The LJM Preservation & Growth fund has dropped 56% since the start of the week as its volatility strategy backfired dramatically when the Cboe Volatility Index (VIX) spiked.
Wall Street's fear index has shot up during this week’s sell-off, spiking at almost 50 early Tuesday morning, before dropping off to finish the day at around 37. It has since retreated to around 22 today.
The fund is managed by Chicago-based LJM Partners, a firm founded in 1998 and which specializes in volatility strategies.
The firm offers three strategies: LJM Aggressive, LJM Moderately Aggressive and LJM Preservation & Growth, the only one available as a mutual fund.
All three of LJM’s funds invest in ‘long and short options on the S&P 500 Index futures that seek to profit, primarily, from the volatility premium—the spread between implied and realized volatility,’ according to the firm’s website.
On Tuesday, February 6, LJM founder and chairman Anthony Caine sent a letter to investors to address the fund’s fall.
In the letter, which was shared on social media, Caine said: 'LJM strategies have suffered significant losses. At this time, the portfolio management team is trying to hedge with as many futures as possible to attempt to insulate portfolios from further losses.'
'Our plan is to go to a defensive position depending on liquidity of options markets. Our goal is to preserve as much capital as possible.’
The LJM Preservation & Growth fund fell by 55.9%, while it’s wider Morningstar peer group, Options Based, gained 0.81% on Monday, according to Morningstar Direct.
The steep decline has erased positive annual returns extending to 2013 as a result of its positions in derivatives contracts.
Prior to the drop, the fund had profited from its bet on volatility, posting positive absolute returns for 10 out of the 12 months of 2017.
For three-year total returns to the end of 2017, the fund, which is managed by Caine and Anish Parvataneni, is ranked third out of 65 funds in the Citywire Global Macro category, and was up 39.1% over that period, versus the average fund’s 8.4%.
Before its dramatic decline the fund had $771.9 million in assets under management.
Morningstar analyst Gretchen Rupp placed the fund under review after it delayed posting its net asset value on Monday and because of the huge drop.
The fund is the latest casualty in a string of blow-ups that has caused investors to question the once-popular bet against volatility.
The VIX, hit an all-time low of 9.14 in November 2017, dropping more than 17% throughout the year. This sense of calm further fueled the flow into volatility products that has since been blamed for the sharp spike earlier this week.
Maneesh Deshpande, managing director and head of equity derivatives strategy at Barclays in New York, took a more measured stance.
'There was a lack of liquidity needed to meet the need for VIX futures contracts' he said. 'The VIX closing at high levels does not necessarily mean that there’s fear in the market but rather a temporary imbalance in price and supply/demand.'
Presenting at the Global Volatility Summit in August 2017, Deshpande’s team had forecaste this trend well ahead of this week’s fallout.
Even while some may be deterred from investing in volatility as products shutter, Deshpande noted that the ProShares Short VIX Short-Term Futures ETF actually saw inflows since the panic on Monday.
'VIX has already dropped dramatically but will stay elevated to some extent' he said.