Michael Wexler discusses the strategies and opportunities that are driving the Maple Leaf Macro Volatility Fund.
Michael Wexler is the chief investment officer and founded Maple Leaf Capital LLP in May 2002. Prior to this, 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. Michael graduated with distinction from the Richard Ivey School of Business at the University of Western Ontario, after studying Actuarial Science.
HW: What is the background to the fund?
MW: 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 hedge fund strategies carrying a long equity 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. As of May 1 we have USD 365 AUM in the Macro Volatility Fund and the principals are as follows:
Michael Wexler (myself), Chief Investment Officer
George Castrounis, Portfolio Manager: George joined Maple Leaf at launch. Before that he was at Credit Suisse First Boston in London responsible for equity derivatives trading of the technology and financial sectors. Prior to that 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.
Tim Rustow, Portfolio Manager: Tim joined Maple Leaf Capital in August 2005. Prior to that, he was at DTAP Capital, a Connecticut-based global macro hedge fund as a portfolio manager. 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, Tim was a journalist with ABC news, a campaign advisor for Rudy Guliani and a foreign policy aide in the US Congress.
HW: How and where do you distribute the fund? 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 institutional investors' fund of funds, corporates, family offices and high net worth individuals. The uncorrelated and superior returns are attractive to a wide audience, and Rupert Douglas joined mid-2005 as a marketer to help increase the client base. There are no 3rd party distribution deals at present.
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 5,500 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?
MW: The fund aims to achieve 15 % annual returns and targets a 12 - 14% standard deviation. In 2004 both sets of numbers were improved upon, with the fund realising +21% net to investors and 9% standard deviation. In 2005 opportunities were more difficult with volatility making multi year lows and stagnating in three of the four asset classes. Returns for 2005 were 4.2% with 4.5% standard deviation. 2006 has started well with a return of +11.49% to the end of April.
HW: Has your performance been as per budget and expectations? Do you expect your performance or style 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 were fewer opportunities than in 2004. Nonetheless we had a pick-up in performance in Q4 2005 through situation specific relative value trades and the pickup in volatility in 2006 has been a welcome change the opportunity set.
HW: What opportunities are you looking at right now?
MW: Investors are invited to hear a replay of a recent conference call hosted by the CIO on the outlook for volatility in 2006, (see www.mapleleafcapital.com ). Asset classes with the most risk allocated as of April 2006 are FX and commodities. In FX the potential end of the dollar carry trade of 2005 and refocus on poor dollar fundamentals has created new market opportunities not seen for many months. Low inventories, unclear fundamentals, and booming emerging markets are fuelling the multi-year commodity boom that continues to keep markets exciting for volatility strategies. Fixed income volatility is imminently set to rise and in equities we are neutral on the volatility outlook and market opportunities.
HW: What events do you expect to see in your sector in the year ahead?
MW: Low risk premiums, tight credit spreads, and low volatility are all linked, and can't go much lower. These have complex ties to low interest rates, stable growth, high liquidity, and high risk appetite. Profiting from simple asset ownership will face greater headwinds going forward, and consequently trading volatility will be increasingly interesting. We expect higher volatility in most asset classes, greater uncertainty, and higher risk premiums. Potential catalysts include volatility in energy, Chinese growth surprises (positive or negative), weakness in US housing, the extent and timing of FED/ECB/BOJ rate hikes, Avian Flu, and the growth story in Japan are some of the 'big picture' topics that may prove prominent in 2006.
HW: How will these changes/future events impact on your own portfolio?
MW: In its simplest form there are two ways in which to make money trading volatility:
- The difference between implied & realised volatility.
- The volatility of volatility ie changes in implied volatility.
Higher volatility across the asset classes will create increased opportunities for points 1 & 2. We shift our risk allocation to different asset classes and different volatility strategies on an ongoing basis.
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 intermarket 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/other product launches in the near future?
MW: You'll have to wait and see. The Macro Volatility Fund will 'hard close' to new investors in the coming weeks.
(Michael Wexler was interviewed on 22 February 2006; the interview was revised on 18 May 2006)