Quant Macro Investing

Risk Taking Disciplined

January 21, 2010 – Stock Returns and Changes in Implied Volatility

http://www.cxoadvisory.com/blog/external/blog1-21-10/

Are there reliable and exploitable predictive relationships between stock returns and changes inimplied volatility? In the January 2010 version of their paper entitled “The Joint Cross Section of Stocks and Options”, Andrew Ang, Turan Bali and Nusret Cakici investigate the relationship between changes in implied volatility and stock returns for individual stocks. Using monthly implied volatilities and associated stock prices and firm fundamentals for a broad sample of U.S. stocks over the period January 1996 through September 2008 (153 months), they conclude that:

  • Stocks with large increases in call-implied (put-implied) volatilities tend to rise (fall) over the following month.
  • The spread in average next-month returns and three/four-factor alphas between the highest and lowest quintile portfolios formed monthly by ranking the entire sample on changes in call-implied volatilities is about 1% per month. A double ranking first on changes in put-implied volatility for the entire sample and then on changes in call-implied volatilities within the lowest put-ranked quintile enhances this spread. (See the chart below.)
  • Options for stocks with high returns over the past month tend to have increases in call-implied volatility over the next month, with an abnormal stock return of 1% implying an increase in call-implied volatility of about 3%.
  • The predictive power of changes in implied volatilities for stock returns stems from idiosyncratic, not systematic, volatility components. In other words, the predictive relationship derives from information about the stock and not information about the market.
  • Results are consistent with the presence of informed traders in both the equity and options markets, with slow inter-market information diffusion.

The following figure, constructed from data in the paper, shows the average next-month gross returns for two sets of equally weighted quintile portfolios formed monthly over the entire sample period. One set derives from ranking the entire sample on the monthly change in call-implied volatility. The other derives from ranking first on the monthly change in put-implied volatility and then ranking the lowest resulting quintile on the monthly change in call-implied volatility. Results indicate that: (1) the larger the change in call-implied volatility, the larger the expected stock return; and, (2) combining the information in changes in put-implied and call-implied volatilities may enhance power to predict stock returns.

It is not obvious that this predictive power is exploitable at the net level (after trading frictions), especially for individual investors.

In summary, evidence suggests that investors may be able to gain an edge from the power of changes in implied volatilities to predict returns for individual stocks, and the power of stock returns to predict future changes in implied volatilities.

For related research, see Blog Synthesis: Volatility Effects.

January 22, 2010 Posted by | Case Study, Indicator setup | Leave a comment

FT: Hedge fund manager seeks to stay top of tree

Hedge fund manager seeks to stay top of tree

By Sam Jones

Published: January 13 2010

Alan Howard’s first job was, fittingly, to look after the keys to the London Stock Exchange.

He was there – straight out of London’s Imperial College – on a three-week work experience in the summer of 1986, in the weeks running up to the so-called “Big Bang” in the City of London – the convulsive reforms that, among other things, helped to pave the way for the growth in London’s hedge fund industry.

A quarter of a century on, Mr Howard is taking full advantage of those changes. Brevan Howard, the publicity shy hedge fund manager that he founded in 2002 with colleagues from Credit Suisse, has been one of the industry’s strongest performers over the past two years. It now has about $27bn (£18.1bn) in assets under management, making it the largest hedge fund in Europe and among the top five in the world.

“He’s one of the best traders in the world,” said one institutional investor. “Everyone has heard of Paul Tudor Jones and George Soros, but Alan has already outdone them.”

The investment strategy that Brevan deploys – global macro – is based on trading the bond and currency markets. It is widely tipped for a successful 2010, because of huge shifts anticipated in global trade and economic balances. Demand has been so strong that the firm has already shut its doors to new money from clients.

pop-up: Brevan Howard FundLike most large funds, Brevan Howard suffered huge redemptions – about $9bn – from investors after the collapse of Lehman Brothers, but unlike other large peers, it has taken Brevan a remarkably short time to return, and surpass, its previous peak.

With institutional investors now looking to increase their asset allocations to the hedge fund industry, strong performances such as that reported by Brevan Howard are in short supply.

In 2008, the master fund made 20.4 per cent, in a year when the average hedge fund lost close to the same amount. In 2009, according to performance numbers sent to clients earlier this month, the fund returned more than 18 per cent. The firm has not yet had a down year.

Brevan Howard also has two listed versions of its funds on the London Stock Exchange – a point of pride for the firm. A plaque in Brevan Howard’s lobby commemorates the launch of the vehicles, which aim to track performance of the firm’s main offshore funds.

Mr Howard remains at the centre of the Brevan funds’ trading. He still sits in the middle of the trading floor – housed in the former headquarters of Marks and Spencer on Baker Street.

According to people familiar with the situation he trades as much as a quarter of the funds’ assets himself. Indeed, close to three-quarters of all trading – billions of dollars worth – is done by a small team of fewer than 10 traders.

Although the instruments traded, which range from government bonds through to options contracts and derivatives, can be complex, the outlook, according to people invested with the firm, is qualitative. “Alan is an extremely intuitive trader,” says one large fund of funds manager. “They don’t just know about the bond market but have a proper feel for it.”

A lot of the success of the firm, however, is also down to risk management as much as pure returns.

Like many peers, the funds run to strict risk limits. Traders are given mandates set by the firm’s risk management committee that limit what they can trade. Losses are closely monitored and quickly curtailed. The more a trader loses, the less money he or she is given to manage by Aron Landy, the chief risk officer. Even Mr Howard is subject to the same strictures.

The process pays off. Brevan Howard began to de-risk its books aggressively in 2007, well ahead of many other hedge funds and financial institutions. The collapse of two Bear Stearns-backed funds that year prompted a dramatic revision of Brevan Howard’s outlook.

The firm significantly decreased leverage, moving as much as 70 per cent of its book into highly-liquid cash-like securities as it became apparent that markets were beginning to seize.

In addition, Brevan Howard also reviewed its counterparty risks, cutting its exposure to investment banks it saw as risky. The firm has all of its cash assets in custodial accounts at BNP Paribas, separate to the prime brokers it uses.

The greatest challenge the firm now faces is how to stay on top.

The hedge fund industry is fickle and retaining talent is a constant challenge.

For example, Jean-Philippe Blochet, a founding partner and the B in Brevan, left the firm in autumn 2009 to join rival Moore Capital. The key question for Brevan Howard now is how it manages to continue beyond the careers of its founders.

January 14, 2010 Posted by | Hedge Funds | Leave a comment

Tracking A Hedge Fund’s UK Positions

http://www.marketfolly.com/2009/09/tracking-hedge-funds-uk-positions.html

http://www.marketfolly.com/2010/01/tracking-hedge-fund-positions-in-uk.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed:+MarketFolly+(Market+Folly)

Tracking A Hedge Fund’s UK Positions

Before we continue to look at the positions prominent hedge funds hold in UK markets, we thought it would be prudent to post up an informational piece regarding the nature of the UK regulatory system as it applies to hedge fund disclosure. Firstly, there is no UK equivalent to the SEC’s 13F filing in which funds have to file their holdings on a quarterly basis here in the United States. In the UK, hedge funds do not have to file on a periodic basis at all. Instead, large shareholders are only required to flag long holdings that are greater than 3% of a company’s issued equity. This means that small hedge funds often do not register on the filing radar at all unless they invest in very small companies. Large funds on the other hand often leave a footprint and we can track their activities with ease (particularly when they are buying small and medium sized companies). Their investments in large cap companies, however, often go (legally) unreported and unnoticed because they do not trigger the 3% threshold. This is most similar to an SEC 13G filing (or 13D filing sans the activism) in the United States whereby a fund has to disclose after they have acquired a 5% or greater ownership stake in a company. We routinely cover 13G filings here at Market Folly and these UK filings can be regarded as their regulatory version of a 13G.

In the UK, once a fund crosses above 3% of a company’s equity in issue it has to report any further changes at 1% increments (regardless of whether it is a purchase or a sale). For example, if a fund moves from 3 to 4% of equity in issue or from 4 to 5, they must report. They must also report sales, for example, from 7 down to 6% until it gets below the 3% threshold where one final filing is required to acknowledge that the fund no longer has a concentrated ownership stake.

The additional filings made at 1% increments are interesting because the funds have to provide the trading date on which the threshold was crossed. This date can then be used to make a rough estimate of the price the fund was willing to pay for a company. Arguably, purchase price information is particularly useful if the fund being tracked is well known for excelling at fundamentally driven or deep value research. It is perhaps less meaningful if the fund follows momentum driven investment strategies such as those used by many Commodity Trading Advisers as these funds often move in and out of positions with much more alacrity and disregard for valuation.

Finally, just like in the United States, we can only provide information on a fund’s long positions in UK markets. Short positions do not have to be disclosed except if they are in financial companies or companies involved in rights issues. We will cover the UK disclosure rules on shorts and disclose some hedge fund short positions in a later article, so stay tuned.

Hopefully this gives everyone unfamiliar with the subject a brief background on how regulatory disclosures work in the UK. Now that we’ve presented this preface, look for more articles relating to various positions hedge funds hold in UK markets going forward.We’ve already covered Lone Pine Capital’s UK holdings, Lone Pine’s recent movements, Sprott Asset Management’s defensive UK portfolio, as well as Citadel’s positions. Then later this morning we’re also going to take a look at the UK holdings of legendary macro investor, Louis Bacon. And, as always, we’ll continue to track the US holdings of prominent hedge funds in our portfolio tracking series, so check back daily.

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Tracking Hedge Fund Positions in the UK

We had previously published a brief look at how to track a hedge fund’s positions in the UK. We wanted to update that piece a bit and break it down to make it easier to understand. After all, we occasionally cover hedge fund holdings in UK markets. Recently, we’ve detailed how hedge fund Eton Park expanded their UK positions and you can view the rest of our UK updates here. So, let’s examine how to do this:

The UK differs from the US in that disclosure is not required on a periodic basis (as in the case of disclosures required quarterly on a 13F in the US). Instead of “across the board” disclosure on a regular basis the UK system is more event driven. There are four main sets of circumstances under which investment funds and hedge funds are required to disclose long and short positions in UK listed companies.

1. Large holdings in a company

Shareholders with a substantial long position of greater than 3 per cent of a company’s outstanding equity are required to disclose it. Note that this includes rights to acquire shares via derivatives at a later date such as Contracts for Difference (CFDs) or options.

Once a fund crosses above 3% of a company’s equity it has to report any further changes at 1% increments (regardless of whether it is a purchase or a sale). For example, if a fund moves from 3 to 4% of total ordinary shares or from 4 to 5%, they must disclose the change. They must also report sales, for example, from 7 down to 6% until they fall below the 3% threshold where one final filing is required to acknowledge that the fund no longer has a concentrated ownership stake.

Large shareholders in companies that trade on the main market are required to simultaneously inform the issuer and the Financial Services Authority (FSA) of changes to major holdings using a TR-1 form. Substantial shareholders in companies that trade on the exchange-regulated markets (such as AIM or Plus Markets) need only inform the issuer of changes to major holdings in that issuer’s shares. Issuers must then disclose this information to the wider market via the Regulatory News Service of the London Stock Exchange.

2. Takeovers

Under Rule 8.3 of the Takeover Code if a fund holds 1% or more of the stock of the offeror or the offeree in a takeover all dealings (including derivatives) must be disclosed by no later than 3.30 pm (London time) on the day following the date of the relevant transaction. This requirement continues throughout the offer period. A disclosure table giving details of the companies involved in takeovers is available for the public to view on the Takeover Panel’s website.

If two or more hedge funds act together to acquire an interest in the securities of the offeror or the offeree company they are deemed to be a single entity and need to disclose as such. Under Rule 8.1 all transactions in the stock of the offeror or of the offeree company by the offeror or the offeree company must be disclosed by no later than 12.00 noon (London time) on the business day following the date of the relevant transaction.

3. Rights issues and short positions

Hedge funds that have a short position of 0.25% or greater in a UK listed company that is undertaking a rights issue are required to disclose it. The deadline for disclosures is 3.30 pm on the business day following the day the short position threshold was crossed

4. Financial companies and short positions

Hedge funds that are net short of a UK financial sector company are required to disclose the position if it is greater than 0.25% of the firm’s issued share capital. In addition, the fund must disclose each time it increases the short by 0.1% of issued share capital (e.g., at 0.35%, 0.45%). The list of companies deemed to be “fianancial sector companies” is available in PDF format on the FSA website .

We’ll continue to cover hedge fund movements in UK markets. Click here to follow our coverage on UK portfolio updates thus far.

Further Reading

Disclosure of Contracts for Difference – Questions & Answers – Version 2 [PDF]

List! Issue No. 14 – Transparency Directive – December 2006 [PDF]

List! Issue No. 14 (Updated) – April 2007 [PDF]

Additional information on the responsibilities of major shareholders is also available.

Information about third country investment manager disclosure non-EEA investment managers. [PDF]

The Takeover Panel’s website.

January 14, 2010 Posted by | Case Study | Leave a comment

Contrarian Investor Sees Economic Crash in China

1. Mr. Chanos, 51, whose hedge fund, Kynikos Associates, based in New York, has $6 billion under management, is hardly the only skeptic on China. But he is certainly the most prominent and vocal.

2. A contrarian by nature, Mr. Chanos researches companies, pores over public filings to sift out clues to fraud and deceptive accounting, and then decides whether a stock is overvalued and ready for a fall. He has a staff of 26 in the firm’s offices in New York and London, searching for other China-related information

3. At Kynikos Associates, he created a firm focused on betting on falling stock prices. His theories are summed up in testimony he gave to the House Committee on Energy and Commerce in 2002, after the Enron debacle. His firm, he said,

(i) looks for companies that appear to have overstated earnings, like Enron;

(ii) were victims of a flawed business plan, like many Internet firms; or

(iii) have been engaged in “outright fraud.”

The New York Times

January 8, 2010

Contrarian Investor Sees Economic Crash in China

By DAVID BARBOZA

SHANGHAI — James S. Chanos built one of the largest fortunes on Wall Street by foreseeing the collapse of Enron and other highflying companies whose stories were too good to be true.

Now Mr. Chanos, a wealthy hedge fund investor, is working to bust the myth of the biggest conglomerate of all: China Inc.

As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse,” he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.

“Bubbles are best identified by credit excesses, not valuation excesses,” he said in a recent appearance on CNBC. “And there’s no bigger credit excess than in China.” He is planning a speech later this month at the University of Oxford to drive home his point.

As America’s pre-eminent short-seller — he bets big money that companies’ strategies will fail — Mr. Chanos’s narrative runs counter to the prevailing wisdom on China. Most economists and governments expect Chinese growth momentum to continue this year, buoyed by what remains of a $586 billion government stimulus program that began last year, meant to lift exports and consumption among Chinese consumers.

Still, betting against China will not be easy. Because foreigners are restricted from investing in stocks listed inside China, Mr. Chanos has said he is searching for other ways to make his bets, including focusing on construction- and infrastructure-related companies that sell cement, coal, steel and iron ore.

Mr. Chanos, 51, whose hedge fund, Kynikos Associates, based in New York, has $6 billion under management, is hardly the only skeptic on China. But he is certainly the most prominent and vocal.

For all his record of prescience — in addition to predicting Enron’s demise, he also spotted the looming problems of Tyco International, the Boston Market restaurant chain and, more recently, home builders and some of the world’s biggest banks — his detractors say that he knows little or nothing about China or its economy and that his bearish calls should be ignored.

“I find it interesting that people who couldn’t spell China 10 years ago are now experts on China,” said Jim Rogers, who co-founded the Quantum Fund with George Soros and now lives in Singapore. “China is not in a bubble.”

Colleagues acknowledge that Mr. Chanos began studying China’s economy in earnest only last summer and sent out e-mail messages seeking expert opinion.

But he is tagging along with the bears, who see mounting evidence that China’s stimulus package and aggressive bank lending are creating artificial demand, raising the risk of a wave of nonperforming loans.

“In China, he seems to see the excesses, to the third and fourth power, that he’s been tilting against all these decades,” said Jim Grant, a longtime friend and the editor of Grant’s Interest Rate Observer, who is also bearish on China. “He homes in on the excesses of the markets and profits from them. That’s been his stock and trade.”

Mr. Chanos declined to be interviewed, citing his continuing research on China. But he has already been spreading the view that the China miracle is blinding investors to the risk that the country is producing far too much.

“The Chinese,” he warned in an interview in November with Politico.com, “are in danger of producing huge quantities of goods and products that they will be unable to sell.”

In December, he appeared on CNBC to discuss how he had already begun taking short positions, hoping to profit from a China collapse.

In recent months, a growing number of analysts, and some Chinese officials, have also warned that asset bubbles might emerge in China.

The nation’s huge stimulus program and record bank lending, estimated to have doubled last year from 2008, pumped billions of dollars into the economy, reigniting growth.

But many analysts now say that money, along with huge foreign inflows of “speculative capital,” has been funneled into the stock and real estate markets.

A result, they say, has been soaring prices and a resumption of the building boom that was under way in early 2008 — one that Mr. Chanos and others have called wasteful and overdone.

“It’s going to be a bust,” said Gordon G. Chang, whose book, “The Coming Collapse of China” (Random House), warned in 2001 of such a crash.

Friends and colleagues say Mr. Chanos is comfortable betting against the crowd — even if that crowd includes the likes of Warren E. Buffett and Wilbur L. Ross Jr., two other towering figures of the investment world.

A contrarian by nature, Mr. Chanos researches companies, pores over public filings to sift out clues to fraud and deceptive accounting, and then decides whether a stock is overvalued and ready for a fall. He has a staff of 26 in the firm’s offices in New York and London, searching for other China-related information.

“His record is impressive,” said Byron R. Wien, vice chairman of Blackstone Advisory Services. “He’s no fly-by-night charlatan. And I’m bullish on China.”

Mr. Chanos grew up in Milwaukee, one of three sons born to the owners of a chain of dry cleaners. At Yale, he was a pre-med student before switching to economics because of what he described as a passionate interest in the way markets operate.

His guiding philosophy was discovered in a book called “The Contrarian Investor,” according to an account of his life in “The Smartest Guys in the Room,” a book that chronicled Enron’s rise and downfall.

After college, he went to Wall Street, where he worked at a series of brokerage houses before starting his own firm in 1985, out of what he later said was frustration with the way Wall Street brokers promoted stocks.

At Kynikos Associates, he created a firm focused on betting on falling stock prices. His theories are summed up in testimony he gave to the House Committee on Energy and Commerce in 2002, after the Enron debacle. His firm, he said, looks for companies that appear to have overstated earnings, like Enron; were victims of a flawed business plan, like many Internet firms; or have been engaged in “outright fraud.”

That short-sellers are held in low regard by some on Wall Street, as well as Main Street, has long troubled him.

Short-sellers were blamed for intensifying market sell-offs in the fall 2008, before the practice was temporarily banned. Regulators are now trying to decide whether to restrict the practice.

Mr. Chanos often responds to critics of short-selling by pointing to the critical role they played in identifying problems at Enron, Boston Market and other “financial disasters” over the years.

“They are often the ones wearing the white hats when it comes to looking for and identifying the bad guys,” he has said.

January 10, 2010 Posted by | Hedge Funds | Leave a comment

BlueCrest’s Platt Turns Grandma’s Advice Into Hedge Fund Gold

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BlueCrest’s Platt Turns Grandma’s Advice Into Hedge Fund Gold

By Stephanie Baker and Tom Cahill

Jan. 6 (Bloomberg) — In a darkened 19th-century former church near London’s Regent’s Park,Michael Platt sips white wine and contemplates an unusual altar display: a life-size wax gorilla nailed to a wooden cross.

The sculpture is a new work by Paul Fryer, a young British artist whom Platt, co-founder of hedge fund firm BlueCrest Capital Management Ltd., has sponsored for the past three years. Like a modern-day Medici, Platt has recouped his investment by selling Fryer’s works to collectors such as French billionaire Francois Pinault.

As he gazes at the ape — intended to represent the desecration of nature — Platt, 41, says, “The point is not to make money out of it; it’s to have fun. I’m not trying to make the art business my ticket out of the hedge fund world.”

Not that he needs one. His $16.7 billion-in-assets firm is one of the best performers and most profitable on the planet, Bloomberg Markets magazine reported in its February 2010 issue. His $5 billion BlueCrest Capital International fund hasn’t had a down year since the firm was launched in November 2000. The fund was up 41 percent for 2009 as of Oct. 31, ranking it No. 14 globally, according to data compiled by Bloomberg. The fund collected $409.3 million in fees, making it the No. 3 earner.

A multistrategy fund that makes money betting mostly on currency and interest-rate movements, BlueCrest Capital International has thrived on market turmoil.

A Time for Traders

“This is the environment where they kick ass, for lack of a more polite word,” saysRobin Bowie, chief executive officer of London-based Dexion Capital Plc, which manages about 1.9 billion pounds ($3.15 billion) in hedge fund investments, including stakes in BlueCrest funds. “The chaotic environment favors the trader, and that is where we are going to be for the foreseeable future.”

While many fellow hedge fund managers crashed and burned in the financial crisis of 2008, Platt, a JPMorgan Chase & Co. veteran, finished the year up a respectable 6 percent. His partner, Leda Braga, a 43-year-old Brazilian who runs a $9 billion trend­following fund called BlueTrend, did even better, with returns of 43 percent. In 2009, she was up 9.4 percent through November.

BlueTrend’s biggest competitor, London-based Man Group Plc’s $23 billion AHL Diversified funds, fell 12 percent through November, while David Harding’s London-based $4.4 billion Winton Futures Fund dropped 2 percent, according to Bloomberg data.

Two-Year Test

“The real measure of how a manager did was in the combined period of 2008 and 2009,” says Omar Kodmani, senior executive officer of Permal Investment Management, which farms out $20 billion to hedge fund managers and has invested with BlueCrest. “Some who did great in 2008 did poorly in 2009 when markets transitioned, and they were left bearish or stayed in trades too long.”

Platt’s firm is the third biggest in Europe, after London- based $26.6 billion Brevan Howard Asset Management LLP and $26.2 billion Man Group (excluding its fund of funds). Platt employs more than 300 people, including dozens of Ph.D.s in mathematics, physics and other fields who crunch numbers for Braga.

BlueCrest’s fund managers move in and out of positions fast. “We’re traders, not investors,” Platt says. While investors yanked about $9 billion from BlueCrest after the liquidity squeeze started to grip markets in 2008, the firm generated $4 billion in trading profits in the year after September 2008, and attracted an additional $5 billion in new investment, Platt says.

“We were getting hit with walls of redemptions because we were one of the few firms who were open, making money and liquid,” says Platt, sitting on a white leather chair in his spare corner office overlooking Buckingham Palace Gardens. “Most funds had suspended withdrawals.”

Hedge Times Two

One happy investor is Man Group, the world’s biggest publicly traded hedge fund firm, which bought 25 percent of BlueCrest for 105 million pounds in cash and stock back in 2003. At the time, BlueCrest had $3.1 billion in assets. Man Group nearly made back its investment in 2008 alone. BlueCrest’s fees generated $137 million of Man Group’s $743 million profit for the year ended on Mar. 31, 2009. BlueCrest generated another $31 million in fees for Man Group in the six months through September 2009, or 10 percent of its $302 million in pretax profit.

“It can only be characterized as a successful investment,” Man Group CEO Peter Clarkesays. “When we invested in BlueCrest, it was a much smaller business and less diversified than it is now.”

Challenger 604

Platt isn’t shy about advertising his success. His desk on BlueCrest’s trading floor has a screen saver with a picture of his private jet, a Bombardier Challenger 604. The office walls are adorned with paintings by artists he’s sponsored, including a series by Zambian-born Jonathan Wateridge, who paints large- scale images of plane crashes and shipwrecks.

Always ready for a good party, Platt hired Michael Jackson impersonator Navi to perform at the BlueCrest Christmas bash in 2009.

Platt says BlueCrest doubles as his family office, a place where he’s betting his own capital alongside that of other investors. His Capital International fund has 40 traders, grouped into desks focusing on interest rates, foreign exchange volatility and the exploitation of price differences between fixed-income securities. The fund’s diversified group of trading desks spreads the portfolio’s risk and prevents any one strategy from bringing down the fund’s returns, Platt says.

Moving to Geneva

BlueCrest has grown so large it’s now planning to open an office in Geneva. The move is also intended to counter increased regulation of hedge funds by the European Union and the U.K. government’s plan to hike the top income tax rate to 50 percent from 40 percent in April.

As many as 50 people may move to Switzerland, BlueCrest Chief Financial OfficerAndrew Dodd says.

A big part of BlueCrest’s magic is keeping a tight leash on its more than 60 traders. If a trader loses 3 percent of the money he has under management, the firm will cut his capital allocation in half. If the trader’s portfolio then drops another 3 percent, he loses his allocation. Risk managers will then look at how he was trading and decide whether to recapitalize him. If not, he’s out.

Since 2000, half a dozen traders have left the firm because of these stringent stop-loss limits, Platt says.

He’s subject to the rules himself. “I’ve never hit the 3 percent drawdown,” Platt says. “Ego is how you lose money in this business. I put a trade on, and if it doesn’t start working straightaway, I respect the price action and cut it fast.”

Grandma the Investor

Platt credits his late grandmother with getting him started as a trader. He was born and raised in Preston, Lancashire, in the northwest of England. His father taught civil engineering at the University of Manchester. His mother was a university administrator. For his birthday one year, Platt’s grandmother helped him buy stock in trust savings banks that were selling shares to the public.

“My grandmother was a serious equity trader,” Platt says. “When I was a kid, I used to go round to her house, and she’d be sitting there working out what she was going to buy and at what profit levels. She wasn’t like most grandmothers.”

At the age of 14, Platt wagered 500 pounds on a little- known British shipping line named Common Brothers, which soon tripled in price.

“I ended up fairly addicted,” he says. “I invested 500 pounds and got back about 1,500 pounds, which was all the money in the world then.”

Math Major

Platt says he made thousands of pounds buying shares in U.K. utilities privatized under Prime Minister Margaret Thatcher in the 1980s. In 1988, he followed in his father’s footsteps and took up engineering at Imperial College, London. After a year, he got bored and transferred to the London School of Economics to study mathematics and economics.

JPMorgan hired Platt after graduation as a trainee in New York and after six months put him on its derivatives desk in London, trading interest-rate swaps — contracts that allow investors to exchange fixed-rate payments for floating ones. By the mid-1990s, Platt says his operation was making at least $500 million a year. In 1998, JPMorgan moved Platt to its proprietary trading desk, where he continued to make profits betting the bank’s own money.

In 2000, Platt and fellow JPMorgan swaps trader Bill Reeves decided to set up their own shop. With $117 million of seed money, mostly from Geneva-based investors, Platt and Reeves began trading on their own under the BlueCrest banner in November of that year. Reeves, who lives in Hawaii, remains a BlueCrest partner.

Interest Rate Windfall

The timing couldn’t have been better for an interest-rate- swaps trader. During the next year, U.S. Federal Reserve Chairman Alan Greenspan began slashing rates to jump-start the economy after the tech bubble burst, bringing rates down to 1.75 percent at the end of 2001 from 6.5 percent in January. BlueCrest used options to bet that rates would continue to fall.

“A blind dog could have made money in that environment,” Platt says.

The firm ended its first year with a 30 percent return and $1 billion in assets under management — almost nine times the money it started with.

BlueCrest’s biggest fund, BlueTrend, came into being almost by accident. Its manager, Braga, was a quantitative analyst on JPMorgan’s derivatives research team who moved to BlueCrest with Platt. The idea was to have her help the new firm’s fixed-income traders stay ahead of the buying and selling patterns of commodity trading advisers, or CTAs, such as Man’s AHL.

Black Boxes

CTAs build so-called black boxes — computer systems that use historical data to predict future price movements in the equity, fixed-income, commodities and currency markets. Braga, who has a Ph.D. in engineering from Imperial College and taught mechanical engineering there for four years in the 1990s, began using systematic trading strategies in U.K. equities in 2002. Platt later asked her to develop trend-following models for fixed income.

BlueTrend has delivered annualized returns of 19 percent since it started in 2004, beating older, larger rivals such as AHL and Winton.

“What’s unique about BlueTrend is that they’ve been able to attract such a tremendous following in such a short period of time,” says Sol Waksman, president and founder of Fairfield, Iowa-based BarclayHedge, which tracks and invests in hedge funds. “For a relative newcomer, they are perceived with a higher level of credibility in the marketplace than others who have been in the business for longer. That’s no small feat.”

‘If It Ain’t Broke’

BlueTrend’s success comes from Braga’s emphasis on constantly tweaking her computer programs to respond to shifting markets.

“With a lot of CTA shops, there’s an ‘if it ain’t broke, don’t fix it’ policy,” says Cem Habib, a portfolio manager at the fund of hedge funds unit of London-based Cheyne Capital Management. “They’ve been able to stay ahead of the curve with continuous research.”

It’s like a Formula One car, BlueCrest CFO Dodd says. “After a certain period of time, it’s not the same car. It’s about doing 100 things 1 percent better.”

The press-shy Braga declined to be interviewed for this story.

Platt navigated the market downturn by moving quickly to contain losses. After credit markets first began to wobble in August 2007, Platt and his partners decided to close the $500 million BlueCrest Equity Fund.

Premonition of Crisis

The fund was down 8 percent for the year at that point. Platt says he judged that equity markets would plunge in reaction to the impending credit crisis, which they did in mid- 2008.

“I thought to myself, this is going to be the disaster space of all spaces,” he says. “In just six weeks, we completely shut the fund and returned $500 million to investors.”

In November 2008, the firm started to wind down BlueCrest Strategic, returning about three-quarters of the capital. The fund’s performance was lackluster, delivering annualized returns of 2.67 percent from July 2003 through October 2009.

The fund, which invests in emerging markets and fixed income, is holding on to less-liquid securities until markets improve.

Platt also brought in a new emerging-markets team and moved the fund’s interest-rate traders into BlueCrest Capital International.

Money Market Risk

BlueCrest Capital profited in 2009 from Platt’s bet that central banks would keep interest rates low for longer than the market was expecting. In May 2008, he pulled all of BlueCrest’s cash out of money market funds and invested in two-year Treasury bills. The move girded BlueCrest for the credit crisis that hit at the end of 2008, which pushed up the price of short-term Treasuries.

Platt’s private passion is his art. He has invested 5 million pounds into All Visual Arts, a private art fund he started with Joe La Placa, a former foreign editor of the magazine Art Review. Platt and La Placa back contemporary artists for three years, sponsoring shows to drum up interest in their work. The pair sell some works to cover their costs, splitting the proceeds with the artists.

“The whole purpose is to get people to want it without actually selling it,” Platt says. “The sexiest word in the English language is ‘no,’ right? At the end of it, I’d like to have an education, a lot of friendships and a decent portfolio of art bought at essentially cost.”

ARK Auction Winner

Platt added what could be a valuable new work to his collection at the spring 2009 London charity dinner sponsored by the hedge fund charity Absolute Return for Kids, or ARK. Platt won the grand prize in a 5,000-pound-per-ticket lottery, a Fiat Cinquecento painted by British artist Damien Hirst with Hirst’s trademark butterflies. The car was one of the most-sought-after items of the night, which raised 15.6 million pounds for ARK.

“I must have bought 20 tickets, so I wouldn’t describe it as a bargain,” Platt says.

He is keeping the car under wraps in a garage “until the next Damien Hirst craze,” he says. In his art and in his investments, Platt is always calculating the odds — just like his grandmother taught him.

To contact the reporters on this story: Stephanie Baker in London atstebaker@bloomberg.net; Tom Cahill in London at tcahill@bloomberg.net. =

Last Updated: January 5, 2010 19:01 EST

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January 9, 2010 Posted by | Hedge Funds | Leave a comment

Engineering targeted returns and risks

From Bridgewater Associates (2005) – click here

January 4, 2010 Posted by | Case Study, Cross-asset-class | Leave a comment

Market Folly Portfolio: December & 2009 Full Year Performance

Here are the 2009 results from our Market Folly custom portfolio created with Alphaclone. The portfolio invests in equities held by specific hedge funds as we seek to replicate their portfolios. The overall goal is to generate alpha and outperformance over the long-term by utilizing their stockpicking skills.

December 2009
MF: +4.0%
S&P 500: +1.9%

Full Year 2009
MF: +13.8%
S&P 500: +26.5%

Total Return (Since 2000)
MF: +885.5%
S&P 500: -8.2%

Annualized Return (Since 2000)
MF: +25.7%
S&P 500: -0.9%

Over the life of the portfolio, we’ve seen Alpha of 22.7, Beta of 0.2, and a 0.2 correlation to the Index. The 2009 performance was disappointing and as we’ve pointed out before, a 50% portfolio hedge severely drags on performance when the market rallies 60+% from the lows in one year. To demonstrate just how much the hedge hurt the portfolio, we’ll pull up the long-only version of the portfolio: It returned 28.6% for 2009, outperforming the S&P by 2%. We created the portfolio with Alphaclone and highly recommend checking it out as you can replicate tons of hedge fund portfolios.

While the hedge put a damper on performance this year, it has also shielded from massive drawdowns in previous bear markets and has helped generate long-term outperformance. Keep in mind that you can run long-only versions or hedged versions, it’s completely up to you. We just prefer to run a hedged book in order to protect from drawdowns.

Those of you who desire to invest directly in our hedge fund replicators, stay tuned. We’re working on a newer, updated portfolio (Market Folly v2.0) that will run on auto-pilot in a brokerage account, so all you have to do is sit back and watch. This portfolio is completely separate of MF clone above, so look for it in 2010! In the mean time, go get your free 14-day trial to Alphaclone to see what stocks our original MF portfolio is currently invested in.

January 3, 2010 Posted by | Case Study | Leave a comment