Florida-based asset management firm Stonehenge Capital Management (SCM) announced Monday that its new direction-neutral hedge fund strategy called Forward Curve Realignment (FCR) resulted in strong returns one month after its launching. FCR returned 0.3 percent in its first month of trading during one of the most turbulent market conditions, SCM Manager Steven Michael said. FCR, which debuted on Sept. 1, focuses on investing in a variety of sectors (energy, grains, metals, softs and livestock) and markets to take advantage of reversions to equilibrium of the forward curve following distortions brought about by large capital flows.
According to Michael, FCR seeks to capitalize on the reversion to equilibrium of the forward curve following the distortions brought about by the rolling of contracts of established positions, primarily by long-index investors and speculators. Michael said, "According to the CFTC (U.S. Commodity Futures Trading Commission), as of July 29, 2011, there was in excess of $180 billion (notional) in net long index commodities positions across 21 markets. Also, we believe that there is more than $100 billion managed by CTAs (commodity trading advisors), and an additional $100 billion in commodities Exchange Traded Funds. Much of this total investment is held in nearby or front-month contracts. As these contracts near their expiration, non-commercial investors must exit their positions in order to avoid taking or making delivery of the physical commodities. This results in massive flows of capital. Most often, these large flows of capital do not exit the market, but rather shift to new positions farther along the curve in order to maintain their overall (long or short) directional interests." FCR uses several proprietary methodologies for analysing these capital flows, allocating investments across all of the markets, and balancing the positions across both long and short interests using calendar spreads. The strategy employs internally-developed volatility and correlation analyses in order to keep overall volatility down, to reduce correlation of returns to the direction of the underlying market, and to achieve smooth margin to equity ratios, thereby increasing the efficiency of the deployment of capital. Michael added, "We employ a proprietary methodology that holds both long and short spread positions in each market in order to minimize exposure to underlying market moves. We maintain positions at the front of the curve, never extending beyond the first year. Our model adjusts the relative long and short positions in order to minimize correlation to the underlying directional moves in each particular commodity. We aim to achieve a result which can be profitable in both an upward and a downward trending market of the underlying commodity and not restricted to making a profit only when prices go up (or down)." By trading calendar spreads, the strategy seeks to avoid the effects of shocks to a market that are felt across the entire curve. Additionally, the strategy frequently holds both long and short spreads simultaneously within a market to further reduce shock risk. Stonehenge Asset Management, sister company to SCM and manager of the Stonehenge Diversified 1 Fund, believes that the addition of this strategy to its portfolio is keeping with its core philosophy that capital flows are the most tradable and consistent factor in price movements.
"Both our intra-day and short-term trading strategies are based on this foundation, as well," Michael said. "We use proprietary means to adjust both our overall allocations to each market traded and to the sub-allocation within each market to each of the components of the trades described above. We attempt to keep a consistent deployment of capital using proprietary volatility analyses to reduce the overall capital required to target a particular level of volatility and to try to have a more predictable use of capital/margin," he said.