[The Institute for Innovation Development interview series seeks to learn from innovative business leaders, uncover innovation best practices, and discover how to apply these insights into the financial services industry.
We recently sat down with Floyd Tyler, President and Chief Investment Officer of Preserver Partners LLC, an alternative asset management firm that manages a liquid alternative mutual fund, the Preserver Alternative Opportunities Fund (PAOIX AND PAORX), private investment funds and separately managed accounts for institutional and individual clients. They shared with us their perspective on the need to challenge our thinking about investment diversification and portfolio risk management.]
Hortz: You characterize your investment approach as an opportunistic value-oriented focus which invests where others “ignore, cannot or fear”. Tell us a little more about why other investment managers are so constrained.
Tyler: Investment managers can be explicitly constrained through rigid investment policies. Over my career, I have seen a large number of investment policies and I am struck by how similar and restrictive many of them are. Investors can also be constrained if they adopt a herd mentality or have limited investment access or expertise. For example, some investors aren’t sure how to categorize or access unique investments. There are numerous ways that investors can enhance their portfolios through broader investment mandates and opportunistic investing.
Hortz: The Preserver Alternative Opportunities Fund seems aptly named. Your maverick approach has led you to a very eclectic and non-typical list of portfolio holdings. Can you give us a sense of the range and types of these investment holdings you might not see in other liquid alternative funds?
Tyler: With a global mandate and the ability to invest across capital structures, we are able to own unique investments such as Vietnamese closed-end funds, Australian infrastructure, US merger arbitrage securities, apartment mortgages, and reinsurance. The Fund’s flexible use of investment vehicles further broadens the opportunity set to include investments that may not be exchange-listed.
Hortz: You have also described your process as a “hunt for uncorrelated yield”. What does a proto-typical Preserver investment look like?
Tyler: A proto-typical Preserver investment is trading at a discount to intrinsic value or growth prospects with an attractive combination of yield or yield plus growth that approaches 5%. Finally, it should have low to moderate correlation to capital markets.
Hortz: Your fund can go 15% into illiquid investments. Can you give us a few examples of private fund investments in your mutual fund and discuss the unique benefits they may provide for investors?
Tyler: To date, the Fund owns an investment in UBS Trumbull Property Income Fund, L.P., which is a $1.3 billion institutional quality portfolio of participating mortgages and real estate assets. A participating mortgage limits downside risk by receiving a significant portion of its total return from the fixed interest component of the loan, while participating in property cash flows and appreciation when the property performs well. Participating mortgages are a unique, uncorrelated exposure for the mutual fund since it is not possible to access participating mortgages through exchanged-traded securities.
Another example is the Stone Ridge Reinsurance Risk Premium Interval Fund, which is a $2 billion portfolio of quota shares and catastrophe bonds. Reinsurance assets have low correlation to equities and traditional fixed income and depending on the perils in a given year, the portfolio can yield up to 8-10%.
Hortz: With your stated emphasis on risk management and low volatility, I am taken by what appears to be a very, differentiated way that you go about structuring those elements into your alternative investment portfolios. You seem to focus on eclectic investment selection and an almost architectural sense of portfolio construction versus a traditional reliance on managing a diversified pool of liquid alternative investment styles. Can you explain more about your view of portfolio risk management and how you build that into your process?
Tyler: We take a layered approach to risk management. It starts with how we run the firm and the type of clients that we seek. We run the firm in a low risk way meaning moderate fixed costs, unlevered and minimal business risks. We also seek clients that appreciate what the Fund does and how it fits into their portfolios, which we believe will enhance the long-term stability of the asset base. The second element of our risk management is investment selection. A typical Preserver investment is income-generating, trading at a discount to intrinsic value or its growth prospects. These securities tend to possess low beta and low volatility. The third element of risk management is portfolio construction, which is accomplished by establishing concentration limits for positions, industries, and asset classes. Overall portfolio construction targets attractive risk-adjusted returns from a portfolio of income-generating, less correlated securities.
Hortz: Your fund and investment process can also employ externally managed portfolios. How do you determine which outside money managers to bring in and when to deploy them?
Tyler: At times, we may allocate capital to outside money managers that we consider ‘domain experts’ if a strategy is outside of our in-house expertise and we want to make a significant capital allocation of 5-10% of the Fund. After determining that we like a strategy and analyzing the available investment securities and vehicles, we conduct thorough investment and operational due diligence on the investment and manager, respectively, in a four step qualitative and quantitative process. We seek to identify a clear investment edge. We want to understand their thought process, risk tolerance, emotional tendencies and blind spots and conduct a risk analysis where we focus on downside risks, understand historical portfolio exposures, evidence of capital preservation in difficult markets and business risk factors.
Hortz: What are other ways that your fund tends to differ from your peers?
Tyler: The Preserver strategy is different than other liquid alternative funds because of our focus on income-generating securities and strategies. Few multi-manager funds invest across such a wide range of asset classes, capital structures and investment vehicles under as broad and flexible mandate. We believe the Fund is unique in that it is the only mutual fund that we are aware of that combines internal portfolio management, the opportunistic use of sub-advisors, and private funds. The mutual fund also has a compelling and innovative fee structure for multi-manager alternative funds of having only one layer of management fees. The annual management advisory fee is .75%. Upon utilizing sub-advisors, the Advisor pays the sub-advisor fees from its .75% advisory fee. Thus, over time as the fund grows and fixed administration fees are spread over more assets, we expect the Fund’s expense ratio to decline significantly below peer funds.
Hortz: Any final words of advice for advisors on rethinking diversification and redefining risk in today’s markets?
Tyler: Diversification is one of the most important investing concepts in order to reduce portfolio risk. Given that owning anything other than the S&P 500 stocks over the last five years has led to relative underperformance, it is more important than ever to rethink what diversification should mean and be applied for advisors and their clients. For Preserver, real diversification is achieved by adding a unique mix of uncorrelated, income generating investments from an expanded universe of asset classes to reduce the risk of permanent capital loss and to create the highest probability path to an investment objective. As a byproduct, portfolios will be characterized by lower volatility and higher risk-adjusted returns.
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