Insights into Vega’s algorithm – the GFC

Greedy when others are fearful.

 


Memo to: Vega Capital clients
From: Scott Shuttleworth
Subject: Insights into Vega’s algorithm – the GFC


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Last week I wrote a blog about Vega’s hedging algorithm – the response was great and I appreciated the positive feedback a lot.

Since investors are keen to learn more about how Vega can deliver downside protection, I thought it would be valuable to show a simulation of our strategy over the GFC during 2008. This is notably where Vega has the potential to really shine.

Let’s start by looking at the SPY. The index began 2008 at circa 145 and capitulated 38.6 per cent over the year to below 89. Annualised volatility was 41.3 per cent for this period. This was one of the worst markets for investors since the Great Depression.

And admittedly, if it weren’t for the actions of The Federal Reserve, The US Treasury and many members of the exiting Bush Administration and entering Obama Administration, it might well have been the Second Great Depression. I always credit Ben Bernanke, Timothy Geithner, Hank Paulson and President Barrack Obama in particular for their huge roles in stabilising the Global Financial System at this time.

So let’s see how Vega would have performed over this period using SPY put options with a duration of 6 to 12 months.

The returns are clearly large...so what happened? In the simulation, Vega during 2007 had been long market exposure through writing put options across various market indices. By late in 2007, it had liquidated all its positions into cash. In late April of of 2008, it began buying puts and also entered into some hedges.

By year end, the simulation results show that Vega would have generated a 142 per cent return on capital employed. Versus the index, this represents circa 180 percentage points of out-performance. Annualised volatility was rather high at 55 per cent, however this is a small price to pay for such a high return. In addition, the strategy was rather inefficient between October and December and had some rough draw-downs, although not as bad as what the SPY would have experienced over the year.

Overall, if this were the result of our portfolio over this timeframe, we’d be quite pleased. But please note a few important points to consider upon reviewing these performance numbers.

  • The simulation is limited in nature. We’ve only run it on SPY puts of a certain duration at a single strike for the purposes of a blog. Other positions on other assets and strike prices may have generated lesser returns.
  • The simulation was done on a portfolio of long SPY put options. In future we’ll most likely have the algorithm use bear put spreads to achieve high returns but with lower downside risk to reduce the impact if our models were to be wrong.
  • Past performance does not equal a promise of future returns. The GFC was a very volatile event and in the simulation Vega was able to capture the downside well. Yet future crises may be less severe which would obviously mean the potential for returns is lesser.
  • Events like this don’t occur every year. We expect Vega to do well but certainly not earn more than 100 per cent annually.

Our mandate at Vega Capital is to invest our client’s investment in such a way as to generate high returns during both expansions and contractions in the economy and financial markets. This means that for sophisticated clients, our offering can help buffer the negative impact of a large financial crash to an investment portfolio as well as generating high returns in better times.

 

The Vega Fund has now formally launched and is open to sophisticated and wholesale investors. Qualified investors may find our Information Memorandum and Application Form here however if you would like a hard copy mailed to you, please don’t hesitate to contact our office on 1800 960 707.

Vega Capital is a Corporate Authorised Representative (No. 001264482) of Alpha Securities Pty Ltd (ACN 124 327 064) AFS Licence No. 330757.

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