Why asset manager has a different view of ETFs and alternatives

David Picton isn’t resting on his laurels. The president and lead portfolio manager of Picton Mahoney is celebrating his asset management firm’s 15-year anniversary by redoubling his efforts. He’s spent the last year leading the firm into a new alternative funds space, including their own ETFs. They’re not rushing into the latest trend, though. The Picton Mahoney approach to alternatives is informed by a 15-year track record of looking at things a little bit differently.

David Picton founded the firm with a core philosophy, a belief that positive fundamental change is a core driver of securities and negative fundamental change is a core driver of negative returns. But the last 15 years in investing could be generously described as “tumultuous”, and Picton had to reassess and re-envision how they would execute on their philosophy.  

“You have to have a philosophy that you deeply believe in to be differentiated,” Picton told WP. “But the way you execute that can absolutely be improved along the way.

“We focused on that improvement process. And then when there were opportunities or crises, we took advantage of those to pick up talent or to look for opportunities, which of course, led us into these alternative funds.”

Picton saw alternatives as a set of products that could diversify his exposures, and boost risk-adjusted returns. His worry, which may have borne out, was that the alternative space would be flooded with interested investors coming over from mutual funds, and a “tsunami” of new products would confuse the marketplace about what these products were.

His answer to that was research. Before launching their first alternative funds a little more than a year ago, Picton developed a framework to fortify the firm’s portfolio and properly articulate what alternative strategies are available and how they differ from each other.

“Our industry so far has lumped all of these things together into one class called ‘alternative funds.’ But it's important to differentiate them,” Picton said. “So we have four different strategies and each of these strategies has a similar objective. Our mission at our firm is to try and help investors reach their long-term goal investment goals with more certainty to boost the quality of returns in their portfolio. And to us, the foundation of boosting quality returns can be boiled down to a simple concept, try and find assets that have a positive return over time, but that act differently along the way.”

That strategy is an extension of the old 60-40 rule, but in an open field, given the width to diversify in a way that only alternative funds and ETFs allow. An alternative like real estate, that isn’t necessarily correlated to the stock or bond markets, adds a third piece of ballast to a portfolio. Picton’s trick is finding the core drivers in each specific alternative, to see how they’ll perform. His detail-focused, delineating approach extends to ETFs as well.

“ETFs are not a separate asset class,” Picton explained. “You have stocks or bonds, and then, people have thought about these ETFs as different for some reason. To us, ETFs are a delivery vehicle for a strategy. You can have a strategy that's in a mutual fund. You can have a strategy that's an old traditional offering memorandum-based hedge fund. You could have a strategy in the new alternative fund framework, or you could have a strategy in ETFs space. And they could be, with small, small differences, they can almost be exactly the same across each of those different delivery mechanisms. For us, the ETF just became a natural extension.”

Picton’s excited about the opportunity his alternative funds and ETFs present for investors. It offers a chance to democratize his firm’s hedge fund investing strategy and open up a new batch of potential investors. That democratization comes with its own challenges, though. Picton sees a huge need for education among these new investors before they fully understand how these different products might work. He’s had a team of six working for almost two years on portfolio construction and product research, just so they can roll out exactly how these different products interact in a way that’s clear for the investor.

Picton Mahoney’s an active manager, and they charge active management fees. So why are they diving into the supposedly passive ETF asset class? In Picton’s mind, ETFs shouldn’t be understood as passive anymore, despite starting that way. ETFs expanded from indices-based and passive, to a delivery mechanism for all kinds of commodities and sectors. It’s not easy, but Picton discovered that almost any mutual fund can become an ETF.

“My belief is that over the next couple of years we're going to have to get used to a landscape where ETFs are kind of like the mutual funds or the alternative funds,” Picton said. “We're going to have to break them into different buckets, whether they are passive and low cost, whether they are diversifying or differentiating within a portfolio… this ETF market is going to explode when different kinds of available products going forward.”

With 15 years behind his firm, David Picton sees upheaval ahead. The traditional part of the industry, he thinks, will get more competitive due to fee compression. At the same time, alternative products, as differentiated as they may be, are going to play a bigger role in people’s portfolios over time.

“I think that's going to be up to our industry in terms of education and delivering on our objectives to make that happen,” Picton said. “I hope we're in a pretty good place to contribute to that process. I’ve never been more excited.”