Those hedge funds who have the highest absolute returns are often those that receive significant media attention, including on ValueWalk. But in reality to a certain breed of allocator, the real performance stars seldom if ever make it onto the HSBC Hedge Weekly top 20 – and importantly generally stay off the bottom 20 as well. These are the volatility managers, those who deliver reasonably consistent returns with lower standard deviation, a prized possession for certain allocators. This concept speaks to mean reversion
Quantedge Global and BlueMountain may be very different, but both have targeted volatility well in the past
This month I have written about two hedge funds with very different returns and risk profiles but one thing in common.
Quantedge Global has a 30.15% standard deviation amid a roller coaster 26.76% annualized return. On the surface such a returns profile might seem uncontrolled. But Quantedge targets a 30% volatility up front – and he is beating his estimates. Up 44.35% year to date, the macro fund is thought to have a discretionary overlay on top of its systematic orientation. The fund is currently experiencing positive volatility, upside deviation – a key point of differentiation in systematic CTA investing. Quantedge appears to let their margin to equity ratios flow freely, particularly when strong market environments are identified.
At first glance BlueMountain Capital might seem like a completely different hedge fund. Take the $6.7 billion BlueMountain Credit Alternatives Fund. With plodding but consistent annualized returns of just 7.79% and an attention getting standard deviation of only 5.82%, BlueMountain and Quantedge might seem vastly different.
But in fact, they are both, based on past performance, volatility targeting experts. So who are some of the other such volatility players that might not make it into the HSBC Hedge Weekly top 20 spotlight?
Convertible arbitrage has numerous moving parts to the performance driver picture
Convertible Arbitrage is always an interesting relative value play. The investor is paid a rate of return and has the equal to an upside call option if the company is successful. Sometimes the bond investments are made in struggling companies that pay a high rate of return – and provide bond holders often preferred terms in a bankruptcy, a key and often volatility generating risk.
It is in this environment that Howard Fischer’s $460 Basso Investors Ltd looks interesting despite the out proportioned 25% drawdown from December 2007 to October 2008, into the teeth of the financial crisis. With a volatility of 5.73% and annual returns of 10.2%, the global Convertible Arb fund is up 3.94% year to date, significantly outpacing the HSBC category average of -0.42%. In terms of volatility, the fund is only beaten by Salar Convertible Absolute Return fund, which comes in at 3.54% standard deviation. However, just like looking only at absolute returns provides a skewed picture, considering only low volatility is less than ideal. In the case of Salar they might have low volatility but their 2.87% annualized return has disproportional downside deviation, particularly the nearly one-year drawdown of -7.33% the fund just escaped from this past June.
Taming volatility in emerging markets with Long / Short credit strategy, while multiple factors are at play when evaluating a manager’s volatility management
Another significant volatility winner operates a Long / Short credit strategy in emerging markets. Emerging market credit – particularly sovereign debt – has a volatile history. But judging solely from the raw performance numbers, the $949 million BAF LatAm Trade Finance Fund volatility / returns profile almost appears as a typo.
The fund’s 0.51% annualized volatility is juxtaposed to an 8.82% annualized return. Typically when one sees such headline performance, the next look then becomes the inception date. In this case the track record, which dates back to February of 2008 – and traverses through a financial crisis – on the surface mitigates concerns that Ernesto Lienhard’s fund might not have multiple market environment seasoning.
On the other end of the volatility swing is George Jiang’s $1.7 billion Golden China Fund, which is not stranger to the top and bottom of the HSBC absolute performance list. With a 24.12% volatility, the Equity Long / Short-Asia fund has annualized returns of 25.17%. When considering a volatility manager, certain systematic allocators get deep into the analysis. At first glance, overall volatility is considered, then they typically examine upside versus downside deviation and might run an analysis relative to the beta market environment. After this they might consider drawdown consistency. Top volatility managers have a certain pattern of operation that can be seen in part through the average versus worst drawdown statistics. Golden China Fund, for its part, let the downside deviation tiger out of the cage in October 2007. They had a worst drawdown of -64.64% from October 2007 to November of the following year, ending the drawdown right as the financial crisis began. Operating positively during crisis – protecting assets – is among the top considerations of a real volatility manager, and here Jiang appeared to benefit from volatility and price relationship divergence.