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The Hedgeweek Interview: Lahrs Buhl, Chief Investment Officer and Partner, Capricorn Asset Management: In search of pure alpha

Lahrs Buhl of Swiss-based Capricorn Asset Management outlines the investment thinking behind the company's currency programs.

HW: What is the background to Capricorn Asset Management?

LB: As a proprietary trader for Smith Barney in Geneva during 1998, Mikkel Thorup found the backing from two clients to establish Capricorn. In the same year Capricorn Advisory Management Ltd. was founded with a combined asset under management of USD 1,850,000. The Capricorn FX3x and FX7x programs were traded with an initial amount of USD 350,000 USD, and Capricorn Financials program (that is no longer traded) was seeded with USD 1,000,000. In addition to the three investment vehicles, a further USD 500,000 was invested in Capital Guaranteed Products.  After increasing the asset under management of the Capricorn FX3x and FX7x currency programs from USD 350,000 to USD 2,800,000, the decision was made to focus purely on high liquid currencies in 2001. This has remained the focus of the company ever since. In the same year, Capricorn Asset Management (Schweiz) AG was formed under the regulation of the independent Swiss investment authority, the PolyReg Allgemeiner Selbstregulierungs-Verein. The Swiss company was formed primarily to attract Institutional investors.

1998 DEC Capricorn Advisory Management Ltd. was established
2001 JAN Decision made to focus purely on FX only investment programs
2001 MAR Martin Zoller joins Capricorn as the company's administrator
2001 JUN Capricorn Asset Management (Schweiz) AG was formed
2001 SEPT Klaus Oesterballe joins Capricorn from Nordea
2002 DEC Assets under management doubles to USD14.4 M in 1 year
2003 JAN Lars Buhl joins Capricorn to strengthen the institutional side
2003 JAN Capricorn Systementum FX2x is introduced
2003 SEPT Klaus Oesterballe leaves Capricorn
2004 AUG Mike Rasmussen joins Capricorn as Chief Operating Officer
2004 SEPT Launch of the new Capricorn website
2005 JAN Prime Brokerage agreement is established with Deutsche Bank
2005 APR Approved by Mercer I.S. for Deutsche Bank's 'FX Select'.

HW: Who are your service providers?

LB: Capricorn has established a Prime Brokerage agreement with Deutsche Bank in London, to minimize operational issues and to curb costs through consolidated financing. However, the flexibility behind the prime brokerage gives us the benefits of executing with a number of banks, thus giving us tighter spreads. This agreement has enabled Capricorn the ability to pass cost savings through better executions, on to our clients. Furthermore, clients interested in a Managed Account are no longer required to establish a new brokerage account. This flexibility allows clients to participate in a Capricorn FX product as long as they make an initial investment with $500,000 or more.

HW: How and where do you distribute the programs? What is the profile of your current and targeted client base?

LB: Our performance data is reported to key industry databases on a monthly basis.  Along with a select number of capital Advisors, we are able to distribute our programs to a global client base. The assets invested in our strategy are predominately from institutional clients.

HW: What is the investment process of your program?

LB: Produce uncorrelated risk-adjusted returns - pure ALPHA, by trading the most liquid assets available to investors; USD, EUR and CHF.  Technical analysis is the major input for the decision-making process behind the programs strategy. However fundamentals such as statistics or information pertaining to the market, which we estimate as having a severe impact, are taken into consideration before taking on a position. As part of overall risk management, the programs are always neutral before and during an event we estimate as having severe impact on movements in EUR/USD and USD/CHF. For example, before the release of the Employment Report in US, the programs will be neutral primarily due to the reason that the strategy does not anticipate the outcome of a release. Secondly, the technical signals generated from market data may be influenced by the pending release. Furthermore, a stop-loss order is placed with a broker and confirmed by telephone with all trade positions. The stop-loss levels are defined using analysis of the technical signals, and are never moved away from the entry level. Under certain trading conditions a trailing-stop may be implemented to secure a profit or reduce risk.

The strategy is categorised as being intraday, discretionary, however the expertise and success behind the two programs are defined by the high degree of discipline within the methodology. This is best shown in the low number of trades executed. Technical analysis is the only input for position taking decisions, whereas other indicators may be used to reduce overall risk. Performance tends to be strong in all markets.

HW: How do you generate ideas for your program?

LB: In order to provide a source of uncorrelated alpha to professional investors, Capricorn's niche as a currency manager is the discipline inherent within our trading methodology. This routine is initiated by an analysis of the overnight movements of the major currency crosses, and updating the in-house 'Information Model'. This model provides an indication of the strength behind the information generated from the technical data. Combined with information on significant levels and flows provided by brokers, the days trading bias is evaluated for EUR/USD and USD/CHF.

Further technical analysis on price data of the currency majors and the USD Index, is studied to determine the support and resistance levels.  Finally, announcements of fundamental events and statistical releases are evaluated for risk management purposes.  Hereafter follows market monitoring and position taking.

HW: What is your approach to managing risk?

LB: Each position carries a stop loss placed at technical levels, and the programs are always neutral over events we estimate as having a severe impact on the Market. From our experience the release of key figures or speeches can change the short term technical picture of a currency cross.

HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?

LB: The first half year of 2006 has been below par performance for the strategy, which has been unable to achieve targeted return.  During the last six months volatility in EUR/USD was relatively lower than in previous years, whereby sudden market movements were seen in connection with key figure releases and FOMC and ECB speeches.  As part of our risk management strategy, we do not carry positions over announcements.  The reason for this is that we do not want to have the "fundamental" risk associated with key releases that can change the technical picture rapidly.  However this also reduced the number of stronger market moves we could trade.  In addition, we have experienced that the corrections following large market moves were both smaller and behaved differently than in the past.  For example, EUR/USD would make a move of 70-100 pips, without any setback after fundamental data or a speech coming out, before stopping and trading in another narrow 10-20 pip range for an extended period of time.  In some situations, the corrections were not seen until one to two days after the initial move.  This market behaviour increases the difficulty in timing the correct entry levels, which is a key contributing factor in our strategy creating excess return.  Therefore under these adverse conditions we adjusted risk downwards by reducing leverage and moving our stops closer.  As a result performance was hurt by a lower hit ratio.

This market environment and particularly the resulting size and behaviour of the corrections, does hurt our intra day contrarian trading method.  Combined with us not having any positions on when a market move started and a weaker hit ratio performance has been slightly down.

Capricorn has maintained the same philosophy and trading strategy since the programs inception in 1999, and by maintaining our discipline we believe in our ability to create pure alpha.  In our judgment the market will return to a more normal attitude as soon as the summer period is over and liquidity is back again.  It seems now that market participants (including ourselves) are getting more used to the influx of news from both FOMC and ECB.  This will lead to markets moving more in tandem with past years, and performance following the same path.

HW: What events do you expect to see in your sector in the year ahead?

LB: We do not expect any significant events in our sector because Capricorn does not hold any long-term positions.

HW: What differentiates you from other managers in your sector?

LB: The 100% discretionary trading style makes us different from other managers by fact.  We also believe we have an advantage because we almost start every day with an open mind (do not have any positions we need to defend every morning).

HW: Do you have any plans for similar/other product launches in the near future?

LB: We are currently investigating if it is possible to create pure Alpha using a strategy primarily based on Options. We will return with a press release if we decide to launch the product.

(Lars Buhl was interviewed on 13 September 2006)

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