Cognios Capital – The Strategy Behind A Five-Star Market-Neutral Fund
June 14, 2016
by Robert Huebscher
Cognios Capital is an independent employee owned quantitative investment management firm that serves as an investment adviser to a mutual fund, private funds, institutional clients and individuals. Cognios creates investment strategies that follow rigorous quantitative processes. These processes utilize proprietary research based on the fundamental factors that drive investment returns.
Jonathan Angrist is its president and chief investment officer and lead manager of the Cognios Market Neutral Large Cap Fund (COGIX). Prior to co-founding Cognios Capital, Jonathan was a co-owner of and portfolio manager at Helzberg Angrist Capital (HAC), the predecessor firm to Cognios. HAC was an alternative asset investment firm specializing in deep value, long/short equity hedge fund management. Prior to HAC, Jonathan was a portfolio manager for a mutual fund company, The Buffalo Funds, where he launched and managed the Buffalo Micro Cap Fund.
I spoke with Jonathan on June 6.
Your firm was founded in 2008. What is the history of Cognios Capital, and how did you come to manage the Market-Neutral Large Cap Fund?
In a predecessor that I was running in 2005 with another partner, we were doing long-short equity. Over time, I decided the best way to add value for clients was with market-neutral equity. We added a market-neutral equity strategy close to six years ago. That became the primary focus of the firm.
We were a small company. But in 2012, we combined our business with a company called Oxford Creek Capital. It was owned by a man named Jim Stowers. Jim’s father founded American Century, the $150 billion asset management company here in Kansas City. Jim was the CEO of that company for quite some time and then retired. He took a break and then started Oxford Creek. Jim and I knew each other and were both doing similar things and considered putting our businesses together. In 2012 we did that.
Today, Cognios Capital is a combination of what was originally my business and Jim’s company. Jim is an owner of the business. He’s on the advisory board and has been a very important part of helping us get where we are today.
You mentioned that it’s a market-neutral fund. Can you explain what that means and how it differs from a traditional long-only fund?
Long-only strategies own stock and are usually highly correlated with whatever index they are trying to track. Long-only funds owning stocks tend to have meaningful relationship with the S&P 500 over time.
There are really two big differences between a long-only strategy and a market-neutral fund like ours. Market-neutral is a subset of long-short equity strategies. Long-short equity means that not only are you long (buying and holding stocks like long-only funds), but you also take short positions. Long positions generally make money as the stock market goes up. Short positions generally make money as those stocks go down.
But there is another way to make money being short, and that is if you are long a stock and short a stock; the short stock doesn’t necessarily have to go down to make money. You just have to have the long stock go up a lot more than the short stock goes up. Similarly, if the whole market is going down and the long position is going down and if the short loses less money than your long stock, then you can make money.
When you are just shorting stocks, you are hoping that the stock goes down. But with a long-short portfolio of stocks, the goal often becomes having a portfolio of short positions that underperform your long positions. They don’t have to go down; they just have to go up less.
Market-neutral is a special case of long-short, where you take enough short positions to offset all of the market exposure or Beta in your long book. Let’s say you have a position of 50 stocks and that is your long-only portfolio. Market-neutral means you want the long portfolio to behave differently from the overall stock market. If left alone, most stock portfolios of 50 positions have a reasonable correlation to the S&P 500 or whatever index they are tracking. But as you add more and more short positions, the correlation between that portfolio and its index starts to decline. The goal of market neutral is to make money, but in a way that is completely unrelated to what is going on in the overall market.
When you measure the degree to which you succeed at being market-neutral, do you look at the correlation to the S&P 500 or the beta of your fund, or are you looking at some combination of those two things?
The primary measurement is beta. A beta of zero, which is our goal, means that the return on my portfolio is completely independent of the return of the market. One test of the power and meaning of your beta is the R-squared or the correlation to the index. Those are two related measures.
In general, the answer to your question is that we look at all of them combined. But at the end of the day, we want low correlation, low R-squared and a beta near zero. That means we are running a portfolio whose returns don’t really have anything to do with the overall return of the stock market.