New hedge fund plans on grabbing flash-crash profits

Manager says systemic risk has reduced, creating opportunity in sell-offs

H₂O Asset Management is to launch a daily liquidity Ucits fund that seeks to make money from flash crashes and panicked sell-offs in financial markets.

The fund, called Barry Active Value, opens in November with a mandate to buy assets other funds are hurriedly dumping when the portfolio manager judges fears of systemic risk to be overblown.

The fund will seek to put on 10–20 trades a year across fixed income, currency and equities, via short-dated options. Vincent Chailley, H₂O's chief investment officer based in London, says there is strong investor demand for a fund that exploits flash crashes, and hopes to raise €200 million ($218 million) by June.

"One of the main consequences of the heavy regulation is there are no more investors being able to follow the down market when it goes in one direction," says Bruno Crastes, chief executive officer of H₂O.

H₂O Asset Management is known for its high-volatility funds, such as the Vivace fund, which lost 15% on the day after the UK voted to leave the European Union but has since recovered and is up 8% from pre-referendum levels.

Crastes sees mispricing as a result of two factors: banks stepping away from providing liquidity in short-term spells of investor jitters and many buy-side firms wanting to dampen volatility.

"Given asset managers' pledge to investors to limit volatility, when there is volatility, they hedge. This amplifies the move," he says. "We do the opposite of hedging when the market goes too far."

Chailley says that shock sell-offs are becoming more frequent but also more short-lived. "Systemic risk in markets has receded since 2008… due to less leveraged banks, so the risk that would see a local shock morph into a global crisis is extremely unlikely today," he says.

"If you believe, like us, the systemic risk is really remote, let's say, then you can make a 7–8% return with low volatility and a decent Sharpe ratio," he says, adding investors understand this argument.

The fund will identify flash crashes on the basis of realised and implied one-month volatility with the portfolio manager opting to buy in a downturn when those metrics exceed certain points.

If you believe, like us, the systemic risk is really remote, then you can make a 7–8% return with low volatility and a decent Sharpe ratio
Vincent Chailley, H₂O Asset Management

The collapse in sterling and the devaluation of the yuan in August 2015 would be examples of such flash crashes the fund could exploit. But the Active Value fund would prefer to take advantage of price falls over a week to one day, rather than one hour, says Crastes.

H₂O Asset Management claims it is one of the first hedge funds to launch a specialist flash crash fund.

"We haven't come across that many [funds like this]," says Tony Gannon, chief executive of Abbey Capital, a Dublin-based fund of hedge funds that specialises in quant funds. "We've seen some people who buy dips in equities, but it's not exactly the same."

Fund of hedge funds managers say the risks of such a strategy are high, especially if the asset price returns to a fairer value after the sell-off.

"In flash crashes, sometimes the volume is just so small and so quick I don't know how you'd catch it. It comes along so rarely," one says. "I'm not really sure it makes sense as a business."

"I'd be interested to see the size it trades. If you're trading a couple of hundred million, that might not work," he says.

"It's the only one I've heard of. My question would be how often would it trade... this year I can think of two major flash crashes," says Stephano Prosperi, London-based chief executive of Kairos Investment Management.

Its Active Value fund is one of a suite of new Barry funds to be launched, all to take advantage of what it terms over-regulation.

It will launch a Barry Short fund in November, aiming to expand to €200 million by June. The Ucits fund will short US Treasuries and German Bunds, taking advantage of low rates. Chailley says most demand has come from insurers.

H₂O will also launch a Barry Yield fund next March, to opportunistically buy assets that banks offload for regulatory reasons, for example to satisfy balance sheet requirements or to reduce correlations.

The assets will have risk-reward characteristics favoured by long-term investors such as insurers, sourced through relationships with the banks. Barry Yield will be an alternative investment fund.