Ed. Note: This article first appeared in Bloomberg
This hedge fund is only looking one day ahead.
That delivered a 30% return in 2016 for the London-based Runestone Capital Fund, which crunched more than 700 variables to develop a quantitative model for trading US equity index volatility.
“We trade with a one-day horizon as predicting volatility long term is completely random,” Rune Madsen, founder and portfolio manager of the $17M fund, said in an interview on Monday.
The absolute return fund, which targets an average annual return of more than 20%, is always directional, making bets that one-day volatility will either rise or fall, according to Madsen. The return for 2016 was 30% with a maximum loss from peak to trough of 5.2%.
As stock markets have steadily rallied, the Chicago Board Options Exchange Volatility Index has dropped.
The VIX traded at 12 points on Tuesday compared with an average of 15.5 over the past five years.
While low volatility has limited returns for the fund to 1.4% for the first two months of 2017, a higher expected average return when volatility increases makes it a useful hedge when markets drop.
“You put on an asset class with a different type of risk so there will be a strong diversifying effect in the portfolio,” he said. “Profit and loss movements don’t have any impact on inherent value.”
Madsen, 42, and Rasmus Andersen, 35, who worked together at Morgan Stanley, started the fund in 2015 and base investments strictly on statistical probabilities to “remove human behavior biases.”
One investor and adviser is Peter Clarke, the former CE) of Man Group.
“It’s a perpetual way of investing,” he said.
“There are always movements in volatility so there are always opportunities.”