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Alternative Market Briefing

Texas hedge fund reaps profits with convexity strategy

Thursday, December 30, 2021

B. G., Opalesque Geneva for New Managers:

Texas hedge fund manager Lavaca Capital is reaping profits from a strategy that is impeccably tailored for his family office investors; a convexity strategy that aims to outperform the S&P 500 index in extreme markets through the use of options.

Scott Phillips, founder and CIO of Lavaca Capital, will be presenting at the Small Managers - Big Alpha Episode 6 webinar on January 11th, 2022.

The Lavaca Capital Convexity Fund seeks to create an amplified return relative to the S&P 500 index using a series of long-dated options, while fully financing the upside convexity via the sale of defined risk option structures.

The route to launching the fund was born out of market demand, Phillips explains to Opalesque. The manager was approached by a family office client that was looking for a replacement of their structured note investment allocation but wanted to eliminate many of the undesirable features of such investments such as capped upside exposure, downside buffers (vs. floors), and lack of liquidity and transparency.

"Lavaca was able to create such a product for this initial investor using their expertise in the listed options space that combined amplified upside exposure to the S&P 500, a left-tail hedge, and a unique financing structure to mitigate the bleed from options held in the portfolio," he says. "The product was first launched as an SMA and quickly grew to a significant allocation ($200m), whereby Lavaca decided to use the existing capital base to launch a hedge fund product with the same strategy."

Source: Lavaca

An investment strategy is convex if its payoff relative to its benchmark is curved upward. Convex investment strategies are expected to be highly correlated with the benchmark in typical market environments but diverge to the positive in extreme markets. However, such strategies are expected to lag during quiet markets. The strategy can be deployed either strategically or tactically.

Lavaca's $148m Convexity Strategy has cumulated a return of 120% (net) from its March 2020 inception to the end of November 2021, compared to 95% for the S&P 500 TR (adjusted total return) index, according to documents seen by Opalesque. It is up 30% (net of fees) YTD, compared to the S&P's 23%. The fund's annual standard deviation stands at 18%, compared to the S&P's 15%.

Next year

The S&P 500 is on track for an 87% gain since the end of 2018, its best three-year performance in more than two decades, Reuters reported last week. But chances of a similar performance in 2022 may be threatened by a more hawkish Federal Reserve, slowing earnings growth, and a relentless pandemic.

"The path of the market's annual return profile is a point of reference for the strategy's success in any given year," Phillips says.

"If the market is to return 0% in 2022 with highly volatile swings between January and December, the fund should perform quite well in this environment as the portfolio is rebalanced periodically and long volatility holdings are monetized during bouts of market volatility.

"The strategy could struggle, however, if the market is choppy with a smaller distribution of returns. This is because the positions used to recoup the cost of the portfolio's long convexity could potentially not generate enough return to offset the portfolio's annual premium bleed. "

Scott Phillips founded Lavaca Capital in 2014. Prior to this, he managed the assets of a Houston-based multi-family office. He is a licensed CPA and has 10 years of investment experience with a focus on the derivative space.

Houston, Texas-based Lavaca Capital, LLC now manages $450m in AuM and serves about 100 investors that include family offices, institutions and advisors across the U.S.



Small Managers - BIG ALPHA Episode 6

We are proud to present you the next episode of this groundbreaking webinar series with the following carefully screened panel of investment managers:

• Andy Chakraborty, Duo Reges Capital Management
Lukasz Tomicki, LRT Capital Management
Steven Grey, Grey Value Management
• Scott Phillips, Lavaca Capital

When: Tuesday, January 11th at 10:30 am ET - 3:30 pm UK time - 4:30 pm CET

Free registration here:

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