For the prepared firm, distressed assets can provide opportunities to add scale cheaply. But the value proposition gets trickier when there's bad publicity linked to the assets in question.
That was the primary challenge facing Chicago-based Cedar Capital when it was approached with the chance to acquire product provider F-Squared Investments.
F-Squared gained infamy after the SEC last year determined it had mislead investors about the performance of its popular AlphaSector ETF-linked strategy. F-Squared paid $35 million in charges after admitting to passing off a hypothetical track record of its ETFs as real.
A reminder of that scandal surfaced Nov. 16, when Hartford, Conn.-based Virtus Investment Advisers agreed to pay the SEC $16.5 million in penalties for "substantially overstating the performance track record," of the AlphaSector strategies from F-Squared, which it hired as a subadvisor for mutual funds.
Nevertheless, Cedar Capital CEO Paul Ingersoll says he is confident in his firm's decision to acquire F-Squared's remaining assets. "One of the reasons [the acquisition] was attractive to us is...we felt we had a very, very strong understanding of what was involved in running [F-Squared's] business, what was involved in running their strategies and how those strategies are likely to work," Ingersoll explained in an interview with Money Management Executive.
What role has M&A played in the growth strategy of your firm?
Actually, when we went out in 2013, we raised some private equity capital and the reason for that was to perform acquisitions.
My background is in M&A. I've done deals in different business service industries and I'm always thinking about how you can leverage the infrastructure you have by adding additional scale.
We were looking for acquisitions all along. It's a challenging space to do acquisitions because personalities loom so large. You're talking to somebody who is an entrepreneur, as well as a portfolio manager, and a buyout is often a difficult transaction.
So, we have looked at different structures, we've done startups; Broadmeadow is a good example. They were going to do a startup and we encouraged them to do it on our platform.
We've made minority investments in partners that we would then hope to grow and increase the value of our investment. So, M&A is an important piece of that. We want to balance it with homegrown assets, but you could also look at these sub-advisory relationships as a joint venture. It's just another way of forming a partnership.
What was your initial reaction when news broke about F-Squared's misleading performance reports regarding its AlphaSector strategies?
We tried to just keep our distance. We really didn't want to engage in speculation on our side about what may or may not have happened, but we were watching from the sidelines with everybody else.
What we do know is they had a live track record that was observable and verifiable, and we were approached at some point well along the way asking if we would be interested in taking over their assets.
One of the reasons that was attractive to us is, one; we felt we had a very, very strong understanding of what was involved in running their business, what was involved in running their strategies and how those strategies are likely to work.
So, we thought it was an opportunity, since we have the infrastructure, sales, operations and compliance, we can then take on this strategy, making no judgment about past reporting practices.
How long had F-Squared been on your radar as a potential acquisition?
We were aware of F-Squared from the very beginning. On a high level, what we say we do and what they say they do was very similar. We were both trading in ETFs; we were both doing primarily separate accounts and we both had the flexibility not to be attached to a benchmark. So, we were moving along parallel to them.
It was probably about 2010 or 2011. At the time it really jumped out at me because when I saw what they had done, it was really similar to the basic high-level description of the way we work. So, when I first saw them, I was just very surprised that no one had once yet mentioned how compatible F-Squared is with our business.
We were aware of one another. And there were some conferences where they would get ETF managers together. One thing the managers tended to have in common is we're investing in indices. In F-Squared's case they are managing across different sectors. In our case we're managing how much risk to have in the portfolio at any time.
What's interesting is ... prior to the financial crisis, when we would discuss the idea that there are times when you may want to have less risk in your portfolio, the answer was, 'You can't do that. That's market timing.' Then following the financial crisis the response was, 'Of course there are times you want to have less risk in your portfolio. How can I do it?' The point is, to do that based on a more systematic, data driven approach.
Our basic thesis is that, while we believe markets are efficient, investor appetite for risk does fluctuate. There are certain periods of time when people feel comfortable and are willing to accept a lower return, but when they are fearful they are demanding a higher return because their appetite for risk is lower.
Changes in investor appetite for risk create opportunities to add value by adjusting portfolio risk exposure. F-Squared had similar worldview. We saw them as a business that we knew very, very well and didn't have to be convinced that what they're doing could be a value-added approach.
Were there any liabilities factored into the acquisition?
When we were approached, they had hired a banker who raised assets for them and when they started to seriously lose assets, they realized that they were looking at a bankruptcy proceeding.
By the time we were contacted, we were asked, 'Would you be interested in purchasing the assets, post-bankruptcy?' So, we didn't have any input or knowledge that happened before; we were simply approached to take over their assets. One of the advantages of the bankruptcy proceeding is that there is just an absolute cut-off of anything that happened prior to the bankruptcy filing and anything that happened during the bankruptcy filing.
How important is it to get that message across to your customer base?
For the most part I haven't had very much difficulty, but when people ask if we have any exposure, we can essentially state that we have a signed order from a federal judge stating that we have gone through this transaction and have no liability.
What types of marketing techniques do you have to employ now with this type of deal?
So, it's still fairly new. Our first order of business was to transition to assets and execute just to demonstrate that we purchased the IP, we have brought along employees that are required to assure the continuity of the strategy and beyond that; the marketing of it is really ahead of us.
First order of business is to execute. And one reason we were attracted to it was that tactical strategies can add value. They are uncorrelated one to another.
Are there any plans to resurrect F-Squared in the future?
The F-Squared name and the F-Squared brand is not something that we would resurrect. They had a strategy. They offered their suite of strategies under the AlphaSector brand. So going forward they will be the Broadmeadow AlphaSector strategies.
How did that affect the decision to acquire F-Squared's assets?
Essentially, we knew from an operational standpoint, from a marketing standpoint, from a distribution standpoint, that we had a complete understanding of their business, so there was hardly anything for us to learn.
We also recognize that for whatever F-Squared went through, they had a significant amount of assets and they had a large fan base that really liked their approach and strategies. What we were able to do is purchase the intellectual property. We can verify it going back to a certain period, and however they marketed it before, will not affect us or our current investors. We can show what the approach has done over its live track record and it fits within our goal of offering a suite of tactical products that are uncorrelated and work well together.
How do you expect this deal to materialize in the year ahead?
We think we've structured it in a way that if people look at the process, look at the live track record and decide it is something that they want, we can service those accounts. If anybody wants the strategy, we are uniquely positioned to offer it.