Volatility in the Third Circle fund still a concern

Fund manager explains that it is due to technical pricing issues.

CAPE TOWN – Although investors in the Third Circle MET Target Return Fund have seen some moderate positive returns for the year to date, it has been anything but a smooth ride getting there. The fund, which lost 66% in just two days in December, has been displaying extreme daily volatility so far in 2016.

During February alone, the fund experienced nine days where returns were either higher than 5% or lower than -5%. This over a period when the JSE All Share Index did not move more than 2.6% either way in a single day’s trade.

This volatility extended into March as well, and hit its peak in a week where the fund showed extreme moves for five consecutive days:

 

Third Circle MET Target Return Fund daily returns

 

07/03/2016

08/03/2016

09/03/2016

10/03/2016

11/03/2016

Fund

-7.65%

13.92%

-5.06%

-5.81%

9.25%

FTSE/JSE Alsi

1.01%

-0.81%

-1.46%

0.10%

0.40%

Flexible fund average

0.06%

0.34%

-0.72%

-0.36%

0.28%

Source: Morningstar

 

The size of these daily moves again raised concerns about the potential leverage being employed in the fund, however portfolio manager Ian Lane told Moneyweb that they have been very cautious in their approach this year.

“The fund has been managed quite defensively, both while we perform the necessary research to address the tail risk issues, and also in response to the very volatile start to the year on global markets,” he said.

He attributed the day-on-day volatility in the fund’s net asset value to a technical fund pricing issue.

“With the December events, a number of options positions were offset and neutralised exactly by futures positions,” Lane told Moneyweb. “The daily net Safex mark-to-market on these is precisely zero, and the effective exposure is also zero. However, the fund is priced at 3pm, and the JSE publishes 3pm prices for the futures, while options prices are only published at 5pm. Hence there is a one day lag in the offsetting movement as incorporated into fund pricing, although not in actual cash flows.”

He added that the reduced capital base in the fund and market volatility have exaggerated these effects. Third Circle also decided not to unwind the positions due to the potential cost of doing so.

“Unwinding these positions would have entailed costs and losses and it was judged better in the long run to live with the short term volatility,” he explained. “With the close outs of 17 March, these effects will be greatly diminished going forward.”

While Lane’s explanation makes sense, his is not the only fund that has this issue. Any manager who utilises options and futures will face the same timing mismatch and the impact this has on daily pricing.

However, few, if any of them, see consistent daily volatility on this scale. The magnitude of the daily moves therefore still raises questions about how geared the fund was before the positions were neutralised.

At the same time, leaving the positions open potentially disregards the impact that these huge movements are having on anyone investing into or disinvesting from the fund. If there is a potential 13% difference in the price of units from one day to the next, this can materially prejudice anyone buying or selling those units.

It will also be important to see whether this daily volatility does indeed reduce after the March close out.

Mickey Gambale, the CEO of Metropolitan Collective Investments (MetCI), which is the management company responsible for the fund, said that the company is monitoring the fund closely and believes that the pricing mismatches will be smoothed out over time. MetCI has also done a lot of work around assessing the fund and its strategy.

“We have engaged with Third Circle on their investment approach and the strategies employed in the management of this fund,” Gambale said. “Third Circle has informed us that the fund is being managed more defensively and with cognizance to the current market volatility. MetCI continues to monitor the fund and has recently completed an internal investment due diligence on Third Circle, its current strategies and future plans.”

He also reiterated MetCI’s belief that the fund is compliant with legislation and that its use of financial instruments is in line with the necessary regulations.

The Financial Services Board is still investigating the losses sustained by the fund in December.

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MetCI will defend Third Circle to shift any blame away from themselves. The FSB will most likely not do anything either – to excuse themselves from any blame. As usual, the investor who was probably miss-sold the fund, or miss-advised to invest in it, is left carrying the can.

I would love to see what is in that fund as it is obvious that they are hiding whatever is. A 14% move in one day!? That is outrageous for a general equity mandate. And why is there large derivative positions in a general equity fund? Something is smelling here.

End of comments.

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