O U R I N V E S T M E N T P H I L O S O P H Y :

I n s i d e O u r M a n a g e r D u e D i l i g e n c e P r o c e s s

A L P H A C A P I T A L ’ S I N V E S T M E N T P H I L O S O P H Y

I N T R O D U C I N G T H E S E R I E S

As the investment arm of many independent broker dealers and

registered investment advisors, a request we receive frequently from

advisors and their clients alike is to describe our investment philosophy

and process. In a nutshell:

“Good investment advice is repetitive and boring.

There is nothing exciting about it.”

We’ll try not to make this series repetitive and boring, but there is

some truth to that tweet by D. Muthukrishnan, a CFP in India.

Brad Alford and Anna Dunn Tabke, the firm’s principals, each came

from the institutional investment world. This experience forms the

foundation of Alpha Capital Management’s investment philosophy. The

institutional community has a reputation of being a bit stodgy and old-

fashioned; sometimes that is true, especially given their size and all of

the processes and procedures needed to make a portfolio change. But

old-fashioned or not, Alpha Capital Management believes that taking a

long-term investment view, as the institutional community does, is a

great way to add value for clients. Although individual clients do not

have the benefit some institutions do of an unlimited time horizon,

these clients can nonetheless benefit from the stability of this

investment approach.

In this series, we’ll cover several different aspects of our investment

philosophy and process:

Part One discusses why we take a long-term investment approach to

portfolio management, grounded in our experience in institutional

investment management.

Part Two examines in detail our approach to manager due diligence

and selection. We believe that this is a distinguishing characteristic of

our firm and an area in which our skill-set shines.

Part Three reviews our portfolio construction process, including our

views on active vs. passive investing, and demonstrates how our

institutional approach to due diligence and our long-term approach

come together in a client portfolio.

AUTHORS

BRAD ALFORD, CFA

Founded Alpha Capital in

2006. Over 28 years of

investment experience.

Former Managing Director

of the Duke Endowment

and Director of Endowment

Investments for Emory.

ANNA DUNN TABKE, CFA, CAIA

Joined Alpha Capital in

2012. Over 10 years of

investment experience.

Former investment

consultant with Mercer and

Rogerscasey (now Segal

Marco Advisors).

CONTACT

atabke@alphacapitalmgmt.com

www.alphacapitalmgmt.com

January 2018 Page 1

ADVISOR

ALPHA

A C L O S E R L O O K A T O U R M A N A G E R D U E D I L I G E N C E P R O C E S S

The goal of our deep due diligence process is to

determine whether a manager’s track record comes

from luck or from skill. By having a strong

understanding of a particular manager’s strengths,

weaknesses, investment philosophy, and character,

we hope to avoid making short-term decisions

based on emotion. We do the work up front so that

when we are faced with the inevitable investment

challenges, like a 10% decline, we don’t panic.

Ideally, we already understand why the manager is

struggling – it should be driven by a feature of their

investing style (an example would be a value

manager during a growth-oriented market), by a

specific investment they hold based on a longer-

term thesis (think of the managers who were early

into the non-Agency mortgage recovery), or by a

characteristic of the market (such as emerging

markets prices declining during risk-off

environments regardless of fundamentals).

With that in mind, we break manager evaluation

into three phases:

1. “Table stakes”

2. Quantitative analysis

3. Qualitative analysis

Let’s look at each phase in detail.

January 2018 Page 2

D U E D I L I G E N C E P H A S E 1 :

T A B L E S T A K E S

“Table stakes” here means meeting the minimum

requirements for due diligence. This is the first

hurdle that prospective managers must clear. Our

goal in this phase is simply to uncover basic issues

with the strategy or firm that may preclude them

from further examination.

Sample Questions for Phase 1

Is the firm registered with the SEC?

Are there any black marks on FINRA’s BrokerCheck

tool or the SEC’s Investment Advisor Public

Disclosure page?

Does the firm claim compliance with GIPS?

Is the vehicle appropriate for the strategy?

Strategy/vehicle match is key, especially in

liquid funds like mutual funds and ETFs. Third

Avenue ran a distressed debt mutual fund that

was well publicized for blowing up in 2015 after

investing too heavily in esoteric, illiquid

investments; a hedge fund or other limited

liquidity vehicle would have been more

appropriate.

Unified managed accounts (or UMAs for short,

where a manager provides a model portfolio

that the client trades) are popular, but many

investment strategies simply don’t work in a

UMA and many others are less effective. An

example is international equity UMAs, which

rely on ADRs so clients are not forced to

register to trade securities in foreign countries.

Is the firm dedicated to asset management?

We often run across strategies run by private

wealth firms where it is hard to gauge how

many of the firm’s resources are dedicated to

investment management. Private wealth

management is a high-touch business. Is the

firm a client service manager or a money

manager? It is easy to do both, but hard to do

both well.

www.alphacapitalmgmt.com

D U E D I L I G E N C E P H A S E 2 :

Q U A N T I T A T I V E A N A L Y S I S

Managers who clear Phase 1 progress to the next

phases of our due diligence process, quantitative

analysis. In truth, there isn’t a clear distinction

between Phase 2 (quantitative) and Phase 3

(qualitative) – our CIO, Brad Alford, prefers to look

at the quantitative analysis prior to meeting with a

fund manager, while our Director of Research,

Anna Dunn Tabke, prefers to meet with a manager

before examining the track record. Sometimes, the

quantitative analysis alone gives us reason enough

to nix a manager from further consideration – after

all, a manager must demonstrate success over the

long run. For the most part, however, qualitative

and quantitative analysis are performed

concurrently.

We use a quantitative system to review net of fees

performance history. If the team has been

managing the strategy for a longer time period in a

different vehicle, we typically append that longer

track record. In order to do so, however, we must

understand how the vehicles differ from one

another and what, if any, impact that should have

on our analysis of the track record.

Sample Questions for Phase 2

Does any part of the track record include a

backtest (especially applicable to “smart beta”

managers)?

Live strategies always have strong backtests.

We look at them, but we give them very little

credence during our due diligence process.

Is the strategy correlated to the other

recommended managers in a client portfolio? How

does this correlation change over time (using rolling

correlation analysis)?

What was the maximum drawdown of the strategy?

What was the most the strategy ever lost in one

month? When? How was the performance in 2008?

We sometimes get pushback from managers or

clients because of our particular focus on 2008.

After all, the next crash likely will look very

different than 2008, be driven by different

factors, and is not likely to be as severe. All of

these are valid points, but 2008 nonetheless

remains a real-life, relatively recent example of

a market crisis. We believe that a manager’s

performance and direction through and after

2008 says a lot about the strategy.

Does the strategy exhibit strong risk-adjusted

returns over a long time horizon?

How has performance been relative to the stated

benchmark? Are there other benchmarks we

believe are a closer match, and how has the

strategy performed relative to those benchmarks?

How has it performed relative to peers?

Note that a manager’s underperformance

relative to benchmarks or peers is not

necessarily a reason to reject the strategy.

Styles go out of favor for long periods of time

(just ask value investors during the tech bubble).

Or a manager may be a good deal more

conservative than its peer group (we see this in

short-duration fixed income). But some

managers simply haven’t proven they can add

value over the long term.

In which market environments has the fund

performed well or poorly? Do we expect this to

hold true going forward, or has a change been

made to the investment team, philosophy, or

process that might impact this?

This is a good example of how our quantitative

and qualitative due diligence phases are

connected. It’s not just about evaluating the

track record, it is about evaluating the quality of

the track record and using that to gain a deeper

understanding of what results the manager

should achieve going forward.

January 2018 Page 3 www.alphacapitalmgmt.com

D U E D I L I G E N C E P H A S E 3 :

Q U A L I T A T I V E A N A L Y S I S

Qualitative analysis is where we focus the majority

of our time and resources, and it is more art than

science. Our principals came from the institutional

world, where qualitative analysis is key. The focus

is on long-term investing, and in order to invest

client assets for the long-term, strategies must be

well-defined, articulated, and repeatable. An

institutional client might be invested in the same

strategy for 20 years, and they had better know

what to expect, or else they will not last through

the inevitable periods when the strategy is out of

favor.

There is far more to successful investment

management than identifying great ideas. A

portfolio manager might find a great stock, but he

or she also has to know when to buy and sell the

security. Our behavioral biases work against

rational investing. Here is a good look at these

behavioral biases and how they impact investors.

Portfolio managers should be better at decision-

making than the average investor. A good portfolio

manager must have the right temperament to be a

long-term investor, able to recognize and resist the

effects of these biases.

It is also very tempting for portfolio managers to

cheat, and plenty do. There are several ways to

cheat at this game – buying stocks at prices that

aren’t supported by fundamentals (consider many

so-called “value investors” during the tech bubble),

loading up on high yield bonds and other risky

assets in a core-oriented bond portfolio, creeping

up in size from small to mid-cap stocks as asset

levels grow too large to implement a true small cap

strategy, and plenty of other examples. Is a

manager staying true to his or her stated style and

philosophy, even when it isn’t performing well? The

longer an investment style is out of favor, or the

longer a particular sector (such as biotechnology)

seemingly defies gravity and keeps going up, the

harder it is to stay the course. Portfolio managers

need discipline, and we need to see examples of

that discipline over several market cycles.

Sample Questions for Phase 3

Have there been major changes to the investment

process, style, philosophy, team, resources, firm

ownership, investment offerings, or anything at all?

What impact might that have on future returns?

What is the structure of the investment strategy?

Are there any issues in the Prospectus, Statement

of Additional Information, or other legal filings that

might give us pause?

Although we review the structure of the

strategy briefly in Phase 1, we do a deep dive

here to understand as much as we can about

the investor experience, including in times of

crisis. Liquid alternatives have many wrinkles

when it comes to structure, so this analysis is

especially important when it comes to securities

and vehicles that are off the beaten path.

Do the portfolio managers invest in their own

products? Are the portfolio managers owners in the

firm? How are research analysts compensated?

A well-run investment firm should align the

incentives between portfolio managers,

research analysts, and investors as closely as

possible – unfortunately, not all of them do.

There are also special considerations depending on

the type of strategy we are examining. Here are

two examples for a quantitative strategy:

Is there is a qualitative overlay? How often does

the portfolio manager override the system?

How are transactions costs modeled, estimated,

and kept within a reasonable range?

P U T T I N G I T A L L T O G E T H E R

At the end of our manager due diligence process,

we want to be able to answer one simple question:

do we believe that this manager will add value in

client portfolios going forward?

The last installment of our Advisor Alpha series will

discuss how we build client portfolios based on our

investment philosophy and best manager ideas.

January 2018 Page 3 www.alphacapitalmgmt.com

ABOUT ALPHA CAPITAL MANAGEMENT

Our firm was founded in 2006 by Brad Alford. We

are located in Atlanta, GA. After spending nearly

two decades at large investment firms, Brad

wanted the freedom and flexibility to provide

customized services to his clients.

An independently owned advisory firm with an

eleven-year history, Alpha Capital seeks to provide

unbiased advice to our partners with our

investment-oriented services and solutions.

For more information on our firm, visit us on the

web at www.alphacapitalmgmt.com.

INVESTMENT ADVISORY SERVICES

Investment Advisory Services (IAS) is Alpha Capital

Management’s investment advice solution. We

build strategic partnerships with financial advisors

to improve investment outcomes for the individual

investor.

Flexibility and customization is the key to driving

value in our partnerships with financial advisors,

and we work to build solutions that are as unique

as the advisors we partner with.

For more information on IAS, visit our dedicated

website at www.alphacapitalmgmt.com/alphaIAS.

January 2018 Page 4