Hedge-Fund Manager 36 South Doubles Bets on Securities Swings

Article in Bloomberg

36 South Capital Advisors LLP, whose [left tail strategy] returned [signficant] in 2008, has doubled bets this year on greater fluctuations in markets including currencies, commodities and equities.

The manager overseeing $626 million has increased volatility investments to 90 percent of assets from 50 percent at the beginning of the year, Chief Executive Officer and Head of Investments Jerry Haworth of the London-based company said in a telephone interview yesterday.

Central bank intervention, including asset purchases globally in the wake of the 2008 global financial crisis, have calmed investor jitters and suppressed price gyrations, making protection against bigger security price swings cheaper to obtain for funds such as 36 South.

The hedge-fund manager’s own Global Implied Volatility Overall Index, which tracks volatility implied by prices for options on currencies, commodities, interest-rate securities and stocks, stood about 10 percent below its average since the end of 2006 and was approaching the pre-crisis level in 2007.

“The central banks have been flooding the world with liquidity, which in a way confuses the pricing mechanism,” Haworth said. “We got the feeling that the longer that it carries on, the subsequent volatility that will happen afterwards will be greater.”

Black Swan

36 South runs funds that profit from increases in volatility. Its flagship series of funds, which account for 94 percent of assets, returned [considerable gains] in 2008, according to a presentation seen by Bloomberg News. They [lost] in the first seven months this year. When volatility is expensive, the funds raise their cash and government bond holdings.

It also oversees funds that benefit from rare events that have a heavy impact on markets such as the global financial crisis. The [left tail strategies] refer to a theory developed by New York University risk engineering professor Nassim Nicholas Taleb, in which highly improbable events wreak havoc on markets.

The Chicago Board Options Exchange Volatility Index, the cost measure of using options to protect against falls in the Standard & Poor’s 500 Index better known as VIX (VIX), is 39 percent below its average since the start of 2007.

Subdued volatility led to investment losses and closure of managers whose funds sought to benefit from increases in price swings. Two Hong Kong-based managers -- Sharp Peak Capital Management Ltd. and Protege Partners LP-backed Expedition Advisors Ltd. -- shut down in the last two years.

‘Cheap Ticket’

People should be reminded that this is probably a better time to buy volatility than sell it, Haworth said.

“You buy a ticket to a life raft well before everyone else is clambering to get on,” he said. “When you have an opportunity to get a cheap ticket, you should buy it.”

Volatility is particularly undervalued in the currency and commodity markets, Haworth said. Equity options are also emerging as attractive bets, he added.

The U.S. stimulus program has funneled more than $2.6 trillion into the financial system since September 2008. Federal Reserve Chairman Ben S. Bernanke told Congress on May 22 that the central bank could scale back the pace of its $85 billion of mortgage bond and Treasuries purchases if the U.S. economy showed sustained improvement.

The Fed this month will taper its monthly bond purchases to $75 billion from the current $85 billion pace, according to the median estimate of 34 economists surveyed on Sept. 6 by Bloomberg News.

‘Gray Swan’

The unintended consequences for the financial system of the unprecedented central bank intervention in the last four years could be significant, Haworth said. He also described the level of credit and debt globally as a “gray swan” that keeps the financial system complex and fragile. Gray Swan refers to a predictable event with a potentially very high impact.

36 South’s assets have steadily grown from about $250 million in March 2011, as asset managers, pension funds and wealthy individuals have sought to increase protection and investment returns that don’t move in tandem with traditional assets, Haworth said. Last month, it saw a small redemption.

“In a way, I’ve been looking forward to redemptions because they tell me that it’s probably the last thing that happens before it turns,” he said, without providing details on the withdrawn amount.

To contact the reporter on this story: Bei Hu in Hong Kong at bhu5@bloomberg.net.

To contact the editor responsible for this story: Andreea Papuc at apapuc1@bloomberg.net