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AlphaWeek Q&A: John Culbertson, CIO, Context Capital Partners

AlphaWeek’s Greg Winterton sat down with John Culbertson, CIO of Context Capital Partners, at Context NYC 2018 to discuss some of the findings from the latest Context Allocator Trends Report, which provides a snapshot of the current outlook for the alternative asset management industry and is based on a survey of more than 400 institutional investors and family offices.

GW: John, thanks for taking the time today. To begin, the Context Allocator Trends Report shows a strong preference for emerging managers (defined as those with less than $300mn in AUM and/or shorter than a three-year track record). Why do you think this is and what are some of the advantages that emerging managers offer over more established managers?

JC: That’s a consistent theme across our surveys for the past two years. If you look at fund flows pre-crisis – so pre-2009 – it’s very clear that the flow of funds was well distributed across all types of managers. Then if you look at fund flows from 2009-2012, the vast majority went to larger funds because they were seen as a proxy for quality. However, many of those larger funds underperformed Because you can’t do the same thing at $30bn than you can at $2-3bn. So, the pendulum is swinging back towards smaller managers, and that’s a healthy thing for the industry and for investors. Investors are certainly becoming more flexible with emerging managers, as evidenced by the 60% of allocators we surveyed who said they prefer to allocate additional capital to emerging managers. However, this allocation decision also depends on the structure of the investors’ capital. If they have an emerging manager mandate and they have the resources to do the necessary due diligence, then they are more likely to seek these smaller or newer managers. If  an allocator doesn’t have an emerging manager program, then it becomes a tougher question. However, allocators are getting much smarter about this; research shows that size eventually kills performance. It’s pretty clear that as managers get very large it is harder for them to produce alpha.

GW: What strategies have you seen gain momentum with investors so far in 2018 and what do you foresee for the rest of the year?

JC: We’re 9 years into this expansion, making it the second longest on record. No-one has any idea how long the bull market is going to last. However, in the US, the Fed is tightening – the first tightening cycle after 9 years of systematic volatility suppression to allow balance sheets to be repaired and heal the system. If the ECB or Japan go into a tightening cycle, you’ll see real central bank policy dispersion for the first time in a decade, which is more favourable to systematic trading and global long/short equity strategies. Fixed income relative value is seeing some positive movement too. Also, only equity volatility has mean reverted. If we were to see this in both FX and rate volatility you could see a renaissance in returns for hedge funds. It’s potentially becoming a more fertile hunting ground for strategies that are globally focused.

John Culbertson
Context Capital's John Culbertson

GW: The report says that only 11% of investors are looking to allocate to crypto strategies. Is that mostly family office and HNW money? Surely large investors won’t allocate until it’s more mature and until funds have a 3-year track record?

JC: If you look at that question from the perspective of family offices it’s actually closer to 25%; institutional money is in the single digits. Clearly, most of the appetite is coming from families because it’s going to be a long time until institutions embrace the asset class. One of the biggest institutional barriers is capacity. For an institution running billions of dollars in allocations, it doesn’t make much sense to allocate a few million to crypto because it doesn’t move the needle. Therefore, it’s going to be a while before those organisations get into crypto in a significant way.

GW: ESG is of course a hot topic, and in the report, 51% of investors said they are looking to allocate to ESG strategies in 2018. There are a few ESG specialist funds out there, but do you see this as becoming a strategy in its own right, or will hedge funds simply absorb this into their existing trades?

JC: ESG has come a long way in the last 5-7 years, but I think it will be difficult for a hedge fund firm to offer a standalone ESG fund. My intuition is that investors love to talk about it and love to have it as part of their goals, but if you look at hedge fund flows to ESG-specific strategies, it’s still small. However, I think that the idea of customising a strategy to consider ESG is happening and growing. There’s definitely more investor awareness of ESG and it’s becoming more obvious that these strategies don’t necessarily hurt performance, but instead may actually enhance performance.

GW: The survey also found that 71% of respondents have not replaced their hedge fund exposure with quant smart beta strategies or algorithmic strategies. What’s driving that lack of adoption?

JC: I’m not convinced there is a performance edge by simply using AI on unstructured data; it’s a trend but it’s certainly not a panacea. There are certain markets and strategies where quant-focused trading works, but it’s important to remember that the investing environment has changed. Investment management is a highly competitive space, so of course the best and brightest are going to be looking at quant strategies. Sure, a few high-profile hedge funds have done well, but they have budgets of hundreds of millions of dollars that allow them to develop the necessary technology. For smaller firms who don’t have the same resources, it’s going to be tough to compete. Yes, 71% is a high number and my guess is that number will be lower next year because you can’t ignore the larger AI / big data trend, but at the same time investors can’t pin all of their hopes on algorithmic strategies. It’s much more nuanced than that.

Context Capital Partners provides alternative investment solutions to family offices and institutional investors. The firm will be hosting its inaugural Context Leadership Summit in Las Vegas, NV, May 8-11.

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