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Reaching for the algorithms

Market slumps that have dampened more than a few Wall Street parties over the past 50 years have left a lot of investors feeling like they’re all out of aces.

But they are never out of algorithms – not if they know where to find them.

The partners at Jackson hedge fund firm Woodridge Capital adopted an algorithm system in Jan. 2010, becoming what they and their algorithm system’s creator believe to be the first hedge fund managers in Mississippi to begin playing strictly by the numbers.

The partners at Jackson hedge fund firm Woodridge Capital — (from left) Danny Williams, Barry Smith, Clark Smith and Roger Davis — adopted an algorithm system in Jan. 2010, becoming what they and their algorithm system’s creator believe to be the first hedge fund managers in Mississippi to begin playing strictly by the numbers.

The partners at Jackson hedge fund firm Woodridge Capital — (from left) Danny Williams, Barry Smith, Clark Smith and Roger Davis — adopted an algorithm system in Jan. 2010, becoming what they and their algorithm system’s creator believe to be the first hedge fund managers in Mississippi to begin playing strictly by the numbers.

The data and technology that allow for the quantitative-analysis approach fit well with a Woodridge strategy the industry describes as investing in “fundamentals with a trend overlay strategy.”

Together, the data and technology applications give “the ability to crunch through massive amounts of data to help guide us in making our choices,” says Roger Davis, one of four Woodridge partners.

Davis credits that guidance for an 18 percent rise in the approximately $7-million hedge fund, Woodridge Equity Partners, in 2010.  The average domestic hedge fund earned returns of 12-13 last year, Davis says.

He didn’t have a figure on the performance of the firm’s other entity, Woodridge Capital Portfolio Management, which manages about $150 million for private hedge-fund investors. Woodridge Capital Portfolio Management didn’t begin using the algorithmic system until spring.

“We have different sets of algorithms for the hedge fund and the managed fund,” Davis says.

Since forming Woodridge Capital in 2006 Davis and partners Barry C. Smith, Clark Smith and Danny C. Williams have keyed on a specific piece of data: the kind that can’t be obscured or restated in later financial reports.

“That primarily is the price a security is trading at,” says Barry Smith. “Price does not get restated; earnings get restated, revenue gets revised

Price-to-sales ratio is perhaps the most important factor weighed, according to Davis. “We found the farther up the income sheet you go, the harder to cook the numbers.”

Woodridge’s hedge fund has shares from the stocks of 4,897 companies. Those stocks made the grade after the firmed stripped each stock’s balance sheet down to those elements “accretive to value,” or more specifically those things that contribute to a company’s revenue picture.

Woodridge applies a 60-day test, dumping all stocks from the fund that fail to place among the top 24 percent of performers during the test period.

If one drops to the bottom 20 percent it is immediately sold, the firm says. And too much price volatility on a given day will get a stock booted, as well.

“We are a trend-following firm,” Davis says. “We believe that a trend that is in place is likely to stay in place.”

“We are looking for opportunities,” he adds, and notes the opportunities can be a headfirst plunge into the market, a trip to the sidelines or a burst of short selling.

But today’s game is changing with the emergence of quantitative analysis, an investing approach devised to give market players a few more cards to play as the market goes into its frequent fluctuations.

“There is no guessing game,” Davis says. “We don’t wonder what to do, or how to make money.”

Adoption of the algorithm strategy meant testing the rules Woodridge has stuck with the past five years.

The firm applied the assigned algorithms and Woodridge investing principles to the market over a period of three decades or so, looking at up, down and sideways markets.  “It allowed us to tweak some of the things we were doing,” Woodridge’s Barry Smith says.

“We ditched some of the things and added a couple of good things.”

Smith says employing the algorithms gave Woodridge a way to identify “how we were getting results.”

Part of the new system’s testing involved applying the assigned algorithms and Woodridge investing principles to the market over a period of three decades or so, looking at up markets, down markets and sideways markets.  “It allowed us to tweak some of the things we were doing. We ditched some of the things and added a couple of good things.”

Numbers guys Clark Love and Stanford Ph.D. Henry Jones of Jackson-based Ironview Capital devised Woodridge’s algorithmic system, tailoring it to the rules the partners had settled on keeping.

The central task they gave themselves involved assigning number values to ratios related to price-to-sales, price-to-earnings and earnings growth. They also designated values to shifts in share price, changes in share volume traded and changes in volume of the entire market, says Ironview’s Clark Love, who has engineering and finance degrees from Northwestern University.

“We tested all of those to see which ones have the most impact and which ones don’t.”

What works and doesn’t work is always changing in this numbers game, Love says. “We have to continuously monitor the data to make sure it is clean.”

Love says he and Jones have a large stake in the numbers they’ve devised. “Absolutely.…  That’s how Ironveiw got started. We were looking for approaches to invest our own money.”

As a principal in the Jackson fund management firm Greenover Group, Kelly Williams has put several million dollars of his fund’s money into Woodridge Capital. The quantitative approach drew him in, he says.

“I was attracted in that it was not correlated with other investment we had and it seems to limit the downside when the market is going against you.

“They tell us when to go to cash or even short positions.”

He says he is convinced the algorithms bring a lot of value to the market strategy.

Williams added, “With the revised algorithms I just think they are much more robust. They’ve done significant back testing. And now they’ve got 12 months performance under their belts.”

To read related stories, click here and here.

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