01 Are Research Ideas Overrated? CEO Says Yes. with Jason Gerlach of Sunrise Capital Partners - 1of2

Niels

Welcome to another episode of Top Traders Unplugged. Thanks to much for tuning in today, I really do appreciate it. On today’s show I’m talking to Jason Gerlach, Managing Partner and CEO of Sunrise Capital Partners. Sunrise is one of the pioneers within the alternative investment area and one of the very few firms worldwide who has a successful track record spanning over more than 30 years.

So it’s a real treat to welcome Jason to the show today where he shares the experiences, the ups and the downs, that Sunrise has collected over such a long period of time. For those of you who are new to the show, I just want to let you know that you can find all of the show notes, including a full transcript of today’s episode, on the TOPTRADERSUNPLUGGED.COM website. Now let’s get started with part one of my conversation, I hope you will enjoy it.

So, Jason, before we jump into some of the more specific topics and questions that we want to cover today, I just wanted to start by saying that it’s actually a great honor for me to have you on the podcast because I think in many ways Sunrise Capital Partners is really one of the pioneers of the CTA industry and it sets such a great example for many, if not the most, of the managers out there to aspire to. So I’m really grateful for you taking the time today.

Jason

Niels, that’s very kind of you, thank you, it’s a pleasure to be on this podcast and I think what you’re doing is great. More information is better, I think, and the more we can tell the story of not just Sunrise but our entire industry via these formats like these, I think it’s great for investors. Sunrise is indeed a pioneer, we started in this business technically in 1980 but actually my partner Rick, who’s our Chief Research Officer, began building models and implementing systems in the early 1970s, believe it or not, when he was still an undergrad at Sand Diego State.

So we go way back, pretty much to the big bang of this industry. And we’re still going strong, we really think that what we do works, that it adds tremendous value for investors, that it compliments all portfolios, and we’ve been very successful doing this for a very long time and we don’t see any reason to stop. We’re very passionate about it and look forward to managing assets for many years to come.

Niels

Absolutely. And I think on that note maybe it’s probably a good idea to start to give a little bit of a background maybe to yourself as well as to the firm. And I know of course that some of the partners, as you just mentioned, have been around for a really long time and it’s also maybe a good idea just to give a little bit of background to them before we jump into some of the more program-oriented questions.

Jason

Sure, of course yeah. Our story is one of the more interesting ones in the alternative investment space for certain. As mentioned, kind of the flash point for our company was Rick Slaughter, my partner. He’s our Chief Research Officer and has been trading nonstop since the early 1970s, as I mentioned. He kind of caught the bug as an undergraduate at San Diego State University, we’re located in San Diego. He had some fantastic finance professors who really just got him excited about markets and about the possibilities of technology.

And he was punch card programming computers back in the ’70s when very few people were even thinking about bringing together computers and finance and that’s really where this all started. He started building models, he studied some artificial intelligence at the graduate level, he studied statistics, he studied finance, and brought all those things together and married them into what was one of the first C.T.A. hedge funds ever launched, which was called Commodity Monitors in 1975, ’76 time frame.

Niels

Wow.

Jason

So he was really on the absolute ground floor of this industry. Now, completely coincidentally a little bit north in San Diego County there were two very smart doctors at the University of California San Diego Medical School. They were radiologists, they were also teachers in radiology and their names were Jack Forrest and Gary Davis. And the two of them were quite friendly and working together in the medical field but also when they were not working at the hospital were talking about markets because they were making a little money and they were looking to try and invest it in a smarter way. And as you may have read or recall, depending on who’s hearing this podcast, the late ’70s were a challenging investment time. Stock markets were kind of stuck in neutral and going nowhere, we had stagflation, there were not a lot of options for investors.

And so these guys started reading books on the commodity markets and systematic trading and different things you can do that maybe were a little bit out of the mainstream. And they started trading their own account while they were still practicing medicine and both of them found success. And so by the late ’70s you had these three guys kind of tinkering with systematic trading in San Diego of all places and they all launched their own firms. As mentioned, Rick Slaughter had C.M.I., Gary Davis launched a firm called Sunrise Commodities in 1980, and Jack Forrest launched a firm in the early ’80s called Cresta Commodities. And these three pioneers kind of carried forward and managed, obviously, mostly their own money to start, they had some friends and family who supported them. But in the early ’80s this business started to get a little momentum and some of the brokers at the..

Niels

Wirehouses.

Jason

Yeah, the wirehouses who were servicing these firms started to see that these guys had some talent and knew what they were doing and started to introduce them to each other and started to think creatively about creating products that would funnel more assets into what these gentlemen were doing. And one thing led to another and before you knew it all their business started to get to relatively sustainable sizes and they started to talk and share ideas and by the early ’90s the three of them kind of thought, “Wow, wouldn’t it be great if we all kind of combined out talents and formed a single firm?.” And that’s exactly what they did, in 1995 Sunrise Capital Partners was formed and the “Partners” was a reference to these pioneering gentlemen, all of whom started in the late ’70s. So truly three pioneers of this industry came together to form Sunrise Capital Partners.

And from there the firm just continued to grow in terms of assets, the intellectual property was pooled, and they just continued to innovate and hone what they did. They went from a single model out to multiple models, they went from just a few markets to more markets, they started to incorporate some more sophisticated risk management techniques, and doing all the things you needed to do to keep a business current and evolving. And they actually, by the time they got to their peak asset level in the late ’90s, early 2000s, were a very large firm, well over 2 billion dollars, and one of the largest C.T.A.s in the world. So my hat is off to them, they were just great, great visionaries and did a wonderful job with this firm. The modern story of Sunrise is an interesting one as well.

Like most asset management firms that started in this era, the ’70s and the ’80s, they faced a succession planning issue. Many, many hedge funds are staring at this issue right now. What do you do when you’ve been wildly successful, you’ve raised a lot of money and made a lot of money on that money for your investors, you’ve been very successful, and you are thinking about the next phase of your life, what do you do with your hedge fund, your C.T.A. firm, your creation? And there were different views amongst those three gentlemen and they had to work some things out in the early 2000s and decide where they wanted to go. And ultimately and thankfully they decided that they wanted the firm to carry forward. They didn’t necessarily agree that they all wanted to be involved in the firm as it carried forward but they did agree that the firm needed to kind of survive into the next generation.

So they started to make some hires of younger people who could carry it forward and I was fortunate enough to be one of them. I joined the firm in 2008 as the, then I would say, Chief Operating Officer working closely with my predecessor, Marty Klitzner, who was the CEO. of the firm at the time. Unfortunately Marty passed away in the last couple of years too early, sadly. But Marty and I worked very closely together, starting in 2008, on a succession plan for the firm. And that succession plan was holistic and comprehensive and it involved coming up with an orderly way for the partners who no longer wanted to be part of the firm to kind of phase out of the firm.

It involved moving to a new headquarters, it involved upgrading our technology, it involved upgrading pretty much every aspect of the business. It involved bringing in some young talent to help us kind of carry forward. And that’s really what I’ve kind of spent the last five years of my life doing is taking this firm and pivoting it, I guess, towards the 21st century and beyond. And it’s been a lot of hard work and a lot of effort and obviously we’ve had a massive financial crises in the midst of it which has posed some interesting challenges that I’m sure we’ll discuss. But the upshot is Sunrise 2.0 is here, a succession plan has been implemented.

Myself and Rick Slaughter, who I mentioned, and Chris Stanton, who’s now our Chief Investment Officer who joined us about three years ago, are the new owners of the firm. We’re carrying the firm forward under the Sunrise name with some new ideas but mostly taking a lot of the great ideas and concepts that the founders implemented back in the ’80s and we’re carrying that forward with us. So that’s where we stand today and it’s a privilege to be the CEO. and Managing Partner of Sunrise Capital Partners and I hope 30 years from now I have to come up with a new succession plan for the firm.

Niels

This is the great thing, Jason, really that imagine you were based on discretionary and fundamental analysis, you wouldn’t be able to do what you’ve just done. This is also the strength of our industry and what we do, rule based strategies can be carried forward for many decades unlike most other strategies.

Jason

Absolutely, absolutely, that is a very important point. And even to more of the credit of the founders of Sunrise is it was never one person, it was never one person’s models or one person’s intellectual property. It was a collective effort, it was always the partners and the staff working collectively as a unit to create this kind of pool of intellectual property that has just continued to improve and expand and grow over time and that’s something that indeed can be passed on. There’s no single point of failure risk in our team, there never has been, and that’s one of the reasons we can carry this forward. All the great ideas they had are baked into what we do and we’ve created a structure in which new ideas can funnel in and mesh with those older ideas and carry forward. So yeah, that’s absolutely right and I think that’s one of the things that give quantitative firms a leg up as we kind of move into this second generation era now.

Niels

And as the CEO or Managing Partner of Sunrise, I’m curious just before we jump to the next point, just one or two minutes as to how you personally ended up in sort of this quirky world of systematic trading.

Jason

My path is not one that’s easily replicated. I was an attorney for ten years and I got to know the Sunrise firm simply through happenstance. I had some person relationships who introduced me to Sunrise and I got to know the Sunrise team and I became an investor long before I joined the firm and they actually reached out to me. Marty Klitzner, who I mentioned who was my predecessor, reached out to me in the mid 2000s and suggested that I might be a good fit for the firm on day. And I kind of laughed, I said, “Why on Earth would you want me?” He said, “Well, you seem like a smart guy, you seem ambitious. You’re a lawyer, you got a good head on your shoulders, and you seem to pick up things very quickly.” I said, “Yeah. But, Marty, I’m not a finance guy, you know that.” And he said, “Well, that’s okay, I  wasn’t a finance guy either when we launched this business in 1980 and look where we are.” And I said, “Good point, Marty.”

So I took a very kind of circuitous route, I was an attorney, like I mentioned, and my specialty as an attorney was learning the facts of whatever case or situation was presented to me. A client would sit down with us and say, “This is our situation.” I’d have to embed myself in that client’s business, whatever it was, insurance or technology, consumer products, whatever it was. And so this just became another case for me. I joined Sunrise, I just started absorbing as much as I could from the very smart people who were running the firm. I took some classes at Wharton and Harvard in finance to kind of bring myself up to speed, I did a lot of traveling to visit clients and I actually met with a lot of competitors to kind of pick their brains, I went to a lot of conferences.

But ultimately brought myself up to speed on the business and it’s been a lot of hard work and it was a steep learning curve but I’m there. You certainly wouldn’t want me building trading models for you, that’s why I have some great partners. But I think I’ve become pretty adept at running the asset management business that we have and creating an environment for the very smart people on my team to be the best they can be, to create the best models they can, and implement those models with great precision.

Niels

And of course I’ve had the pleasure of listening to you on other podcasts and on television and I certainly know that you also adapted the passion for the industry and for Sunrise. So it’s a great contribution to all of our industry from that point of view as well.

Jason

Well thank you. I do, I’m very passionate about it, I love it. And a personal note is before I came to the systematic investing space I didn’t know a whole lot about investing and the little bit I knew I didn’t like, I didn’t understand. I could never figure out, for example, why my father would watch Wall Street Week with Louis Rukeyser or whatever that show was called back in the day, hear what those gentlemen would say, and then go and run out and maybe buy one of the stocks they recommended. It made no sense to me, I would sit there and say, “How on Earth does this gentleman on TV know what’s going to happen in the future? It seems like a very circumstantial, happenstancial kind of way to invest, there has to be a better way.” And only when I sat down and really got to understand quantitative systematic investing did it finally dawn on me, “This is the way to do it, this is a much more intelligent, precise, scientific way of investing.” So I was sold from day one.

Niels

Yeah, absolutely. Jason, do you mind giving me just a brief overview of the programs you run today and sort of roughly where you stand on the AUM?

Jason

Sure, sure. So at present we’re running about 200 million dollars through Sunrise as an asset management firm and we have currently two offerings for our investors, two programs. The first program is called Sunrise Evolution and what Sunrise Evolution is the latest iteration of what we’ve been doing since 1980 and, in fact, before 1980. And it is a multi-asset, long/short, C.T.A., for lack of a better term, approach to investing. With Sunrise Evolution we invest across six different sectors, metals, energies, agriculturals, and all the financial markets, stocks, bonds, and currencies. Long/short using a multitude of systematic approaches ranging from trend following to reversion to what we like to call a diversionary pattern to a beta capture model that we built. A whole variety of models working together in harmony, so that’s Sunrise evolution, that is, I would say, the more traditional product we offer.

Niels

Sure.

Jason

The second offering we have is an equity-only offering and that we started trading the beginning of 2012. And so we’re nearing our three-year track record on that and starting to actually generate a lot of interest in it and raise some money in it. And we actually just recently renamed it, it is now known as the Sunrise U.S. Equity Optimized Growth Program. And what it does is it takes some of the DNA from our Sunrise Evolution flagship and applies it just in the U.S. equity space. And this product was created really by demand of investors. We had a large investor who was really interested in seeing if we could apply some of our models to something they were doing internally with U.S. equities. And we were able to come up with something that we thought was so great that we decided to implement it as a standalone program.

So those are our two current offerings.

Niels

Sounds very interesting and a good topic for a follow-up in a few months.

Jason

Yes.

Niels

Do you offer sort of general access to your programs both via funds and managed accounts today?

Jason

We do, Sunrise Evolution is accessible via our master/feeder fund structure which has an onshore component and an offshore component. The master/feeder itself is a Cayman-based structure, the offshore fund is a Cayman-based structure, the onshore fund is a Delaware fund. And we run about a third of our capital through that fund vehicle. The other two-thirds are separately managed accounts.

Niels

Fantastic. Of course a lot of people listening to this will be wanting us to get to the more details but before we do that I was just, because I think it’s so important for people to understand what we do and what our firms do. Also to understand a little bit about how do you structure a firm like that, what’s important, which functions do you need to have, which functions do you need to have in house, which functions do you need to have outsourced. Do you mind just taking a couple of minutes and just explaining how you’ve resolved that based on all of your experience?

Jason

Yeah, that’s a great question and the answer to that is evolving and it’s changed a lot even in the last few years. Our view has been that we’re very good at certain things and there are some things we’re probably not as good at. We want to focus on the things we’re best at, our core competencies, to use kind of a more corporatized terms. And the things that aren’t in our core competencies we want to make sure we have experts doing that even if it means those experts are outside the walls of our office. So what we really focus on doing in house is the thing we’ve been doing for many years which is building very good investment models, implementing those investment models with precision, overseeing and improving those investment models continually.

Everything else is secondary to that because that’s really ultimately what people are hiring us to do, take their money, put them in these models, and hopefully make them money on their money in a risk responsible way. So obviously research and implementation are by far the core of our business and the partnership is set up that way. So I’m the CEO, I oversee all aspects of our business. Chris Stanton is our CIO, he oversees all aspects of the implementation of our investment models, in other words the day to day execution, making sure what we’ve decided we want to do in the markets is actually happening on a day-in, day-out basis. He has a deep, extensive Wall Street trading background at J.P. Morgan and later at Deerhurst Capital. So he’s a perfect fit for that and if there’s a better execution team in our business I’d like to see them because Chris is outstanding and the people who work with him, Annette and Josh and others are fantastic.

And then Rick Slaughter oversees the research function of what we do, he’s our Chief Research Officer, so he’s the kind of engine behind all of the R&D we’re doing. he maintains a queue of projects that he and his team are continually looking at, whether it’s just a small, subtle market add to one of our models or it’s the creations of a new system, all that’s kind of umbrella’ed under him. And then of course there’s a lot of communication at the top of that structure, Chris and Rick speak daily and work closely hand in hand because obviously a good research idea is only as good as the implementation ability you have.

Niels

Absolutely.

Jason

And of course I’m in constant touch with both of the two of them because I’m trying to give them the tools they need. I’m want to find out what technology they need to do what we’re doing, who do we need to hire to make sure they can do the job they need to do, what relationships do we need to build with brokers or banks in order to achieve what we need to do. So it’s a very synergistic approach. But on the business side, outsourcing has become an increasingly valuable tool for us. Things like human resources we’ve decided to outsource and it’s been incredibly helpful.

We get some very good outsourcing help in the compliance realm now. Certainly we have a great Chief Compliance Officer on staff, Gary Hirschfeld, who’s been with us a long time but he’s complemented now by a team of compliance specialists out of San Francisco at Gordian, for example, who work with us and obviously our great legal team. So it’s, to me, the best asset management businesses are focusing on the asset management piece of what they’re doing and perhaps using some outsourcing help in some of the other areas. Because it’s very hard to be good at all the things you need to be good at to run a successful asset management firm.

Niels

Sure. Yeah, I agree completely and I think that’s just part of evolution and it’s part of adapting to new technology, et cetera. That’s the way to do it and you’ve clearly done that.

Jason

Well yeah, and technology is a catalyst for all this. The things we’re able to do now with technology just didn’t even exist five years ago, let alone 30 years ago when this firm launched. So it’s really changed the game. For example, to be able to implement complex strategies on an automated computer commuter basis is a game-changer. We would need a room of 20 traders to do what we’re doing now 20 years ago.

Niels

Yeah, that’s true. And what about, this is a question which is very difficult to answer I think generally when it gets asked, but do you have any sort of target or optimal size for the strategies that you run today? Obviously the equity strategy I can imagine is pretty limitless but for the sort of traditional CTA structure, do you feel that there is an optimal level that you want to get to?

Jason

Absolutely, this is something we study constantly. We think Sunrise Evolution has a cap and a very hard cap somewhere in the neighborhood of 3 to 4 dollars and we will not grow that product beyond that. We’ve always capped our growth, when the predecessor owners of Sunrise were at their peak assets they reached that peak and hard closed the firm because they had concerns about their ability to implement our models in some of the markets we were trading at a size much larger than we were at. And we share that view, we don’t want to decay our alpha generating ability simply to raise as much money as we can. So our evolution is a cap proposition, no doubt. Now obviously at 200 million we have plenty of room to grow in it but I would think around 3 billion we will take a long, hard look at our execution and see, “Are we starting to see more slippage? Are we finding it harder, and harder to get in and out of trades in certain markets?”

And if that’s the case we will cap it. Now, as you mentioned, our equity product we think the ceiling is much higher on that. I don’t know where that is, honestly, but it is certainly in the billions. That program simply trades deep ETF markets right now and those markets only seem to be growing. So it would be a nice problem to have to get to the ceiling on that product. But it’s not how much money you manage in this business, it really isn’t, although some of our competitors seem to think that it is. It’s really about the quality, “Can you deliver returns for you investors?” Because if the quality is not there, the quantity will never come.

Niels

Sure, I agree, I agree. Now let’s focus on the Evolution product. And of course, as you mention, it sort has gone through different phases and was relaunched recently and I noticed it had a great year last year. But take me back a little bit further because obviously it is based on all the learnings and the successes, the failures from 20 or 30 years of research and trading. So take me back a little bit and talk about the program and also about how you think it’s been performing. Because we all have expectations as to how it should perform in certain environments and we know that the environment since 2009 has been somewhat different.

Jason

Yes.

Niels

So just talk to me a little bit about that and how you really see the program and the changes, whether they have actually done exactly as you were hoping.

Jason

Sure, very, very good questions. And the product is called Sunrise Evolution for a very simple reason, it represents the evolution of Sunrise, without a doubt. There’s one thing we know for sure in this business, if you are standing still you are falling behind. Markets have evolved so much since 1980, there are more participants, they move faster, there’s more information being proliferated globally than ever before via Internet, Twitter, and whatnot. If you’re doing the same thing you were doing in 1980 you are probably out of business at this point.

Niels

Sure, and many are.

Jason

Yeah, exactly. So we’ve continually evolved since our launch to try and keep up with what’s going on, not just keep up but stay ahead of what’s going on and continue to find a source of alphas. So this is just the latest kind of iteration of what we’ve done. Think about 1980, I think we were trading one model that looked at essentially one time frame, it was a fairly simple trend following breakout approach, and it was trading perhaps a dozen markets, whatever markets were available at the time. It worked quite well because markets at that point were fairly inefficient, there weren’t a lot of participants, and it was quite possible to capture quite a bit of upside of some very significant market moves without much interruption.

Niels

Sure.

Jason

And so that worked at that time but obviously things change. And over time we added models, we added time frames, we added techniques, and all of this allowed us to continue to be a viable business throughout the ’80s and throughout the ’90s. But in the early 2000s something changed and Rick Slaughter would be the best to speak on this but he and I have had long, long conversations about this so I feel comfortable speaking for him to some degree. In the early 2000s he started to see real fundamental changes that he had never seen before. He started to see evidence of decay in trend following, long-term trend following.

Niels

Interesting.

Jason

Not just our approach to it but everyone’s approach to it. Just so you understand, we run our models the way we think they should be run but we also run a lot of models in the background in kind of a simulated environment that we think are emblematic of what the industry might be doing. In other words we want to study different approaches to trend following at all times.

Niels

Yeah.

Jason

And what we started to notice in the early 2000s was that all trend following approaches of all stripes were starting to have problems. Why were they having problems? We weren’t quite certain but certainly markets were correlating more than ever, we were seeing some very violent kind of events where all markets were correlating to one and then reversing sharply together. If you remember, for example, the summer of 2007 and the spring of 2007 were very, very hard on a lot of trend following strategies, including Sunrise’s. But Rick saw this happening and it concluded in the early 2000s that if Sunrise was going to survive long-term it was going to have to break out of simply doing long-term trend following, it was going to have to start to become a little more nimble and use some different techniques in addition to trend following.

What those techniques were he wasn’t necessarily sure, how we were going to bring those techniques together he wasn’t necessarily sure, but he started working on it, he started drawing things up. And, in fact, when I joined the firm in 2008 the first thing I did was sit down with Rick and kind of figure out what he was doing in research and what was looking promising. And he showed me a couple things and he said, “Jason, this is the future of Sunrise, let me show you this strategy and let me show you this strategy.” And it was eyepopping stuff and said, “We’re not quite there in terms of having the ability to execute these but we’ll get there and I’d like you to work with me on that.”

So it was this process that started, as I mentioned, way, way, back and started to accelerate in the early 2000s. But you’re absolutely right about 2008, 2009 really starting to change thing. What was the game-changer in 2008, 2009? It’s not clear what it is precisely but we think government intervention is a big part of it.

Niels

Sure.

Jason

Whether it’s the U.S. Fed or the Japanese government or the European governments, the effort governments have made to try and control markets and reduce volatility and honestly save the global economy, which I credit many bold government leaders for doing in 2008, it has changed the way markets behave fundamentally. And trend following, as you know, has pretty much fallen off a cliff in terms of performance since ’08, the statistics show it. And it’s been hard to make money as a long-term trend follower in the last five years, no question.

Luckily for us we’ve been continually working on alternative models in the 2000s and by the early points in 2010 a lot of these models were coming to fruition. We had moved to a new plant, we had added a lot of technology, I had brought in Chris Stanton as our new CIO and execution specialist. And so by, I’ll let you know, by the 2010, ’11, ’12 time frame we were in a position to start to put prop capital in a lot of these models and get them going and watch them and evolve them. And we liked what we saw so much that ultimately in, I would say, mid 2012 it became clear to us that we could bring some models together in a way that would radically change the fortunes of Sunrise, we thought, for many years to come. And that’s when we decided we are going to go forward with a much more multi-logic approach.

And we launched that on January 1st, 2013 as Sunrise Evolution, we started trading that program and the first half of 2013 began talking to all of our investors about Sunrise Evolution and telling them why we thought it was vastly superior to what they were in, which was our legacy, long-term trend following approach. Which, by the way, has been a wonderful investment program, don’t get me wrong. It only had four losing years in 34.

Niels

Yeah, I think that’s one of the best track records in the business.

Jason

But it wasn’t delivering what we wanted it to anymore and we were seeing the weaknesses in it and we felt that this more evolved approach was better and most our investors agreed. In fact, at the end of the day they all agreed, almost every one of them rolled over into the new program. A couple really were much more comfortable with longterm trend following and decided to stay just doing that. But 99.5 percent of our investors said, “We trust you guys, you know what you’re doing, we like the studies we’re seeing, we think this is a better approach,” and they’ve rolled over. So as of middle of 2013 our official flagship was Sunrise Evolution and will continue to be going forward.

Niels

And I don’t know whether it’s possible to put a percentage on it but how much of the original program, if we call it that, would you say is still kept in Evolution? And also what’s the profile of Evolution in terms of what kind of targeted return and what expected volatility do you go for?

Jason

Sure. So the way I like to explain Sunrise Evolution is as just that, an Evolution. In other words nothing we’ve done historically has been—

Ending

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