The Hedge Week Interview: John Tilney, Investment Manager, Armajaro Commodities Fund Limited: Leveraging on Commodities
John Tilney outlines the USD 180m Armajaro Commodities Fund, which soft-closed on 10 March 2005 and re-opened to new investors in October 2005.
Tilney's career has spanned over 20 years trading physical and futures commodities. He started his career in 1980 at Marc Rich & Co in London. During his 18 years with this group, which in 1994 became Glencore International, he gained experience different facets of commodity trading both in the physical and futures markets in the UK, USA and Switzerland. John joined Armajaro in April 2004 as investment manager for the Armajaro Commodities Fund.
HW: What is the background to the fund?
JT: The fund was launched in April 2004 and first opened to external investors in October 2004. It is one of two hedge funds managed by Armajaro Asset Management LLP, a London-based partnership formed to manage alternative assets. Armajaro Asset Management LLP also manages a Pan-European equity long/short market neutral fund - the Coolum Fund.
The founder members of the partnership are Neill Brennan, Richard Gower, Anthony Ward and Armajaro Holdings Limited. Anthony Ward and Richard Gower are also the principals of Armajaro Holdings Ltd, the corporate member of the partnership.
Armajaro Trading Ltd, which is 100% direct subsidiary of Armajaro Holdings Ltd., is one of the major cocoa trading companies in the world, and is involved in the sourcing of the commodity from producing countries through to delivery to end-users. The company is a major cocoa supplier to end users such as Mars and Cadbury Schweppes. Supplies are sourced mainly in Ghana, Ivory Coast and Nigeria. It is also a major player in coffee trading.
HW: What benefits do the various stakeholders bring to the partnership?
JT: We believe a great benefit of the structure of Armajaro Asset Management is that it combines the stability of a multinational institution with the flexible decision-making and entrepreneurial spirit of a small company.
The joint partners bring different resources to the Partnership. Armajaro Holdings Ltd supplies the initial financial resources to ensure the business can invest in the correct systems and people prior to assets under management reaching critical mass.
Armajaro Holdings Ltd is the administration company for the group. It was established in 1998 and employs approximately 2,000 people globally. Turnover for the group was USD 750m in 2004. Armajaro Holdings also invested a significant amount of seed capital in the current hedge funds - The Coolum Fund and The Armajaro Commodities Fund.
The principals of Armajaro Holdings also have a proven business expertise and a wealth of experience trading financial and commodity markets. The asset management company is able to leverage off the existing infrastructure with respect to compliance, accounting, office space etc…
HW: What is the strategy of the Armajaro Commodities Fund?
JT: It is a pure commodity fund that trades on a discretionary basis in soft commodities, hard and precious metals and energy. The fund does not trade in fixed income securities, foreign exchange or equities. The Fund does not trade cocoa.
HW: How do you create new ideas for the fund?
JT: The investment team has significant expertise in successfully interpreting the price impact of fundamental factors on commodity markets gained from 20 years experience trading commodities. Our analysis takes into account the demand for commodities based on underlying macro-economic conditions, microeconomic analysis of supply, technical analysis and market sentiment.
HW: What experience does the team have in commodities risk management?
JT: Our risk management committee has a wealth of experience in commodities. For example, Anthony Ward (CEO of Armajaro Holdings Ltd) has over 20 years experience trading soft commodities and Martin Lambert (Chairman of Armajaro Holding Ltd) was formerly risk manager at Phibro when Phibro had one of the largest balance sheets in the City of London. Richard Gower (Partner), Neill Brennan (CEO) and Richard Ryan (Finance Director and compliance officer) also sit in the committee. The risk management committee receive all positions traded on a daily basis and formerly meet at least once per month.
HW: How do you control market risk?
JT: When constructing a commodities portfolio there are three main types of risk the manager is concerned with. These are:
- Idiosyncratic risk
- Systematic risk
- Liquidity risk
Idiosyncratic risks are specific risks associated with a particular commodity. The most important risk control is the investment manager. Our investment team has a successful track record of over 40 years trading international commodities and controlling risk.
Open positions are controlled through:
- Multiple stop losses per position. Stop losses may vary according to market conditions and volatility
- Volatility also leads to a reduction in position size.
- Systematic risks are those that relate to non-specific factors such as movements in the overall commodity market. The largest impact on systematic risk is from the amount of leverage applied by the fund.
The fund intends to use leverage in the investment process. Overall portfolio leverage is controlled by a 30% margin limit (this equates to approximately 300% leverage).
Liquidity risks involve not being able to trade out of a position either long or short and hence we optimally re-balance the portfolio as required.
HW: What is the team's investment process?
JT: The fund only trades in base and precious metals, soft commodities and energy on a discretionary basis. The trade ideas originate from a combination of fundamental and technical factors. The analysis takes into account the demand for commodities based on underlying macro-economic conditions and microeconomic analysis of supply.
In-depth knowledge of markets is also gained from a network of contacts, many of which occupy senior positions in the industry, established over the last 20 years.
We exploit a technical framework to ensure an awareness of potential price signals and to stimulate trade ideas. The technical signals are not part of a 'black box' that is rigorously adhered to but rather an indication of what is happening in markets. The fund will typically always hold a small long or short position in each commodity. The reason is that having a small live position focuses the trader's continual attention on activity in each commodity and helps to identify opportunistic trades.
HW: What is the decision-making process?
JT: The decision-making process is discretionary and is best described in the following manner:
- The first step is to examine the commodity universe by sector (i.e. base metals, energy, grains precious metals etc…)
- The second step is to look at the technical indicators on each commodity sector to determine whether it is at an important technical point (such as lows, highs or break outs)
- The third step is to establish whether the micro and / or macro fundamentals are bullish, bearish or neutral.
- The final element is market sentiment which is sometimes used as a contrarian indicator.
The strength and alignment of the fundamental and technical indicators determine the manager's level of conviction in a particular trade idea. For instance, if macro and micro economic indicators suggest a course of action which is reinforced by the technicals and contrarian sentiment indicator, then the manager is prepared to implement an aggressive directional position.
A good example of this is with copper at the beginning of 2004. In that instance, Armajaro Commodities Fund/Armajaro Asset Management LLP's macro economics suggested strong demand for the commodity, while our micro economic research indicated a shortage of supply, technical indicators pointed towards a breakout and sentiment was negative.
HW: What instruments do you trade?
JT: The fund currently trades in commodities through exchange traded futures and options on futures. It has the capability of accepting physical delivery:
HW: What types of trades do you conduct?
JT: The types of trades entered into depend on market conditions and the trader's conviction. The trades may be characterised as: Directional; Spread; and, Volatility:
- Directional trades occur when we have a reasonably strong view with regard to direction and extent of price movement in a commodity.
- Spread trades are generally put in place when the expected price movement in a commodity is less clear.
- Volatility trades are placed to take advantage of perceived anomalies in the price of options contracts.
HW: What is the level of gross leverage in the fund?
JT: The leverage in the fund is between 100 and 300% (based on a maximum 30% margin).
HW: How has the fund performed to date and do you have any plans to re-open the fund to external investors?
JT: Yes, we have reopened the fund to external investors as from October 2005 and will be taking the size from USD 200 million to around USD 400million. The fund has returned over 22 per cent since inception in April 2004.
(Interviewed on 17 February 2006)
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