Q2 2024
ir@qvradvisors.com
www.qvradvisors.com
NEXT GEN HEDGED EQUITY
= REAL ALPHA + BETA
Derivatives markets are about supply and demand. These are markets where risk is manufactured for the end user.
Convexity Alpha PM: We believe current hedged equity providers have been selling calls too cheap and buying
puts that are too expensive.
Client: Why does the team think that?
Convexity Alpha PM: Because we take the other side of their trades and deliver on what they have been unable
to deliver for the last 10 years.
Client: Wait, what? Can you repeat that?
This is a typical response we receive. Let’s dive into more detail on what drives this bewildered response. For over
a decade, we have presented a strategy and our thesis on why it exists with a number of investors and asset
managers. To be straightforward, over a decade ago, it also took us a while to realize option pricing drastically
changed. This opportunity did not always exist, at least in its current structure. From the early 1990’s to GFC,
option overlays were used almost exclusively at Hedge Funds and in proprietary trading operations at banks.
Today there is widespread access, and the opportunity set is, as said, on the other side. Ultimately, leading to
improved Hedged Equity outcomes.
How do we do it? Re-invent, re-combine and restructure the familiar for synergistic and enhanced results. Portfolio
construction techniques have always evolved to seek outperformance relative to applicable benchmarks. Our
Hedged Equity approach is no different. First, combine an investor’s desired level and type of beta, matching
applicable benchmark. Second, overlay it with non-correlated stream of excess return (alpha), allowing for
potential improvement of up-down capture, dramatically increasing probable long-term outperformance. The
need for new non-correlated alpha strategies is even more vital to ensure the continued success and evolution of
hedged equity as a component of investor portfolios. Historical techniques such as put-spread collars employed
by some of the largest hedged equity providers, have become so overcrowded, they will likely lead to nothing
but value destruction.
Market beta is relatively easy and cheap to obtain and rather efficient in large cap space. So how do investors
improve risk-adjusted performance in hedged equity? Combine an alpha strategy, that has negative correlation
to broader equity. Moving alpha and porting that atop of beta has historically been broadly referred to as
portable alpha. The term is most often associated with active stock picking alpha in small caps ported to large
cap beta. Although the term may be new to younger investors, the concept is rather simple = Real Alpha +
Beta. We use the term “Real Alpha” to emphasize our approach is not simply a vanilla hedge gone right, market
timing gone well or other hidden marketing-oriented spin on performance. We seek real alpha delivered
through real manager skill.
REAL ALPHA + BETA
We have said before, derivative markets are about supply and demand. These are markets where risk is
manufactured for the end user. End users dominate the market and are the marginal price setters. When themes
within end user flows grow excessively relative to the size of the market (such as zero premium put spread collars
or simple option overlays such as put buying or call selling), they significantly affect market prices and change
risk premia. Said simply, too many options sellers and implied volatility will be cheap, not compensating sellers
via upfront premium. Too many long-dated option buyers, implied volatility will be expensive, thus not
performing for the insurance buyer.
Jerry Seinfeld, a character from a 1990’s sitcom bearing his name, said to the character George Costanza, “If
every instinct you have is wrong, then the opposite would have to be right”. We think this applies to many
Hedged Equity strategies available to investors. We successfully managed strategies like JP Morgan Hedged
Equity JHEQX and JP Morgan Equity Premium Income ETF JEPI in the 1990s and 2000s. Then the Costanza
moment became apparent. Our model did not change, but how we positioned did.
The discrepancy in performance from what is expected by an investor and what is received is determined by the
price of the options overlay. With the proliferation of option overlay strategies offered by large asset managers,
it has caused too much supply of front month call selling and too much buying demand for longer dated puts.
This imbalance leads to price dislocations that mitigate the intent of the strategy. For example, JP Morgan states
the intent as “the Hedged Equity Fund Series enables investors to participate in equity market gains, while
mitigating risk in declining markets”. The Equity Premium Income ETF states the intent as “Seeks to generate
income through dividends and options premium… offering an innovative, active solution”. The income and
innovative part we’ve already addressed in prior papers, see Option Selling Has Become Consensus: Its Impact
and Have Option Selling Strategies Suppressed Implied Volatility? Both Q1 2024. Figure 1 shows the
performance of this so-called risk mitigation and innovative selling away of upside of JHEQX and JEPI. Notice
the 50/50 strategy, it is effectively half the downside risk with better returns.
2
Figure 1. Performance of Convexity Alpha Hedged Equity, 1x Beta2,3,4,5
Source: QVR. JP Morgan.
These types of outcomes for large, disadvantaged hedged equity strategies have become more extreme and it is
reflected in the poor performance. The rub is in reading the fine print disclaimer: “There can be no guarantee
the objectives will be met”. We believe their underperformance is the lack of price sensitivity on the options they
use to deliver their stated investment mandate. Put spread collars (buy put spread vs. sell call) are net short
optionality and can generate large relative losses in rallying markets. High returns from volatility selling attracted
more money post-GFC compressing volatility risk premium and lowering upside call strikes on popular “zero
cost” collars, which are certainly not “zero cost”. Pricing in the derivatives markets is simply the result of excess
trade flow and with a decreased call premium received to buy a put spread, the upside call strike decreases.
Investors will always look for ways to cheapen hedges but unless very closely understood, capping the
upside on your equity allocation is not the answer.
So who takes the other side of these option dislocations? There are a few hedge funds that participate in this
price dislocation but is not their core strategy. These hedge fund traders who implement derivative strategies
tend to have different methods on how to profit from these price dislocations. And since they are price sensitive
and have less capital than these Hedged Equity products, they don’t stand in the way of the oversupply of price
insensitive trading. The market makers also have different price objectives. Market makers take advantage of
small and short-term market dislocations often caused by buyers and sellers who cross the bid/offer spread to
initiate positions. Since banks have limited capacity to take risk, their ability to take advantage of this dislocation
is restricted. The opportunity set exists and is growing in our opinion.
3
Figure 2 shows the total AUM of Morningstar “Derivative Income” Funds. This data only includes public funds
that are included in this category.
Figure 2. Total AUM of Morningstar “Derivative Income” Funds
Source: Cboe.
• The first large wave of option selling and hedging strategies hit the marketplace post Global Financial
Crisis (“GFC”).
• The second large wave hit the marketplace around 2013, with a large number of public funds hitting
the market.
• The third wave has taken a new marketing spin in the form of “derivative income” strategies.
This trade flow, without a doubt, is contributing to a large and growing structural dislocation which is not
compensating “insurance sellers” (i.e. near dated call and put writers) and overcharging in implied volatility
terms, buyers of insurance (i.e. long dated puts). As we have said, excerpted from our Q1 2024 paper, Have
Option Selling Strategies Suppressed Implied Volatility?:
If you run a backtest on a long historical time period where the relevant market was small and the
relevant strategy had no material institutional capital, you will get a very different answer than the goforward answer when institutional capital shows up.
NEXT GEN HEDGED EQUITY
Delivering alpha-focused strategies to the market is a core competency of our experience. Taking it a step
further, we primarily focus on equity derivative oriented strategies. Over the years, we have watched both the
cost of executing come down but also the available pool of alpha shift from OTC to listed markets. This is a
4
market that continues to evolve. We are in a world that demands constant evolution, re-inventing, recombining, and restructuring of the familiar for synergistic and enhanced results. What we can offer today is a very
compelling next generation Hedged Equity strategy. Our Hedged Equity offering combines alpha plus beta (Figure 3), a
simple concept, which takes much manager skill to deliver, dramatically improving up-down capture, which we will discuss
next. See APPENDIX for a study showcasing long term impact of detrimental up-down capture.
Figure 3. REAL ALPHA + BETA1
Source: QVR. For illustrative purposes only.
ALPHA MATTERS
Up-down spread is indicative of manager skill. Capturing positive returns in upside equity markets (positive up
capture) and capturing positive performance or at least flattening downside beta returns in equity downside (flat
to negative downside capture) is ideal. The vast majority of managers are upside down on up-down
capture. Hedge funds and various alternative strategies with a negative up-down capture spread, rely
on persistent positive equity upside for returns.
Figure 4 depicts monthly up-down capture for various strategies and showcases the upside down up-down
capture that is a headwind for overcrowded strategies.
Figure 4. REAL ALPHA + BETA2,3,4,5
Source: QVR. JP Morgan. For illustrative purposes only. Data July 2023 to May 15, 2024.
This brings us back to our opening statement; we believe current hedged equity providers have been selling
calls too cheap and buying puts that are too expensive. We take the other side of their trades and deliver on
what they have been unable to deliver.
QVR IN THE NEWS
April 2024 EQDerivatives: San Francisco-based volatility manager QVR Advisors has appointed two staff to the
role of co-chief investment officer. Tae Hong, currently deputy CIO, and Steven Richey, portfolio manager for
QVR’s convexity alpha series, will take over from Benn Eifert as co-CIOs. Eifert will continue in an oversight role
and in driving research forward to support business growth further as managing member and president,
according to Scott Maidel, head of hedge funds business at the asset manager.
February 2024 HFA The Grapevine: A veteran portfolio manager who once ran a $3 billion systematic volatility
program at First Quadrant has joined QVR Advisors. Steve Richey started in January at the San Francisco firm,
where he oversees market-neutral equity, hedged equity and volatility convexity strategies. Richey counts
Capstone Investment and Parallax Volatility Advisers among recent employers, though he’s perhaps better known
for his 12-plus years at First Quadrant, where he was a partner who managed a short-volatility arbitrage book
and headed global options strategies.
March 2024 Bloomberg The Big Take: “Yet QVR Advisors also sees the footprints of the boom in vol-selling. The
degree of swings priced into S&P 500 options — so-called implied volatility — has drifted lower over the years
versus how much the index actually moves around, its data show. The theory is that money managers flooding the
market with contracts to generate income are putting a lid on implied volatility — which after all is effectively a
gauge of the cost of options. The hedge fund has recently launched a strategy seeking to take advantage of
cheap derivatives that benefit from large swings in the S&P 500, whether up or down.”
QVR IN THE NEWS
January 2024: Tae Hong, deputy chief investment officer at QVR Advisors, said despite the S&P 500 near alltime highs, the hedge fund continues to see dislocations caused by excessive market flows under the hood. “At
QVR, we believe the foundation for a successful program is to have a variety of strategy levers to pull,” Hong
said in a statement to EQD. “End users dominate derivatives markets and are the marginal price setters.
Therefore, when we think about potential positioning it’s usually around excessive movements in volatility skew,
volatility term structure and relative volatility moves in SPX versus VIX, to name a few. Unfortunately, many
investors are far too often affected by herd mentality or are far entrenched in existing programs to change
course.” QVR recently launched new relative value strategy sleeves in commodity and interest rate futures with
more expected to come in 2024.
October 2023: San Francisco-based hedge fund QVR sees no need to use over-the-counter derivatives to
expand into new strategies. The fund is expanding strategies and adding assets under management, but Scott
Maidel, head of business development, said QVR is sticking to listed instruments. Liquidity and volumes for
listed products have ballooned, allowing QVR to add strategy sleeves without turning to OTC markets.
February 2023: Inclusion in the Top 25 Leaders In Systematic And Volatility Investing is based on feedback and
data collected from allocators across the globe over the prior 12 months.
APPENDIX
Excerpt from Option Selling Has Become Consensus: Its Impact Q1 2024.
Disclaimer Footnotes
Disclaimer #1
The description herein of the approach of QVR and the targeted characteristics of its strategies and investments is based on current expectations and should not be
considered definitive or a guarantee that the approaches, strategies, and investment portfolio will, in fact, possess these characteristics. In addition, the description herein
of risk management strategies is based on current expectations and should not be considered definitive or a guarantee that such strategies will reduce all risk. These
descriptions are based on information available as of the date of preparation of this document, and the description may change over time. Past performance of these
strategies is not necessarily indicative of future results. There is the possibility of loss, and all investment involves risk including the loss of principal.
Disclaimer # 2
Performance results of the Market Neutral strategy are used to calculate Hedged Equity returns and are presented for information purposes only and reflect the impact
that material economic and market factors had on the manager’s decision-making process. No representation is being made that any investor or portfolio will or is likely
to achieve profits or losses similar to those shown.
Net monthly returns are calculated net of a 1.75% annual management fee to the investor; however, performance of individual investors may vary based upon differing
management fee and incentive compensation arrangements, and the timing of contributions and withdrawals. The returns shown also apply certain return on cash
assumptions. Performance numbers were prepared by QVR and have not been compiled, reviewed or audited by an independent accountant. Performance estimates are
subject to future adjustment and revision. The information provided is historical and is not a guide to future performance. Investors should be aware that a loss of
investment is possible. Performance of the Market Neutral (fully funded) strategy as of February 1, 2024, is extracted from the performance of a larger portfolio. The
performance results of the total portfolio from which this performance is extracted will be made available upon request.
This presentation cannot and does not guarantee or predict a similar outcome with respect to any future investment or account. QVR makes no implications, warranties,
promises, suggestions or guarantees whatsoever, in whole or in part, that by participating in any investment of or with QVR you will experience similar investment results
and earn any money whatsoever.
Disclaimer #3
The above graphic does not represent actual performance of the Hedged Equity strategies, but rather a mathematical exercise applying certain return on cash and beta
assumptions to the Market Neutral (fully funded) strategy’s performance (which has not been audited), as well as the application of a 1.75% management fee. Certain
hypothetical scenarios described herein are for illustrative purposes only and the securities and/or financial instruments described may not be actual securities and/or
financial instruments held. Inclusion of such scenarios is not intended as a recommendation to purchase or sell any security or financial instrument, and performance of
these scenarios is not necessarily indicative of actual results.
No representation is being made that any QVR account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences
between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical
performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical
trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or adhere to a particular trading
program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in
general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of
which can adversely affect actual trading results.
Disclaimer # 4
References to market or composite indices, benchmarks, or other measures of relative market performance over a specified period of time are provided for information
only. Reference or comparison to an index does not imply that the portfolio will be constructed in the same way as the index or achieve returns, volatility, or other results
similar to the index. Indices are unmanaged, include the reinvestment of dividends and do not reflect transaction costs or any performance fees. Unlike indices, a Fund or
other QVR account will be actively managed and may include substantially fewer and different securities than those comprising each index.
References to market or composite indices, benchmarks, or other measures of relative market performance over a specified period of time may be presented to show
general trends in the markets for the applicable period and are not intended to imply that a Fund's portfolio or the portfolio of any QVR account will be benchmarked to
any indices either in composition or level of risk. Benchmark data is provided for comparative purposes only.
Disclaimer # 5
The prior performance results for the Market Neutral (fully funded) strategy derive in part (prior to February 1, 2024) from accounts other than those of QVR or the Funds.
Steve Richey was primarily responsible for achieving the prior performance results presented herein and is presently responsible for investment decisions at QVR. QVR
believes these accounts are sufficiently similar to the accounts that will be managed by Steve Richey at QVR such that the prior performance results presented above
provide relevant information to prospective investors. All accounts managed over the specified time frame in a substantially similar manner to QVR’s management of the
accounts and/or Funds employing the above strategies are represented herein. Performance numbers were prepared by QVR and have not been compiled, reviewed or
audited by an independent accountant.
Disclaimer
These materials are not an offer to sell securities of any investment fund or other pooled
investment vehicle (each, a “Fund”, or collectively, “Funds”), or a solicitation of offers to
buy any such securities. Securities of any Fund managed by QVR LLC d/b/a QVR
Advisors (“QVR”) are offered to selected investors only by means of a complete offering
memorandum and related subscription materials which contain significant additional
information about the terms of an investment (such documents, the “Offering
Documents”). Any decision to invest must be based solely upon the information set forth
in the Offering Documents, regardless of any information investors may have been
otherwise furnished, including these materials.
An investment in any strategy, including the Market Neutral, Volatility Hedge, or Hedged
Equity strategies described herein, involves a high degree of risk. There is no guarantee
that the investment objectives will be achieved. Past performance of a given strategy is
not necessarily indicative of future results. There is the possibility of loss, and all
investment involves risk, including the loss of principal. Securities are not registered with
any regulatory authority, are offered pursuant to exemptions from such registration, and
are subject to significant restrictions.
The information in these materials was prepared by QVR and is believed by QVR to be
reliable and has been obtained from public sources believed to be reliable. QVR makes
no representation as to the accuracy or completeness of such information. Opinions,
estimates and projections in this presentation constitute the current judgment of QVR and
are subject to change without notice. Any projections, forecasts and estimates contained
in these materials are necessarily speculative in nature and are based upon certain
assumptions. It can be expected that some or all of such assumptions will not materialize
or will vary significantly from actual results. Accordingly, any projections are only
estimates and actual results will differ and may vary substantially from the projections or
estimates shown. These materials are not intended as a recommendation to purchase or
sell any security. QVR has no obligation to update, modify or amend these materials or
to otherwise notify a reader thereof in the event that any matter stated herein, or any
opinion, project on, forecast or estimate set forth herein, changes or subsequently
becomes inaccurate.
These materials are strictly confidential and may not be reproduced or redistributed in
whole or in part nor may its contents be disclosed to any other person without the express
consent of QVR.
Standards Board for Alternative
Investments Disclaimer
No responsibility, duty of care or liability whatsoever (whether in contract or tort or
otherwise including, but not limited to, negligence) is or will be accepted by the
Standards Board for Alternative Investments Limited ("SBAI"), the Board of Trustees of
the SBAI, any member of the SBAI's Investor Chapter (each an "Investor Chapter
Member") or a Core Supporter of the SBAI to Signatories, investors or any other
person in connection with the Standards or any Conformity Statement or Disclosure
Statement made by any Signatory. A Core Supporter can be a Signatory to the
Standards, a member of the SBAI’s Investor Chapter or an investment consultant.
Neither the SBAI nor its Board of Trustees is a regulator of the alternative investment industry and their
role does not extend beyond being a custodian of the Standards. None of the SBAI, its Board of
Trustees, the Investor Chapter Members and the Core Supporters will seek to enforce compliance with
the Standards by Signatories. The fact that a manager is a Signatory to the Standards is not and
should not be taken as an endorsement of such manager by the SBAI, the Board of Trustees, any
Investor Chapter Member or any Core Supporter or as a representation by the SBAI, the Board of Trustees, any Investor Chapter Member or any other Core Supporter that
such Signatory operates in conformity with the Standards. In determining whether to accept a manager's application to become a Signatory (or whether to revoke a
manager's status as a signatory), the Board of Trustees is entitled to rely on the information provided to it by such manager without further investigation or verification.
Further, subject to any duties a Trustee may have under applicable law, it is not envisaged, or expected, that a Trustee will when participating in any such decision of the
Board of Trustees take into consideration information which it may possess otherwise than in its capacity as a Trustee. For the avoidance of doubt, Trustees act as
individuals.
None of the SBAI, the Board of Trustees of the SBAI, the Investor Chapter Members and the other Core Supporters accept any responsibility or liability for any loss or
damage caused to any person who acts or refrains from acting as a result of anything contained in or omitted from the Standards or any Conformity Statement or
Disclosure Statement made by any Signatory or in reliance on the provisions of or material in the Standards or any Conformity Statement or Disclosure Statement made by
any Signatory, whether such loss or damage is caused by negligence or otherwise.
Contact Information:
Scott Maidel, Partner, Head of Hedge Funds Business
Scott.Maidel@qvradvisors.com
www.qvradvisors.com
Steve Richey, co-CIO, Head of Convexity Alpha