Generating alpha as a liquidity provider
Aequim Alternative Investments: Best Credit Long/Short Hedge Fund – Aequim is a relative value credit manager focused on capital structure arbitrage established by Portfolio Manager and CIO Franklin Parlamis in 2018. The Aequim Arbitrage Master Fund is essentially a continuation of the Pine River Convertibles Fund Parlamis managed during his tenure at Pine River from August 2009 to January 2017.
The Fund’s objective is to generate market-neutral returns by dynamically allocating capital across Convertible Arbitrage, Credit Arbitrage and Volatility Arbitrage. Since its inception in May 2018, the Fund has generated a Sharpe Ratio of 2.2 and an annualised volatility of 4.4 per cent.
“It pays to be a disciplined liquidity provider,” says Parlamis, when asked to explain Aequim’s investment philosophy. “In the post-GFC world, bank trading desks enable liquidity (via agency trading) but do not provide liquidity (via risk warehousing). As a result, there is market-neutral alpha to be earned as a buy-side liquidity provider.”
Earning this alpha requires: (i) cross-asset class knowledge, to maximise hedging options and the accuracy of risk assessments; (ii) relationships of trust with sell-side firms, to get looks at axes, as well as stable financing and borrow; and (iii) a willingness to eschew “easy” profits from Fed following.
One unique aspect of its risk management programme is to balance its book of traditional or “standard” arbitrage trades (long illiquid/short liquid) with a reverse arbitrage book (long liquid/short illiquid) to protect against liquidity premium spikes as a result of a market sell-off.
Parlamis says 2020 proved to be a good stress test for this reverse book: “It worked for a single-shock sell-off. We didn’t, however, get to test a double bottom, where there’s hope and then despair.”
Cloud computing and other “new model” businesses currently represent interesting arbitrage entry points for the strategy. Bubble-like behaviour in stocks owing to “Fed juicing” is supportive for convertible arbitrage.
“On the other hand,” says Parlamis, “commodity-related businesses are always good shorts, as they have exceptionally high credit-equity correlation, and the hypothecability of their assets tends to lead to low unsecured recoveries. Also, the growth of the SPAC market promises to provide good pure volatility product for the next few years at least.”
The pervasiveness of long-only passive investors in CB gives active managers like Aequim ammunition to short converts and as Parlamis remarks, “The presence of passive managers is very welcome for a truly market-neutral shop.”
The influence of passive capital also extends to high-yield markets, which are important to Aequim. “In fact, I would say that converts are now less influenced by passive capital than they’ve been over the last 10 years as a whole, and the best shorts are in the high-yield market, where you have a weaker cohort of issuers from a credit standpoint,” comments Parlamis.
With heightened volatility earlier this year in response to Covid-19, Parlamis says 2020 has been a “wheat and chaff” year during which it has paid to be a disciplined portfolio manager.
“The pros won, and pretenders were exposed,” says Parlamis. “Not all of them, though ... since the Fed put in the floor a bit early. We responded to the volatility by providing liquidity in the new issue market. This is a good way to take liquidity risk in an uncertain tape, since you know the whole deal has to cross, and you are less likely to be standing on the edge of a ‘liquidity cliff’.”
Portfolio Manager and CIO, Aequim Alternative Investments
Franklin Parlamis began his career as an attorney with Cleary Gottlieb Steen & Hamilton, where he was part of a small team representing the Russian government on its 1998 debt default and restructuring. Franklin also worked on domestic bankruptcies. In early 2000, Franklin joined Paloma Partners which would shortly spin out as Amaranth Advisors. At Amaranth, Franklin co-managed the convertible arbitrage and credit arbitrage portfolios and was an early active participant in the credit default swap market. Franklin left Amaranth in 2005 and moved his family to Hawaii, ultimately relocating to the San Francisco Bay area in 2007, where he founded and managed the west-coast office for Pine River Capital Management. Franklin served as Portfolio Manager of the Pine River Convertibles Fund, which launched in August 2009. Franklin was named a partner at Pine River in 2010 and remained one until his departure from the firm in 2017. Franklin earned a BA in Mathematics and a Certificate in Russian Studies from Princeton University, a JD from Yale Law School, and an MA in Statistics from Yale School of Graduate Studies. He is married with 3 children and lives in Mill Valley, California, where Aequim’s office is located.