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July 31, 2000

The Midnight Trader

By Sanford Wexler

When most traders are inhaling their lunch, James Burns, president of Aventine Investment Management, is usually arriving at his trading desk.

Based in Huntington Station, N.Y., Aventine is a hedge fund that specializes in the Japanese securities markets. Burns typically starts his day around noon with administrative chores and keeps the same trading hours as the Japanese traders in Tokyo - 8:00 p.m. to 2:00 a.m Eastern Standard Time. "We straddle two time zones," he said.

Burns, who obtained an MBA in finance from New York University's Stern School of Business and holds a BSE from Princeton University, founded Aventine in 1993. Before establishing the hedge fund, he was vice president of Japanese derivative sales for six years at Cresvale International.

Aventine manages about $75 million in assets which is invested equally in two off-shore funds, including the Nippon Performance fund, a convertible bond arbitrage fund; and the Nippon Market Neutral fund, a multi-strategy fund that engages in convertible bond arbitrage, long and short equity, and high-yield arbitrage. Both funds have been averaging a return of about 16 percent annually. The firm handles about ten trades each day.

Just before 1996, when the Japanese market tanked, both funds were realizing returns of about 120 percent over one brief period and declines of 30 percent over another. The markets were wild. Since that time, Aventine has drastically restructured its risk mandate. The fund now follows a fully market neutral approach. "We have sacrificed the upside to deliver a consistent institutional product," Burns said.

Aventine has a staff of ten, including three trader/portfolio managers and one trader based in Tokyo. Its clients consist of institutions, including pension funds banks, professional investors and high net-worth individuals.

What attracted Burns to the Japanese marketplace is that, unlike the U.S. and European markets, it has structural and pricing inefficiencies that enable traders to implement relatively low-risk strategies and deliver high-risk returns. Foreign investors, moreover, can participate in short-selling while Japanese domestic institutions are generally prohibited from taking advantage of this hedging strategy.

"We are specialists in market neutral strategies," Burns said. "The unifying factor of all our strategies is that we don't take directional market risk."

One of Aventine's core strategies, for example, is convertible bond arbitrage. A convertible bond is a hybrid security - it's part stock and part bond. The convertible bonds that Aventine trades are all listed domestic Japanese convertible bonds that are traded on the Tokyo Stock Exchange.

Unlike the U.S. stock exchanges, convertible bonds are traded on the Japanese equity exchanges. "They trade just as often as shares of stock," Burns noted.

Aventine's overriding trading strategy is to buy Japanese convertible bonds and at the same time to short the underlying stock as well as the appropriate bond market. "We try to buy undervalued convertible bonds," Burns explained, "and sell short fairly priced shares of stock."

The hedge fund draws upon complex quantitative, arbitrage investment strategies, including statistical and option pricing theory. For trading equities, Aventine applies a "long and short" equity strategy. "We look to go long on undervalued stocks," Burns said, "and short on overvalued stocks."

The marked difference between Aventine and many other hedge funds, according to Burns, is that his firm goes long and short the exact same dollar amount. "The way we make money is by the long portfolio outperforming and the short portfolio underperforming," he explained. "We are long a portfolio of undervalued stocks in the anticipation and hopes that they will become less undervalued, and we are short a portfolio of overvalued stocks with the expectation that they are going to become less overvalued."

Unlike most equity hedge funds, Aventine does not have stock market exposure. Rather, it only has exposure to the relative values of both its long and short portfolios. Burns emphasized that his fund is "the most classic and conservative type of hedge fund."

Burning the midnight oil does not bother Burns. In fact, he finds that working late night hours gives him more time to spend with his two young boys, ages four and two. "It's nice to have some time in the morning with them," Burns said. "Sometimes I'm even able to have lunch with the boys."