How a Long/Short Equity Hedge Fund has Benefited from Using Omega Point
Executive Summary
A long/short equity hedge fund added Omega Point into its risk management arsenal to better manage factor exposures across its investment portfolio. The fund credits its use of the Omega Point platform with helping it improve portfolio performance and successfully raise additional capital.
Based in Northern California, the Fund maintains a low net, low correlation strategy with a concentrated portfolio of emerging technology growth companies. Since its 2013 inception, the Fund has recognized the volatility of its long portfolio and sought to make profitable single- name short positions that exhibit similar characteristics. This heavy emphasis on risk management has been an integral component of both its culture and investment process. The Fund recognizes that these risks can take many forms, and thus uses a mix of qualitative and quantitative tools to remain vigilant in executing its strategy.
The Fund added Omega Point into its risk management arsenal to better manage factor exposures across its several hundred-million-dollar investment portfolio.
The Fund selected Omega Point bundled with the Axioma dataset to be able to gain an in-depth view of the factors that are driving portfolio performance - both as a monitoring tool and as a way to assist in its efforts to maintain a low non- idiosyncratic exposure.
From analyzing the portfolio’s current exposure to market factors across styles and sectors, to prioritizing new ideas that might better hedge out exposure to unwanted risks, Omega Point provides drill-down insights and visualizations through its one-stop dashboard.
The Fund believes that through its use of Omega Point, they have gained a better understanding of factor risks and are better positioned to limit large performance fluctuations (whether positive or negative) that are outside of individual stock selection.
ABOUT THE FUND
The Fund and its team primarily focuses on large and growing markets disrupted by new entrants empowered by a major technology shift of a technology-enabled business model. The team believes successful growth companies hold common characteristics and by identifying these key attributes in market, product, business model and management, the team strives to establish conviction around a small handful of companies with the potential to emerge as industry leaders. These companies stand out from most small cap technology growth companies who are pretenders unlikely to achieve lasting importance. The team then builds a portfolio of these potential breakouts at what is believed to be fair prices while seeking to short pretenders at rich prices. The size of long and short positions is initially determined based on the team’s conviction and a detailed risk/reward analysis.
Most of the Fund’s work is fundamental in nature, with due diligence of a theme, business, management and stock involving numerous conversations with industry participants. These include calls with customers, employees at relevant companies, venture capitalists, institutional investors, and other industry contacts. The Fund also relies extensively upon industry trade shows, company user conferences, company filings and proprietary models.
Through this thematically driven but bottoms-up approach, the Fund establishes a small list of companies it desires to own, a larger list of businesses identified for shorts and finally a portion that would need further analysis are put on a watch list. Patience to find a reasonable price to own these businesses is an essential part of the portfolio construction methodology. It may take several years for a stock to trade at an attractive price to add as a long position and many of the Fund’s positions have been in the portfolio for over three years.
THE FUND’S USE CASE FOR OMEGA POINT
Consideration of non-stock-specific factor exposures is a key component to the Fund’s overall risk management process. Over a long career in the investment industry, the Fund’s Portfolio Manager has learned an important lesson about what can happen if a portfolio ignores factor exposures. This experience has been a key consideration in the Fund’s investing ever since, and it is a vital aspect of the portfolio construction process. By aiming to balance factor exposures on each side of the portfolio, the Fund strives to limit its risk to anything other than the idiosyncratic behavior of the individual stocks in the portfolio.
The Fund believes that the alpha created from its concentrated stock portfolio is their most consistent source of significant positive returns, so the Portfolio Manager actively tries to reduce non- idiosyncratic risks from the portfolio. Avoiding macro factor risk has helped the Fund’s return stream diverge widely from other managers in both the technology sector and overall small cap market – something likely appreciated by many investors.
By minimizing factor exposure, the Fund’s performance is mostly driven by the individual stocks in the portfolio and not from the results of external news items such as tariff wars, currency fluctuations, or Presidential Tweets.
BETTER INSIGHTS FOR INVESTOR REPORTING
Utilizing Omega Point has helped with fundraising. As a newer fund concentrated in a perceived ‘risky’ sector of small cap technology growth, being better able to articulate the Fund’s low correlation strategy has been particularly useful. The Fund’s management team has found that allocators are increasingly aware of factor aware portfolios and have an increasing interest in understanding how external factors impact portfolio returns. Many allocators seem to be moving away from managers with a significant portion of returns resulting from structural factor exposures and want to understand how the Fund measures and minimizes these risks.
The Fund’s ability to generate complex reporting in a format that can be shared with third parties in an electronic or in-person format has helped educate interested potential investors and eventually helped some in their decision to invest in the Fund. Additionally, the ability to drill down into specific factor risk components with precision allows the Fund manager to answer specific questions in face-to-face meetings and focus on those areas that are the most relevant to the person across the table.
The team at Omega Point has also made themselves available for participation on calls with investors and prospective investors to assist them with understanding how their tools are used by the Fund.
OMEGA POINT PLATFORM
Implementation of Omega Point was low friction. The Fund’s financial team provided monthly historic position history and integrated an automated connection for daily updates. Originally intended as a risk measurement platform, Omega Point has developed several useful features around portfolio optimization, new idea prioritization or even discovery and increasingly useful historical analysis to better understand the manager’s inherent biases. As the tool has developed, this Manager has evolved from measuring current exposures and risks, to now using the multi-year historical perspective to evaluate performance.
CLOSING THOUGHTS
The Fund’s relationship with Omega Point has become more important over time. Continuing to push the factor awareness education of a fundamental L/S equity manager has been one of the softer but most important roles of Omega Point. Similarly, feedback from a Portfolio Manager (rather than a dedicated risk team) seems to have made positive improvements to the evolution of the product.
