Michael Wexler, who founded Maple Leaf Capital LLP in 2002, outlines recent developments within the company's flagship volatility trading fund.
Maple Leaf Capital launched its first offering in October 2002, the Opportunity Fund, as a long equity volatility product. Whilst initially popular with investors, as a hedge of most hedge fund strategies that carry long market bias, the product performed poorly as equity markets rallied and volatility fell in 2003.
The strategy changed in two ways in January 2004 and is now called the Maple Leaf Macro Volatility Fund: First, the scope widened to be multi asset, therefore including commodities, currencies, fixed income and equities, instead of just equities. Second, it became a volatility trading hedge fund (long, short, relative value, dispersion, skew, calendar) as opposed to long volatility previously.
The Macro Volatility Fund currently has USD 110 million in assets and the principals are as follows:
Michael Wexler is the Chief Investment Officer and founded Maple Leaf Capital LLP in May 2002. Prior, he was at Credit Suisse First Boston in London for four years establishing and managing the single stock derivative trading group and as a proprietary trader focusing on global single stock volatility and correlation trading. He began his career in currency derivatives with Citibank Toronto and London trading Canadian dollar options, Japanese Yen exotic options, and Dollar/Euro options for five years. Wexler graduated with distinction from the Richard Ivey School of Business at the University of Western Ontario, after studying Actuarial Science.
George Castrounis, Portfolio Manager, joined Maple Leaf at launch. Prior, he was at Credit Suisse First Boston in London responsible for equity derivatives trading of the technology and financial sectors. Before he was responsible for stock derivatives trading in German, Dutch, Scandinavian, Southern European, and European Emerging markets. He began his career with Citibank in the Financial Engineering and the interest rate derivatives area in 1995 in Toronto, then New York and London in equity derivatives. Castrounis studied economics and graduated with distinction from the Richard Ivey School of Business at the University of Western Ontario. Castrounis and Wexler have worked together for eight years.
Tim Rustow, Portfolio Manager, joined Maple Leaf Capital in August 2005. Prior, he was at DTAP Capital, a Connecticut based global macro hedge fund as a money manager and strategist. Preceding this he had a similar role at SAC Capital and Falcon Family under Jim Leitner and also worked as a currency strategist at Bankers Trust. Before entering financial markets, Rustow was a journalist with ABC news, a campaign advisor for Rudy Guliani and a foreign policy aide in the US Congress. He has a JD from St John's University School of Law and a Bachelors in Political Science from UC Boulder.
HW: What is your current and targeted client base?
MW: The range of investors in the fund is diverse as far as type and geography, and includes fund of funds, pension funds, corporates, family offices and high net worth individuals. The uncorrelated and superior returns are attractive to a wide audience, and Rupert Douglas has recently joined as a marketer to help increase the client base.
HW: What is the investment process of your fund?
MW: Every trade is looked at from a quantitative and a macro point of view.
A) Quantitative: There is a database of 2000 assets on which daily implied volatility is tracked, meaning that every asset has a full term structure and skew going back up to 10 years, requiring the input of two full time quantitative analysts. Sixteen different valuation screens are run daily, with a weighted relative merit system assigned and from this it is possible to establish whether volatility is expensive or cheap.
B) Macro: Studied from the same perspective as many other macro funds assessing inflation, central bank policy, global flows of money, market positioning, event risks, geo-political factors etc, but with a major difference - The conclusions that are drawn are volatility related rather than directional.
In order for a single trade to be placed, both the quantitative and the macro analysis must line up simultaneously. For a long (short) volatility position to be taken, quantitatively implied volatility would have to be cheap (expensive) whilst at the same time macro factors would need to be indicative of increasing (decreasing) realized volatility.
There are significant supply / demand imbalances that continuously appear in the derivatives markets since the principal users of options (i.e. pension funds, corporates, mutual funds, insurance companies, retail, and hedge funds) trade these instruments with a view to the direction of the underlying asset rather than its volatility. Consequently they execute transactions with 'non-economic' volatility components thus creating opportunities for volatility trading strategies.
HW: How do you generate ideas for your fund?
MW: Ideas are generated through the process mentioned in the previous question, and initiated from the macro side and confirmed quantitatively or vice versa. Typically trades are held for three months and span the four major asset classes. There are three types of volatility trades: outright, relative value within an asset class and cross asset class.
HW: What is your approach to managing risk?
MW: With their own net worth invested in the fund the portfolio managers are adamant about risk management, particularly on short volatility positions. Of paramount importance are concentration limits, diversification and stress tests. Short volatility positions have substantially smaller limits than long volatility exposures, and potential correlation of volatility across asset classes features prominently in risk structure. The fund does not use leverage.
HW: How/against what do you benchmark the performance of your fund? How has the fund performed?
MW: The fund aims to achieve 15 % annual returns and targets a 12 - 14% standard deviation. Last year both sets of numbers were improved upon, with the fund realising +21% net to investors and 9% standard deviation. This year opportunities have been more difficult with volatility making multi year lows and stagnating in three of the four asset classes. Returns to date in 2005 are flat with 4.5% standard deviation.
HW: What is the performance/track record of your fund vs. the overall performance of the sector?
MW: It is difficult to define as a sector, as there are not that many dedicated volatility funds and none that are truly multi asset. As well, there are several styles of trading volatility - some managers are long only, some short only, others purely statistical or purely fundamental which again makes it hard to compare results. However, feedback from investors and potential investors seems to place us very favourably against our peer group and asset growth must be a reflection of that.
HW: Has your performance been as per budget and expectations? If not, please explain the variance? Do you expect your performance to change going forward?
MW: Since markets are not constant it is natural to conclude that neither will be returns. With volatility contracting in 2005 across fixed income, foreign exchange and equities there have been fewer opportunities than last year. Nonetheless we believe that there will be significant opportunities for the strategy in the fourth quarter of 2005 and going forward.
HW: How is your portfolio allocated?
MW: Currently, the fund has long volatility and relative value volatility positions in currencies and equities with no exposure in fixed income or commodities. Capital allocation is dynamic and moves opportunistically and frequently between the asset classes.
HW: What opportunities are you looking at right now?
MW: There are several indicators in the market right now that all is not well. US homebuilder shares are selling off, gold is rallying, the Swiss Franc is strengthening, equity skew is increasing and the VIX is grinding higher amongst other things. The odds of a financial market 'accident' and increased volatility are rising and the fund is positioned accordingly.
HW: Do you expect any style shift in your fund going forward?
MW: No, there is ample structural alpha within the volatility space. As well, being multi asset provides the flexibility to move to more interesting pastures if one area becomes stagnant, such as equities in 2004 or fixed income in 2005.
HW: What events do you expect to see in your sector in the year ahead?
MW: Higher volatility in most asset classes, greater uncertainty , and higher risk premiums. Potential catalysts include volatility in oil and Chinese growth, weakness in US real estate, and Fed rate hikes.
HW: What differentiates you from other managers in your sector?
MW: First, an edge from trading the four major asset classes, which improves the Sharpe Ratio due to diversification. It also allows the portfolio managers step back from dull and inactive markets and to implement very attractive inter-market volatility trades which prevents myopia. Second, the dual approach to every trade from both the macro and the quantitative perspectives is extremely powerful, in a sense top down & bottom up, both forward and backward looking.
HW: Do you have any plans for similar product launches in the near future?
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