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Pengana Aims to Grow Volatility Hedge Fund Amid Market Swings

Date: Friday, April 24, 2009
Author: Malcolm Scott, Bloomberg

Pengana Capital Ltd., a Sydney- based asset manager that oversees A$1.5 billion ($1.1 billion), aims to increase the amount of hedge fund assets that bet on market swings by six times in two years.

Pengana is seeking to grow assets managed by its Chicago- based volatility team to $2.5 billion from about $420 million currently, Russel Pillemer, co-founder and chief executive officer, said in an interview yesterday. Pengana’s Global Volatility Master Fund returned 19.3 percent last year, while the hedge fund industry fell an average 19 percent.

The Chicago Board Options Exchange Volatility Index, known as the VIX, reached a peak of 80.86 following the collapse of Lehman Brothers Holdings Inc. in September. The index, which measures the cost of using options as insurance against declines in the Standard & Poor’s 500 Index, was at 37.15 yesterday, still almost double the average of 20 over its 19-year history.

“With this level of volatility there are fantastic opportunities,” Pillemer said. “This sort of performance is pretty unique, so we would think we’ll get a lot of traction.”

Managed by Alvin Wilkinson in Chicago, the volatility fund trades options contracts on U.S. equity indexes. Wilkinson has been a member of the CBOE since 1986 and is credited with the creation of the VIX, according to Pengana’s Web site.

Counter Bets

The volatility strategy, employed since November 2007, seeks to profit from the mispricing of U.S. equity index options by “playing on the other side” when institutional investors push prices too far either up or down, Pillemer said.

“People generally tend to overreact at various points in the market, and we take advantage of that,” he said. “Fast changing times are good for us.”

The S&P 500 Index tumbled 38 percent last year and lost a further 25 percent from the end of 2008 to a 12 1/2 year low on March 9. It has since rallied 26 percent.

As the U.S. volatility fund grows, Pengana will start to look at trading options on European and Asian indexes, targeting $7 billion in total in the next five years, Pillemer said.

Pengana, which manages investments across 10 funds including accounts for institutions, has increased the amount its hedge funds manage by about A$200 million over the past year.

It escaped the redemptions that beset other global hedge funds because it doesn’t rely on the fund-of-funds investors that led withdrawals, said Pillemer, who previously worked at Goldman Sachs & Co. in New York.

Weathering the Storm

The worst average annual performance on record and investor redemptions reduced hedge fund assets managed by the industry globally by 27 percent to $1.4 trillion by December from a mid- 2008 peak, Chicago-based Hedge Fund Research Inc. estimated.

The HFRI Fund Weighted Composite Index, compiled by Hedge Fund Research, retreated 19 percent last year, the worst performance since records began in 1990.

“We weathered the crash late last year very well and the level of interest has really heightened now in terms of volatility,” said Denis Carroll, head of distribution at Pengana. “People are starting to think about risk in their portfolios. We think that’s good, because if you talk about risk, you think about volatility.”

Funds that bet on price swings rather than market direction have been among the best-performing strategies over the past 12 months, according to Australian Fund Monitors, which tracks about 200 hedge funds based in the country. Equity market neutral funds returned 11.6 percent on average in the 12 months to March 31, while volatility funds gained 9 percent.

Re-opening Funds

Pengana is also seeking to attract investors to its A$2.2 million Asia equities long-short fund, which seeks to invest in companies it believes will rise, while short-selling those it bets will decline. It gained 2.7 percent in March and 11.1 percent since its July 1 inception. The MSCI Asia Pacific Index tumbled 41 percent over the same period.

Pengana last year opened an office in Singapore, seeking to boost sales and its research capacity in Asia. The firm is also in the process of building tailored credit portfolios for institutional investors, Pillemer said.

Hedge funds are investment pools that can bet on falling as well as rising asset prices. Their managers gain substantially from profits on money invested.

To contact the reporter on this story: Malcolm Scott in Sydney Mscott23@bloomberg.net