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Hedge funds fatten returns with exotic bets on cheese, maize

[LONDON] Cheese, sunflower seeds and rough rice sounds like an unappetizing mix - unless you happen to be a hedge-fund manager.

A handful of computer-driven funds had a bumper 2017 by betting on the future price of such "exotic" assets. The success of this type of managed futures strategy, the industry's term for trend-following, is now drawing new entrants despite the risks created by the low levels of liquidity.

Hedge funds returns have been battered by central bank monetary policies that have made it more difficult for them to outperform the market in everything from bonds to equity futures. That's prompting some trend followers to move into less crowded markets such as over-the-counter securities, electricity and coal.

Man Group's AHL Evolution fund, one of the first to enter this niche market, had a return of 18 per cent last year. The Systematica Alternative Markets fund run by Leda Braga fared even better, posting gains of 24 per cent, according to a person with knowledge of the matter. By contrast, funds that speculated on more mainstream assets and indexes had average returns of just 1.9 per cent.

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"Exotic markets provide an opportunity to take bets away from the usual macro risk factors," said Douglas Greenig, the founder of Florin Court Capital and a former chief risk officer of Man Group's AHL unit. "Sharpening our focus to exotics just made sense."

Quick Turnaround

In April, Florin Court switched its fund's strategy to focus entirely on exotic assets. That enabled the London-based hedge fund to turn a first-quarter loss of 9 percent into a full-year gain of 7.6 per cent, according to a person with knowledge of the matter.

Trend-following hedge funds recorded some of their best gains during the market crashes at the turn of the century and in 2008. That encouraged investors to put money into this type of fund to diversify their portfolios and try to protect themselves from future shocks. In the first 11 months of last year, US$13 billion flowed into these funds, helping to swell their assets to a record US$267 billion, according to data compiled by Eurekahedge.

In October, a unit of Zurich-based GAM Holding AG, started a fund that trades around 200 unusual and difficult-to-access markets, such as rough rice and ethanol.

Aspect Capital began a fund in November that trades credit indexes, emerging markets currency forwards as well as sunflower seeds and maize. The money pool gained 3.4 per cent through end of last year, according to the firm's website.

Devet Capital started a similar fund this year that mainly trades alternative markets. The fund, run by former Man AHL quant researcher Alberto Cozzini, will open to external clients in mid-2018.

Spokesmen for Man Group, Systematica, Florin Court, GAM and Aspect Capital declined to comment on their returns.

As a rule, non-traditional assets offer higher yields than more liquid markets. However, these hedge funds enhance their trades with borrowed money, so if there's a credit crunch, investors could face significant losses.

Unknown Territory

"The big demand for these strategies is just due to the good performance," said Marcus Storr, head of hedge-fund investing at Bad Homburg, Germany-based Feri Trust. "If there's a liquidity crunch for some reason, we do not know how these strategies would react."

To address the problem, assets managers are capping the size of their funds. AHL Evolution stopped accepting new money last year, while Florin Court reduced the amount it can manage to US$2 billion from US$3 billion after changing its strategy. GAM Systematic's new fund will restrict the money it overseas for clients to just US$500 million.

This obscure corner of the hedge-fund market may become less exotic as more firms are lured by the attractive returns. Funds may come under pressure to seek out new, untapped markets that offer more potential, such as cryptocurrencies. Florin Court is one of the few hedge funds to trade bitcoins.

At the same time, the limited capacity in many exotic markets, along with the relatively high trading costs and the need for extensive research, may deter some firms.

"While the best way to trade futures in traditional funds is little and often, that's possibly the worst way to trade in alternative markets," said Chris Reeve, a senior product manager at Aspect Capital. "The devil here is in the detail. The principles of trend-following are easy, but deploying the strategy in these markets is a challenge."

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