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Inside CenterBook Partners, a Hedge Fund Using Other Firms’ to Invest

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David Stemerman, who has picked stocks for decades, knows investors like him have left returns on the table.

He made it to the top of one of the best-performing managers in history at Steve Mandel’s Lone Pine and had — at the time — one of the largest launches in history when he started Conatus Capital with $2 billion in 2008.

But the best stock-pickers in the world are “not as skilled in risk management and portfolio construction” as they could be, he admitted in an interview.

So, when he returned to the industry in 2021 after an unsuccessful run for Connecticut’s governor, he didn’t start another long-short equity fund despite his lineage and previous success (Conatus had more than doubled the market’s returns in 2017 when he shut it down).

Instead, he partnered with Alpha Theory, a portfolio analytics firm based in Charlotte that specializes not in stock-picking, but in making sure funds are getting the most out of their stock picks with detailed analysis on position sizing and risk protection.

Using the holdings from dozens of independent fund managers, who are all Alpha Theory clients and get a portion of CenterBook’s performance fees for their trouble, CenterBook creates its own book that Stemerman believes is “tapping into the alpha potential” of these funds.

The structure is unusual, especially in an industry so paranoid about protecting its edge. That dozens of funds — the firm currently has 28 different partner funds that feed data into the strategy plus a waitlist of five other managers — would share their holdings is novel.

Last year, the unique structure worked for CenterBook. The firm’s market-neutral fund — known as Centaur Global Alpha and most similar to multi-strategy firms’ flagship strategies — returned 21%, an investor tearsheet notes. The average hedge fund was up 7.5%, according to Hedge Fund Research.

The firm is still obviously a long way off from being in the same conversation as Citadel, Millennium, and the top of the industry. Managing just $600 million across two strategies, CenterBook is raising money and trying to grow its profile, but Stemerman said the firm expects “we will earn our right to be in that conversation” in time. A source close to the firm notes that the firm expects to be around $1.5 billion in assets by the end of 2024.

A place to stay independent

Stemerman said the willingness of managers to share their data was the biggest question he had before signing on.

He said CenterBook built on the trust Alpha Theory, which Conatus was a client of, had with its managers, and also offers insights on the firms’ data on how they could trade better, along with research credits for other Alpha Theory services and the cut of incentive fees.

The managers who have partnered with CenterBook, Stemerman said, have a long time horizon — think months instead of days — on their trades, so the edge isn’t lost if CenterBook also makes the same trade in its book.

The firm hopes the structure will be attractive to smaller managers who feel squeezed by the continued rise of the industry’s multi-managers. Stemerman said CenterBook doesn’t interfere with the trading strategies of any of its partners, allowing them to run risk as high as their own investors are comfortable with.

“Our aspiration is to be the partner of choice for those who don’t want to join a platform, who want to remain independent,” but still want advice on portfolio construction, Stemerman said. CenterBook, if assets grow as expected, aims to bring on another 10 partner funds this year, the source close to management tells Business Insider. While the manager has only 18 full-time employees, its partner funds have more than 100 investment analysts working at them.

The hedge-fund space has changed dramatically since Stemerman launched Conatus 16 years ago. The biggest funds have always been powerful, but the industry has grown increasingly top-heavy, and to make a dent, CenterBook had to be something allocators hadn’t seen before, he said — even if it’s more difficult for them to understand initially.

“We knew we needed to build something structurally differentiated,” he said, comparing it to past tech investments he made while working at Lone Pine and Conatus. Bets on Apple in the mid-2000s and on Amazon more than a decade ago were far from popular choices, he said, but as a stockpicker, he sought out businesses with unique business models.

“We wanted to do the same here.”

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