V2 Capital Pursues A Liquid Alternative

Last fall, Victor Viner, the founder and chief investment officer of V2 Capital, converted his hedge fund into a liquid alternative fund. Why? Its all about liquidity and the clients needs.

The year 2014 was a rough one for hedge funds in the U.S. According to data from Hedge Fund Research, 461 funds closed in the first half of 2014 alone. If this pace were to continue to the end of the year, Bloomberg News estimates that 2014 would be the worst year for hedge funds since 2009, which saw 1,023 liquidations. Bloomberg also estimates that hedge funds saw an average return of 2 percent, the worst year of returns since 2011.

With this dire outlook of diminished returns and an uncertain future, what is an ambitious money manager to do? If youre Victor Viner of V2 Capital, you see an opportunity in the crisis. The Chicago-area-based chief investment officer and founder of V2 Capital converted assets from his Hedge Equity Strategy Limited Partnership Structure into the new V2 Hedged Equity Fund. With assets of roughly $240 million, the open-ended single-manager mutual fund began trading on Halloween. According to company claims, its the largest hedged equity mutual fund launch of the year.

Why take this risk at this time? According to Viner, he has read all of the reports and agrees that it has been a tough time for hedge fund managers for several reasons. One, youve seen over the last couple of years the flow of funds into the managers and into the companies, Viner said. The larger companies are getting the vast majority of inflows. There are any number of statistics that bear this out, but clearly the top funds in terms of size have anywhere from 80 to 90 percent of all the assets.

Shakeout Healthy and Good

The smaller firms are having a hard time raising assets, and sometimes its irrespective of performance, he added. Now, you add in not the greatest performance of the industry as a whole relative on a net basis, and youre seeing a little bit of a shakeout, which I think is healthy and good.

Viner launched his new fund by converting a limited partnership vehicle into a Liquid 40, also known as a liquid alternative. We had one of the largest, if not the largest, launches within our category on Morningstar, which is the long/short, he said.

A 40 Act fund refers to The Investment Company Act of 1940, which was passed by Congress in August of that year. The regulation grew out of the wreckage of the stock market crash of 1929 as an attempt to bring stability to U.S. markets and to gun-shy investors. The law requires fund managers to register with the SEC, have a board of directors in place, and have cash on hand for investors who wish to cash out.

According to a press statement, the V2 Hedged Equity Fund will provide daily pricing and daily liquidity to institutional and high-net-worth clients. The fund is broken into a pair of classes: an Institutional Class that will be listed under the ticker VVHIX, and an Investor Class listed under the ticker VVHEX, with minimum initial investments of $100,000 and $1,000, respectively.

The V2 funds objective is straightforward: It will seek to provide long-term capital appreciation with reduced volatility, according to the press statement. As the funds manager, Viner and his team will seek to combine a long, concentrated portfolio of 30 to 50 U.S. equities with a short portfolio of customized S&P 500 Index options, the statement said.

With the fund, V2 will have the ability to transform its older fund into a 40 Act fund with daily liquidity. Many hedge fund strategies dont [do this]. I would argue most dont because of the instruments they use; there are liquidity provisions. You have to conform to the 40 Act statute as to what you can have in your portfolio and how much illiquid assets and how much leverage and all of these things, Viner told Traders.

Therefore, Viner and his 13-person team in Glenview, Ill., north of Chicago, didnt have to change very much in their operations. They will manage their ’40 Act vehicle the exact same way theyve managed their hedge fund. Viner called it an easy transition for us to go from one structure to another.

From a business standpoint, it just makes perfect sense because Im running a business, and, first and foremost, I have to do best for my customers, he added. I look at whats best for investors who want to get access to our strategy. If we can provide competitive fees and we can provide transparency and daily liquidity and all the regulatory and oversight benefits of having a RIC, a Regulated Investment Company that comes within a 40 Act, it makes perfect sense.

Liquidity Concerns

Todays investors are truly concerned about liquidity, and these fears have grown since the dark days of 2008 and 2009. Over the course of last year, industry analysts noted the lack of volatility in the market, despite explosive world events such as Russias annexation of Crimea, the plummeting price of oil and fears that the recovery in Europe may be further stalled. The lack of liquidity has been especially tough on smaller investment firms, Viner told Traders. With this in mind, investors large and small are also taking a close look at fees charged by mutual funds and hedge funds.

What we and what other firms that have jumped into this space have done is give up the ability to charge a performance fee. For a lot of the more established, larger funds that charge performance fees and 2 and 20 or whatever the number is, if theyre sitting with a substantial asset base, say a billion or more, many are not going to want to give that up, Viner explained.

V2 Capitals new fund will trade in a more liquid strategy. We know what our capacity is; we trade in large-cap U.S. equities; we trade in customized exchange-based options and derivatives, he said. I feel that the type of exposure were offering clients and investors, which is U.S. equity exposure with a lower overall profile and better risk-adjusted returns with a net-long bias, just makes sense.

Considering the Options

And clients are enthusiastic about investing via derivatives. According to Viner, people are trying to understand how to use derivatives to mitigate risk and reduce volatility. He points to a quote from Peter L. Bernstein in his book Against the Gods: The Remarkable Story of Risk. Bernstein says, Derivatives are like a razor blade: you can use them to get up in the morning and shave, or you can use them to slit your wrists and kill yourself.

For Viner, its not the instrument but how its used. In our case, we use derivatives. We use calls and we use puts, but we use them solely to reduce the risk in what were doing, he said.

When asked if trading derivatives is still confusing to market participants, Viner likens it to former Speaker of the House Nancy Pelosis famous quote about Obamacare. For some new investors, he says, its kind of like the health-care bill: You have to pass it to see whats in it.

So why not just trade equities? Today, there are not too many really great short equity traders and managers out there because of the challenging environment. For me, using derivatives effectively is a more efficient way. There are also some anomalies in the volatility space that allow us to take advantage of that.

Rising Above the Noise

Another challenge for hedge fund and mutual fund managers is rising above the noise. Despite a rough year with some spectacular closings − SAC Capital closed to trade just the funds of beleaguered owner Steven A. Cohen, and Brevan Howard Asset Management closed its $37 billion fund − the hedge fund arena remains crowded. Viner acknowledges that he has his work cut out for him: We have to be better. We have to communicate and educate more effectively, and we have to figure out a way to tie into the distribution channels because I cant hire enough people to go out to thousands of branches of wealth managers and registered investment advisors, broker-dealers and wirehouses.

For V2 Capital to stand out, Viner and his team need to offer a competitively differentiated product that is run by experienced investors. Hopefully, we can attract investors based on our performance, our pedigrees and our track record, and then we have to do well, he said.

How Viner Trades

When it comes to actual trading, V2 Capital is old school. In the entire 13-person team, two employees are traders and Viner does not do any trading himself. The fund also eschews HFT by holding stocks for a lengthy time period. It does not create hedges with high-frequency or low-latency trading. We don’t do a lot of trading, he told Traders.

For instance, on our long book we have very low turnover, so were not in and out. Our turnover is less than 25 percent annually. In our short book, were trading more frequently than that, but we are the antithesis of a high-frequency-trading shop.

When asked if this means that he holds stocks for more than three seconds, he quipped, More like three years.

The CIO of V2 Capital described his approach as being agnostic when it comes to broker-dealers. He will use some algorithms when trading stocks, but when trading on the options side, We use models that Ive developed over the last 15, 20 years.

As for trading tools, he relies on Bloomberg but has no interest in mobile trading technology via Apple iPads or over smartphones. Our edge isnt in trading, he said. If you understand how the over-the-counter business works when you want to do an option trade, for instance, you literally would call up various desks and youd price it out. So were talking old school. We don’t quite do that, but yet we do something similar to that, so theres no reason for using anything other than our standard server-based trading environment.

The 54-year-old Viner started trading at the CBO in 1982. He co-founded Volaris Advisors, a multi-billion-dollar equity options advisory firm that was acquired by Credit Suisse Group. One of the longtime investors in the fund has been Ken Langone, co-founder of Home Depot. Despite a true love of trading, Viner left high finance to earn his masters degree and attend medical school in Chicago. He said that he loved his experience but did not pursue a residency. Instead, he started a software company, which seems to be the 1990s equivalent of hitting the open road back in the 1960s.

Medicines great, but I did what made the most sense at that time; but I got a great education, he said. The self-confessed late starter is married with three children under the age of 10 and said that he spends too much time at the office, in his wifes opinion.

Even after a quarter-century, Viner still loves the investing world. Im a math guy, and I liked the mathematical aspects of investing. I took a detour in the early 90s when I was 32; I went to graduate school and medical school. He returned to capital markets in the late 1990s and hasnt looked back since. I like it, its fun and its intellectually challenging.

One more salient point: Its very Darwinian: If youre good, you get paid well.