is there’s an incredible amount to learn. So, you know, given that you’re, you know, at best, right, 55, 45 at any month, that means that you’re wrong 45% of the time, which means you have the opportunity to learn something new 45% of the time. Which means that, frankly, you know, this is something that continues to be enriching, continues to be challenging, right? Every day there’s a ton more to learn about the macroeconomy. And so, in many ways, from like a career perspective, you know, it’s very enriching because you could basically constantly be learning. There’s a reason why, you know, many of the most famous macro folks that are around, they’re still investing into their ’70s and ’80s because there’s still more to learn, to understand. And I certainly have seen that in a 20-year career and almost certainly will see that through the rest of my career.

Andy: And that’s what I mean. Like it’s clear that it’s almost like an addictive riddle. It’s like it’s not just about maximizing profits. At some point, it’s intellectually stimulating. And as you say, even the very best hedge fund managers, you know, in this space are correct 55% of the time. So, I want to talk a little bit…I know we’re gonna talk about ETFs, but I also wanna talk about hedge funds. So, when we’re talking about a macro hedge fund, I sort of understand the concept that we’re understanding how the world works. We’re finding these patterns, these linkages. We are maybe trading or investing in maybe 100 different markets or asset classes on various bets. Could we say bets?

Bob: You could definitely say bets. Bets is okay.

Andy: Sure, sure.

Bob: And many times it’s important… Bets is actually a great way to describe it. And the reason why it’s a great way to describe it is because you always wanna be thinking about you have a bet, you have an expected, you know, payoff if you’re right, you have an expected payoff if you lose. And it also emphasizes the fact that there is uncertainty, right? And so, you really do have to think about any trade that you do as a bet in one direction or the other.

Andy: So like even if you’re pretty certain, you know, there’s a chance the Cleveland Browns might make the playoffs next year. Like, you know, there’s a probability that that could happen.

Bob: And when you trade markets, what you do is it’s not just about knowing the probability that the Browns will make it, which is probably zero. It’s also relative to what’s priced in. So, it’s not just whether you understand it. It’s whether you understand it relative to the collective wisdom of everyone in the world who is also thinking about that question and essentially pricing it, right? So that’s…

Andy: And you might know that Browns fans are betting with their heart, not with their head. And so, you’re saying this is a market mispricing of this probability.

Bob: That’s right.

Andy: So, I kind of get that. And so, you’re looking for alpha by saying such and such is mispriced or the market, or the aggregate not really calculating the odds here or pricing them in, or there’s a way to play this trade. So, then what does that look like in practicality? Is that buying derivatives, futures, options? Like how does that trade actually get executed, like, in financial terms?

Bob: Yeah, I mean, there’s a lot of different security styles that investors can use in order to express that view. You know, people will regularly trade things like futures or swaps. Options are often popular for certain traders in terms of, you know, how they construct their views of the world or, you know, buying and selling or shorting cash security. So, pretty much that’s the beautiful thing in…when you think about a hedge fund, one of the great things that they have at their disposal is the ability to work across a wide range of different assets and also to work across long and short positions and to express that in a variety of different, you know, forms or structures.

Andy: So, one more question about hedge funds, and then I wanna move on to some other topics, but with traditional hedge funds. So, our audience at the Alternative Investment podcast, you know, it’s a combination of RIAs, high net worth investors, family offices, kind of spanning that whole universe. And certain types of alternative investment funds really open to any kind of accredited investor. And then at the other end of the spectrum, it’s basically just institutional investors or very, very large family offices. What about a typical hedge fund? Or are they all over the map? You know, are they open for accredited investors or do they tend to be more family office and institutional only?

Bob: Yeah, you know, if you go back, actually when I was starting my career, a lot of the primary interest in hedge funds was really from, you know, the big-name institutional investors that, you know, everyone knows the CalPERS and, you know, the Future Fund of Australia, the big sovereign wealth funds, all of those places. That’s basically who the investors were in hedge funds. But over the course of the last 20 years, there’s been an increasing interest and ability for smaller scale investors to get into many of these funds, whether it’s structured as feeder funds or various platforms like the iCapital platform or the equivalent platforms. Those different platforms have made the hedge fund structure and the hedge fund industry more accessible. The caveat to that is that it hasn’t necessarily made the most sophisticated or the most successful funds more available to investors.

And so, what we have actually, I think, is a real bifurcation in the industry where the most successful, most sophisticated funds basically only take money from institutions because they can only take money from institutions because in general, you’d only wanna manage money, you know, for 300 people rather than 3000 people or more. And so, you have a challenge for many individual investors or smaller scale investors when it comes to getting a negative selection by a situation or not being able to access, you know, the best funds, which may even be closed, not only to smaller scale investors but even they may be closed to institutions because, you know, they’ve reached their maximum capacity limits. And so, I think that’s kind of what we’re seeing in the industry is some risk that the newer entrance or the newer availability is also availability that’s a bit worse than what you typically see, you know, at the industry level as a whole.

Andy: So that’s really interesting and, you know, I wanna put a pin in that point because we’re gonna kind of come back to that whole issue of access. And I’m bringing up some notes here because I wanna get to your fund. But first of all, I also wanna talk about how hedge funds performed in 2022. This has been this topic. We’ve covered that a lot on this show. Recently, you know, we’ve kind of said that 2022 was like the year of alts in the sense where…and we had the alts expo show in December where we had a panel and it was like, number one, the inflows across alternative investment landscape. Very, very strong in 2022 overall, but also from a performance standpoint, I’m not saying every sector did perfectly or every sector…I’m not saying that, but overall, a lot of sectors in the alternative investment landscape, they did live up to the hype.

You know, there were less drawdown than you saw in fixed income in equities. For instance, managed futures. Those were up 20% last year, right? After like a decade of, you know, of not doing too much. And we recently did a webinar on that, so I’ll link to that in the show notes, but onto hedge funds. So, this specific sector, you wrote a blog post about how they performed in 2022. Could you give us the headlines? Did hedge funds…did they live up to the hype? Did they do what they were supposed to do last year?

Bob: Well, I think if you take the overall hedge fund industry, which to be clear is a compilation of a number of different strategies. So, you’ve got your managed futures, your equity long-short, your global macro, all those sorts of different fund styles and you put all those together, what you see is the hedge fund… The hedge fund industry in aggregate, did pretty well in a challenging market environment, right? At its, you know, 60/40, depending on exactly how you price it, was maybe down between 15 and 20%. Hedge fund performance before you consider the fees that they may charge, individual funds may charge, the strategy…

Andy: Who cares about fees? Come on, we don’t even need to consider fees, do we?

Bob: Well, I think, I think it’s important to recognize to start without the fees, because that really tells you how good the strategies are. That’s a very important thing. Let’s start with the strategies. The hedge funds in aggregate were basically flat, down maybe one or two, you know, a couple of percent…

Andy: Oh, that’s incredible in a year [crosstalk 00:22:44].

Bob: …over the course of 2022. Yeah, they did very well. And even if you dig into the sub-strategies, you know, a strategy like equity long-short, which you know, underperformed in the sense of like relative to cash it underperformed. It only fell about 8% relative to pick your equity benchmark down 15% to 20%. And so, even equity long-short, which like has been panned in the media for some reason, delivered like a thousand basis points of alpha relative to passive investing in the market. And so, when you look at these strategies, what you see here is, you know, they delivered a pretty good outcome in an extraordinarily challenging environment. And it highlights the fact that, you know, hedge funds in these sorts of difficult market environments, they’re very good at preserving capital in general, right?

What they do is they cut their risk, they manage, you know, they hold lower beta exposures. They find, you know, value stocks and other value opportunities and move into those positions in order to be defensively positioned through these difficult market environments. I wrote that piece, the title of which is, you know Hedge Funds are Playing Defense Effectively, which is exactly what they were able to do during the period. And I think it’s important to think about the strategies and the goodness of the strategies because that way you can separate. There’s a difference between the goodness of the strategies and the costs, which are expressed in the fees, right? So, I always like to start with the gross of these returns to start to think about how good are these managers at actually, you know, navigating the markets themselves?

Andy: Sure. Okay. So, broadly speaking, you’ve already made the point. There’s kind of a bifurcation in the hedge fund industry. Broadly speaking, it is strategy by strategy, but hedge funds overall performed pretty well. I mean, frankly, a big part of the point isn’t just alpha, but it’s also strong performance in a year where that traditional 60/40 portfolio has a drawdown. You know, that’s when you’re thankful that you’ve invested in alternatives.

But you’ve kind of alluded to, you know, if I’m reading between the lines, you know, maybe some limitations or problems for some investors trying to invest in these strategies. You know, either access to the top quality managers, top quality funds or the fees. I mean, and the fees in any investment product, I don’t care what the product is. It could be S&P fund all the way to the world’s most expensive hedge fund, which you might be happy to pay the high fees because it generates so much alpha. You know, you always have to look at fees, right? Because as an investor, that’s your triple net returns. You know, fees, inflation, taxes, those are part of your total returns. So, you know, I guess to kind of set the table, I wanna talk now about your ETF and maybe how it’s a little bit different. So, I’m talking about HFND. By the way, that’s an awesome ticker.

Bob: Yeah, we were surprised that it was still available, but we were able to grab it which is great.

Andy: Yeah. And I’m just pulling up my notes here so I have the summary. This is the unlimited HFND multi-strategy return tracker ETF. And I’m gonna read from my notes verbatim, “The fund seeks to create a portfolio with return characteristics similar to the hedge fund industry’s gross of fees returns, and believes the fund may outperform the hedge fund industry net of fees returns by charging comparatively lower expenses,” excuse me. Bob, those are fighting words. So, tell me about this ETF and the strategy.

Bob: Well, I think it’s important to…if you take a step back and you think about the hedge fund industry as a whole, there are a number of problems, a number of pain points that investors who are outside of that sort of institutional area, a number of pain points that they face. The first pain point is that hedge fund fees are very high. So, if you take the hedge fund industry as a whole, they’re typically adding between 300 and 400 basis points of fees on an annual basis. And what that does is it takes the returns of the strategies, which in general are actually quite good, like 100 basis points better than the S&P 500, you know, over time, about half the volatility, about a third of the drawdowns. Like that’s how good the strategies are and the managers are. But you add 300 to 400 basis points of fees, and investors look at something and they say, “Well, I’m not that much better off than I would be, you know, doing it on my own.” So you’ve got a fee problem.

The other problem you have is a tax problem, right? The problem with an LP structure, typical LP structures, is that typically, you know, they’re taxed at, you know, you get annual distributions, they’re taxed at marginal income or worse. And so that’s a real problem because I’m close…

Andy: Well, and Bob, with alternatives, that’s something… You know, I’m always looking at a product and I’m like, is this designed primarily for an institutional investor? If so, I’m almost just gonna move on instantly because…

Bob: Right, because the taxes is such a huge problem. And then the next problem you have is the diversification problem, which is that if you’re a small-scale investor, you can’t buy into a wide variety or a diverse variety of funds because you just are not big enough to be able to invest in, you know, 50, 100, sort of the range of the number of funds that you’d need to have in order to really get diversification. Or if you do through a fund of funds, you end up paying fees on top of fees, and it’s even worse, right? And then the last thing is, to be blunt, is the paperwork, right? Which is, you know, if anyone…I’m sure plenty of people who listen to this podcast have signed up for various alternative investments where there’s paperwork upon paperwork, and I can only…

Andy: You’re getting lots of K1s, Bob.

Bob: That’s right. So much paperwork. And if you’re a financial advisor, I frankly empathize with the fact that you’ve gotta go track down all of your clients to get them to sign the paperwork, people who are busy, challenging to get in touch with, things like that. And so, we saw all those, those pain points that existed in the market. And what we thought was, was there a way to bring the kind of low-cost diversified indexing approach, which has obviously totally changed stock and bond investing, right, was there a way to sort of take that concept and apply it to the world of two and 20? And the first step of that is to think about it in the context of hedge funds. And so, instead of pursuing that sort of strategy by investing in all these different funds, which you can’t really do because the good ones won’t take your money, and, you know, you pay fees and then you have to pay yourself and things like that, what we thought was, could we create an ETF that leverages our experience, having developed proprietary hedge fund strategies with modern machine learning techniques that have advanced a lot over the course of the last 10 or 20 years, to develop a technology that allows us to look over the shoulder of the hedge fund managers, see what they’re doing in close to real-time, take that understanding, translate it into long and short positions in various index products, and package that up in an ETF form.

And that’s really what HFND is all about, which is this idea of creating a portfolio which replicates the risk-return characteristics or, you know, replicates the returns, the gross of fees, returns of the hedge fund industry, you know, in that ETF wrapper in order to address a lot of those pain points. And because we’re using technology rather than, frankly, star PMs that you have to pay millions and millions of dollars. We can offer it at, you know, about a quarter of the management fee that a typical hedge fund would charge. And because it’s in the ETF wrapper, it ends up being about twice as tax efficient, or half the taxes roughly, than it would be in a traditional LP structure.

Andy: Okay. So, it’s almost like a hedge fund for the little guy. I mean, I know it’s not a hedge fund, it’s an exchange-traded fund, but it’s replicating hedge fund strategies in it. With machine learning, there’s a couple things going on here. If I’m unpacking it, it offers liquidity. There’s not gonna be a minimum investment, right? You can buy one share.

Bob: There’s lots of investors that have come in that have bought one single share.

Andy: Well, that’s amazing. Yeah. So, there’s that side of it, but then there’s also, because I’m thinking with the strategy that you’re talking about with machine learning, and it sounds to me like machine learning could potentially really revolutionize the whole hedge fund industry. But even independent of the wrapper here, sounds like you’ve kinda lowered the cost structure of implementing the long-short strategy. Are you the only guys, you know, doing that where you’ve kind of figured out how to be the Costco…Are you the Costco of long-short?

Bob: Right. I mean, that’s kind of the idea is, you know, if we can create…What investors care about in the end is their post fee, you know, their net of fee post-tax return, right? That’s what they really care about. And so, by using technology, our replication of these strategies is imperfect because it’s naturally…you know, because we can’t perfectly replicate investing in 5,000 hedge funds. But if we can do a pretty good job of that to replicate the strategies which, you know, is based upon the fact that we have actually…between my partner Bruce and I, we’ve actually created proprietary strategies and all these different fund styles over the course of, I think 50 years of combined hedge fund experience between the two of us. So, we know how these strategies are created. We can therefore replicate how the strategies work and what are the types of exposures and risk positions that these investors are taking on at any point in time.

If we can do a pretty good job of replicating that and then offer it at, you know, a lower management fee and a more tax-efficient structure, the end result that the investor sees, and to be clear, in a more diversified package, which is a very, very important component as well, the end investor sees a much more…you know, we expect that the end investor will see a much more consistent return stream and a higher return net of fees and taxes than they would were they to go out and invest in a handful of individual hedge fund positions or frankly, a lot better than what they get if they invested in a fund of fund structure, which layers fees on top of fees.

Andy: Okay. So, I think I get it. Now a couple last questions on the fund. So, you’re using machine learning to kind of make it more cost-efficient, just efficient overall to make these trades. That’s overseen by you and your partner? You kind of like the human gut check, I guess, layer of supervision of the machine?

Bob: Of course. I mean, it’s neat that we started this conversation talking about the development of systematic investment strategies, which, you know, both of us have done for decades. When you are a manager of systematic investment strategies, you know, you still have to manage the money, right? That is a critical component. And that doesn’t mean that what we’re doing is applying our own discretionary views on markets. We’re not doing that. We’re using a systematic process to essentially understand the wisdom of the crowd of hedge fund managers. Take that understanding and translate it into those long and short positions that back the ETF. But that process means consistently monitoring and evolving the underlying systematic process to the extent that we see things that can improve the way in which we replicate those strategies.

Andy: Yeah, that makes sense. And so this is an actively managed ETF. And it’s interesting, you know, reflecting, again, we’ve done this kind of mini-series on liquid alts and alternative ETFs. And my partners and I, we co-founded ETF DB, ETF database back in, I think it was 2009. We were kind of covering. It wasn’t the very beginning, but the earlier days of the ETF beat and actively managed ETFs were kind of like, they were pretty new and honestly, they weren’t very well received. Like wave one of them was just everybody kind of was rolling their eyes, so to speak. And I might call this like the third wave or even the fourth wave of alternative ETFs and liquid alts. Kind of depends how you count those waves. But, you know, do you think that liquid alts and alternative ETFs, hedge fund ETFs, you know, all these alternative strategies, is there final, you feel like the market RIAs investors are finally really accepting them? I mean, obviously the AUM kind of speaks for itself, but is there more openness? Do you think that’s a trend with liquid alts is just more openness to active management?

Bob: Yeah, I mean, we’re really seeing, you know… With our product, we’ve raised 70 million and it launched just a touch over three months ago. So, I think that, you know, speaks to the demand and interest, both for alternatives in general as well as the particular structure and approach that we’re taking to it. And I think a big part of that is, you know, ETFs, you know, in the past were seen very much as the way to run very low cost, you know, liquid indexing products. And increasingly investors are recognizing that you can run more sophisticated strategies than the ETF wrapper. There’s also been actually some regulatory evolutions which haven’t gotten a lot of press outside of, you know, the real ETF nerd community that allow managers to run more sophisticated strategies in exchange for basically implementing what I described as institutional quality, common sense risk controls.

So, that’s a good thing. It’s a good thing for the industry because it allows more flexibility and increases the risk controls that are in place for the end investor. And so, you know, a number of those regulations passed back in 2020, 2021 and I won’t nerd out on them there for you. But what I will say is it actually creates the…it’s opened the door for the next generation of sophisticated products. Because overall, if you think about ETF, the ETF structure is the best structure for the investor. There’s no question about that. It’s liquid, it’s transparent, it’s, you know, it’s tax efficient, right? And it’s executable without having to fill out any paperwork, right? Like all of those things make it much, much better.

And because it’s also tradable and because, you know, there are liquid underlyings, you can trade into it, you can trade out of it. If you like the product, you can stay in it. If you don’t like the product, you can just…you know, there’s no redemption process, no big redemption process with paperwork. You just sell it and you’re out, you know, that day, right? That’s the whole benefit of the ETF structure. And I think managers like us are increasingly recognizing that investors and advisors in particular are demanding that they get investor-friendly structures for the products that they’re gonna buy, right? They know, they understand that low-cost, tax-efficient liquid products are the best thing for their investors and so, they’re demanding that. And so, I think we’re just, you know, we’ve just thrown out the first pitch, so to speak, on the evolution of sophisticated investment strategies moving from, you know, mutual fund products and LP products and those moving into the ETF structure. And, you know, I think that’s very exciting. And I think there’s a lot of great promise available. And it will no doubt significantly benefit the investor as this transition occurs. And, you know, ultimately that’s what we should be doing is trying our best to figure out a way to benefit the investor, not to enrich the manager through these strategies.

Andy: Well, that’s why the whole industry exists as far as we’re concerned. Yeah, and you know, we’re almost outta time, but you kind of teed me up for one more question. Bob, you referenced the first pitch being thrown, and I love my baseball analogies, but I do feel like this is a little bit of a battle between hedge fund ETFs and hedge funds in the sense that for some investors, they may view them as a substitute. Some investors may want both, you know, because personally, I can see, especially for high net worth investor, for family office, you might want some liquid alts and you might also want some traditional illiquid alts in a portfolio. You know, I can see an argument for even including both. But do you see hedge fund ETFs as a whole, you know, not just yours, but as a group in alternative strategies ETFs, are they gonna gain ground at the expense of traditional hedge funds? Or is it just, you know, within alts, are they all gonna grow? Are they all gonna continue growing?

Bob: Yeah, I think we’re likely to see over the course of the next 5 or 10 years a rationalization of fees, I think in general, across the investment management industry. Like when all assets are going up and money is easy, no one really cares if your fee is 100 basis points, 200 basis points, or 400 basis points. It kind of gets lost in the shuffle. We’ve entered, you know, a macroeconomic environment that’s very much the end of the era of cheap money. And that means probabilistically lower returns, particularly for beta, you know, for passive investing. And that means, you know, that the skill of the investor, the actual skill of the investor relative to the fees that they charge is really gonna come into focus over the course of the next, you know, 5 or 10 years. And that’s where we’re probably in the hedge fund industry going to see a real bifurcation.

There are absolutely hedge funds that deserve the fees that they charge. You know, they generate unique and differentiated alpha, they may even charge high fees, but when you net that out for investors, it makes sense. But that is also a relatively small portion of the hedge fund industry, and it’s a part of the hedge fund industry that’s very hard to access for the vast majority of investors, basically only accessible for the biggest, most sophisticated institutional investors in the world. For the rest of the world, you know, who aren’t those big, sophisticated institutions, we’re gonna have a real reckoning of the rest of the hedge fund industry, where frankly, the vast majority of the hedge fund industry does not justify its fees. And so, when we see these various products, these various innovative products that are replicating hedge fund style strategies, but doing it at a quarter of the cost and essentially half the taxes, there’s gonna be a lot of people who are gonna look at, you know, investing in the sort of average equity long-short manager, the average macro manager, where their fees don’t make sense in the context of the alternative options that are available.

And so, increasingly we’re gonna see a bifurcation between, you know, money’s gonna go as much as can to the best most sophisticated managers. And then I suspect we’re gonna see a lot of capital flow into these increasingly sophisticated replication strategies put in structures like ETFs. And that, you know, will vastly benefit…you know, that’ll benefit investors incredibly because they’ll get access to sophisticated investment strategies that are diversified and more consistent and much lower cost relative to where they were, you know, over the past 10 or 20 years.

Andy: Yeah, absolutely. I mean, and you know, I cover alternatives, whether liquid alts or I call ’em traditional alts, which is maybe an oxymoron, but you know, illiquid alts. I invest in both. I cover both. To me, it’s not an either-or. I just love the existence of new products when, you know, kind of…I think that the point you’re kind of alluding to is just that give investors more choice and put pressure on everyone, every asset manager. Every asset manager, just be on their game and to offer the most value as possible within their sector and within their segment. That’s a very good thing. So, Bob, can’t thank you enough for coming on the show today, sharing your insights not only on hedge funds, but replication strategies and your ETF. So, where can our audience of high net worth investors and financial advisors go to learn more about unlimited and about your fund?

Bob: Yeah, for sure. The best place to go is our website, unlimitedfunds.com, where you can check out more information about the HFND ETF, as well as some regular commentary that I’m writing, that we’re writing on various investment topics in our blog. The other place you can check me out, sort of the start of this conversation, is, you know, I’m still keeping up with macro in a fair amount. Part of our view of the world is not to just make the return streams more accessible, but also make the understanding of the macroeconomy more successful. And so if you’re interested, you know, check out my pretty active Twitter @BobEUnlimited on Twitter. I’m there all the time talking about what’s going on in the world and the macro economy.

Andy: Yeah. And Bob, I follow you on Twitter, and I’ll be sure to include a link to your Twitter in our show notes, which as a reminder to our listeners, you can always get our show notes at altsdb.com/podcast. Bob, thanks again for coming on the show today.

Bob: Thanks so much for having me. It was really fun.

Andy Hagans
Andy Hagans

Andy Hagans is co-founder and CEO at AltsDb, and host of The Alternative Investment Podcast. He resides in Michigan.