Time marches on.
As the financial crisis of 2008 recedes into memory, the market surges upward and volatility subsides, investor demand for options as protection fades. While clients are still concerned about risk, they are also interested in making money in the current low-interest-rate environment.
One hedge fund manager, which offers both an alpha fund and a tail-risk strategy designed to protect against crisis periods, is finding that clients are opting for the alpha strategy after comparing the two. A fund’s alpha is the excess return of the fund relative to the return of the benchmark index.
“When interest rates are as low as they are, investors have to reach a little further to find absolute return. So any positive alpha businesses are attractive right now,” said Justin Golden, chief operating officer of Lake Hill Capital Management, a hedge fund specializing in quantitative strategies using exchange-traded derivatives.
Lake Hill was founded in 2005 by Zem Sternberg, the firm’s CEO and a former managing director at Salomon Brothers, and Scott Kovarik, a former partner at George Weiss Associates and head of quantitative research at Lake Hill.
The money manager has $100 million in assets under management and offers three strategies: the tail-risk program and two alpha strategies. One invests in equity index options, and the other also includes energy, metals and other commodity futures and options.
The hedge fund, which makes money via electronic trading in support of its strategies, first made the strategies available to the public in late 2011. Clients, who invest in the firm’s strategies or have separately managed accounts, include institutional investors and high-net-worth individuals. The firm, which is paid via performance fees, can also run its strategies inside client accounts.
Potential clients often come to Lake Hill with an interest in the tail-risk strategy. But after comparing it with the alpha program, they usually opt for the latter, Sternberg said.
The decision they must make: Would they rather have alpha, or would they rather pay to protect their beta, or market exposure? The cost of hedging that beta can be expensive and can degrade returns, Golden said.
However, in choosing one of Lake Hill’s alpha programs, which are relative value volatility funds, these clients are not necessarily embracing risk. That’s because the fact that the alpha strategy’s performance is not correlated with the S&P 500 Index helps clients achieve diversification, Golden said.
Some investors are looking to build portfolios with uncorrelated investments that can provide absolute returns, and that is how they are using Lake Hill’s alpha strategy, he said. “This is a way to ‘all weather’ your portfolio-to find investments that can make money in a variety of market conditions,” he said.
Golden, who joined the firm over one year ago, is a former head of institutional equity derivatives sales at Bank of America in London. He is responsible for expansion efforts and product launches, as well as investor relations.
Lake Hill’s alpha strategy involves trading broad-based index options on indices like the Standard & Poor’s 500 and Russell 2000 indices, and hedging those positions with the underlying futures or ETFs The firm does not trade any single stocks, Golden said.
The quantitatively driven strategy involves being both long and short options-buying relatively cheap options and selling relatively expensive options, Sternberg said.
While the options trades are on the same underlying, it is not an arbitrage, said Golden, adding that arbitrage implies riskless profit. “We trade relative value across the different parts of the option curve within a given maturity, a strategy known as skew trading,” he said. “There is no free lunch in doing this. It is a lot of work.”
Lake Hill uses historical data and live data to determine the fair values of the options. Then the firm’s computerized and automated systems compare those fair values to the actual option prices trading in the market to determine what’s relatively cheap and what’s relatively expensive, he said.
As well, the portfolio is tuned through rules-based risk management to target a volatility that is tolerable to the firm’s clients, Golden said.
The firm, which identifies opportunities on a real-time basis, trades once a day, using options with expirations of 30 to 90 days. The average trade is small, Sternberg said. The firm can trade “hundreds and hundreds of odd lots” because of its automated trading system, he said.
Golden says that there are very few firms that offer a similar strategy, adding that Lake Hill is the only firm with a publicly available offering like the firm’s alpha strategy.
The interest in alpha strategies as compared to tail-risk strategies makes sense to one analyst. While institutional investors looked to options following the 2008 stock market crash, volatility and “the fear factor” have abated since then, said Howard Tai, a senior analyst with Aite Group.
“Outside of a major military conflict worldwide, or economic disaster coming out of Europe, in particular, it looks like a benign environment and the central banks are trying to keep interest rates at zero,” Tai said. “That lessens the fear factor and volatility.”
(c) 2013 Traders Magazine and SourceMedia, Inc. All Rights Reserved.
http://www.tradersmagazine.com http://www.sourcemedia.com/
