By the time Aaron Izenstark and his partner, Howard Nixon, opened IRON Financial in 1994, they were veterans at managing downside risk. Both were members of the Chicago Board of Trade when the stock market crashed in 1987 and when the first Gulf War erupted in 1991-events that left a lasting impression on their investment philosophies. 

"When you're in the middle of these events in terms of financial markets, you get scars that never leave you," says Izenstark. "You're concerned that the next morning when you wake up, some other disaster is going to hit."

This sense of foreboding helped shape the new firm. "We tried to create a culture that manages for all times," he says, "not just an up market, not just a down market, but for all markets. The key is being prepared for all market conditions all the time. The strategies need to implement that."

IRON Financial, a registered investment advisor in Northbrook, Ill., with $1.3 billion under management, provides asset management services to individuals and institutions and corporate retirement services to employer-sponsored retirement plans.
The firm serves some 600 family offices and other private wealth clients across the country, with accounts of up to nine figures. The average allocation is in the $2 million to $5 million range.

Although IRON Financial's private client business is substantial, it's also "happenstantial," says G. William McCoy, the firm's chief development officer. "Those are clients who have approached us over time," he says. "We've never marketed for private clients. Our primary business, asset management and corporate retirement services, is focused solely on wholesale distribution channels-other intermediaries, including wealth managers."

"The best way to put it is, we're the wealth managers' asset manager," Izenstark says. All private clients, regardless of how they come to the firm, are in the same asset management programs, he adds.

Communicating Risk
Clients come to IRON for asset management, says Izenstark. "Our goal is always to communicate about how much risk the client wants to take. Many times, the client doesn't understand what that means," he says.

Education is a major component of the firm's initial interaction with clients, he says. "In my experience in talking with these clients, they always tell you how much they want to make, not how much they want to lose," he says. "Typically, the high-net-worth individual, and even the super high-net-worth individual, doesn't want any lifestyle change. So it's very important to make sure they understand the risk they're communicating to you and what that means."

Whatever understanding of risk clients do have tends to come from checking out financial software online, plugging some numbers in and looking at average annual returns, as opposed to drawdown or losses, Izenstark says. "We first focus on the worst possible scenario the investor might confront, " he says. "Many times, just because of their lack of knowledge, they're not schooled on what that risk would have been."

Once clients have established the level of risk they are willing to expose themselves to, the next step is portfolio construction, says Izenstark. "You first explain to them how they're invested and why they're invested and what that means in terms of beta, their general exposure to stocks and bonds," he says. "We don't think it makes sense to pay for beta. If you're just getting expensive exposure to the stock market, then there's a cheaper way to do that."

IRON Financial's strength-the area in which it can add value to a client's portfolio-is alpha management, Izenstark says. "We can add value as an asset manager by increasing return and lowering the overall standard deviation in a client's portfolio, which again comes to the alpha side," he says. Most clients allocate a piece of their overall assets to the firm, very often coming to the firm for the proprietary alternative strategies in which it specializes, he adds.

Alternative Strategies
IRON Financial's focus is designing liquid alternative strategies, whether in a 1940 Act mutual fund or an ETF that can be bought and sold with the push of a button, or a separately managed account that affords the client full liquidity, disclosure and transparency and that does not involve long lockups.

"We started the business with a high-yield strategy," Izenstark says.

The firm looks for the best risk-adjusted exposure to the high-yield market, which includes limiting drawdown during adverse market conditions.

The firm's high-yield strategy is a model Izenstark designed in the 1980s when he was a member of the Chicago Board of Trade, trading 30-year Treasury bonds. "Back then, there was a lot more volatility, so you had a less buy-and-hold mentality," he says. "The bond market was perceived as a lot more risky, a lot more volatile. By investing in money markets, you could get 9%; so unless you were doing something that had the potential of getting you higher than that, what was the point?"

He says the strategy is designed to look at the yield curve, credit spread and flows in and out of the high-yield market. It adjusts the exposure to the current high-yield market. Over time, it allows the manager to keep the lowest-cost, highest-quality exposure during good markets, which is beta, and then adjust the risk of that exposure during adverse market conditions. This is the alpha-"which is the only reason people should invest with us," he says.

IRON Financial delivers the high-yield strategy in a mutual fund it launched in October 2006: the IRON Strategic Income Fund (IFUNX). "We do it inside a mutual fund so the individual trades are the largest possible because it's inside a pooled account," says Izenstark. "The hedging techniques we use can be done only inside a qualified institutional type of account."

As of April 30, Morningstar ranked the fund number one out of 487 funds in the high-yield bond fund category for the sixth consecutive month, based on its three-year annualized return. The fund received a five-star rating in March, as well as a Morningstar return rating of "high" and Morningstar risk rating of "low," the most favorable ratings in those categories.
"We're not just exposed to the high-yield market," says Izenstark. "We'll use hedging techniques to limit credit risk during adverse market conditions."
IRON Financial offers other strategies in a managed account format. "We also manage short-term corporate bond strategies, convertible strategies and dedicated short-stock strategies," says Izenstark. "We call those alpha strategies. The whole idea is to try to lower the risk and increase the average annual return to your portfolio."

The IRON Financial team discusses portfolio construction with its high-net-worth clients or their consultants to show how the firm's strategies may fit into their portfolios. "They may say, for instance, that they would like dedicated exposure to high yield, but don't know when to invest in it and when to raise debt," says Izenstark. "Our strategy is designed to provide dedicated exposure to high yield, so they don't have to think about when to increase or decrease exposure to the market. That's what we do."

The same thing applies to the way the firm manages convertibles, short-term corporate bonds and short-stock strategies. "Most people don't understand what a dedicated short-stock strategy would be," he says. "A separately managed account is a way they can do it, have full transparency and see how that fits into their portfolio."

Incubating Ideas
Izenstark says that when he talks about alternatives, he is not interested in something that is locked up, such as private equity or many hedge funds. Instead, the firm has developed a think tank for alternative strategies and risk exposure to various markets.

The firm's investment department of six people, including two quantitative researchers, meets weekly in an effort to generate investment ideas to which IRON Financial might add value. The firm puts some of the new models to work in the market and incubates them with its own money to see whether they are viable. "Sometimes you have ideas that look like they would work in the market, but are actually impossible to execute," says Izenstark. "It's an inventor's shop. The difference is we try to do that with the capital markets as opposed to hard commodities, light bulbs or what have you."

In summing up IRON Financial's place in the market, Izenstark returns to his days as a floor trader. "Our competitive advantage is having these battle scars over time and then creating a culture of individuals in both management and the investment department that believe in that," he says. "The people who are going to work with us, especially on the investment side, are going to have this belief of needing to look at the downside and protect for downside. We like to be involved with people who have been in front of the freight train and not been able to get out of the way."