Lynx Arbitrage is an Asia Pacific, relative value volatility
arbitrage fund with a stated focus of delivering optimal,
consistent "risk-adjusted" investment returns uncorrelated
to general market movements and trends by exploiting pricing
anomalies between Asian Pacific stocks and related exchange
traded derivative contracts.
Interview with Jessica McCarroll
- You are due to launch your fund in February 2004.
Why did you choose to launch an arbitrage hedge fund? What
experience do you have in this field?
In short, we believe there is a very real opportunity
to make money with a pure volatility arbitrage strategy
in Asia, and we are uniquely qualified to execute such
a strategy. We have been investing our own money in this
exact strategy over the last 12 months in a pilot fund
and have delivered 27.5% returns for the year, which we
believe justifies our conviction. We also believe the
timing is perfect for launching the fund.
Nobody else is doing what we do in Asia and most hedge
funds are not set up or able to execute our much focused
trading strategy. Asia is dominated by long/short hedge
funds, which do apply hedging techniques but typically
hedge apples with oranges. At Lynx, we hedge apples with
apples and are looking for pricing anomalies, not studying/screening
balance sheets to look for absolute or relative stock
out-performance. We are capturing Alpha, not creating
it and there is no one else in Asia adopting this trading
strategy or possibly even with the experience to execute
Between the Lynx Arbitrage principals we have a combined
35 years of experience in the Asian and global derivative
markets, and including VivianTing, our head dealer, we
have 42 years of directly relevant experience to offer
to investors. This experience spans from Lesley-Ann's
many years running Exchange Traded Derivative Desks at
Morgan Stanley and UBS Warburg, to my many years as an
O'Connor trader, fund manager and hedge fund manager with
extensive experience in managing derivatives arbitrage
strategies, and Vivian's years both on the floor at the
Hong Kong Futures Exchange and as a dealer at UBS Warburg.
Lesley-Ann was also one of only two foreign nationals
invited to sit on the Migration Committee when the Hong
Kong Futures Exchange migrated to screen-based trading.
So we feel our credentials are pretty strong for running
In addition, Lesley-Ann and I are licensed Commodities
Trading Advisors and Investment Advisors under the Hong
Kong Securities and Futures Commission (SFC), while Vivian
is a Dealer's Representative, Member Representative under
the Hong Kong Exchange and Hong Kong SFC. The Investment
Advisor is SFC-licensed and the Fund and Investment Manager
- Who are the other key members of the team and what
do they do?
At present there are the three of us, Lesley-Ann, Vivian
and myself, an all-girls team but more by accident than
design. Lesley-Ann and I have known each other for nearly
ten years, both professionally and socially, and developed
the Lynx Strategy between us over a number of years of
discussions. Vivian was Lesley-Ann's head dealer at UBS
and jumped at the chance of joining us when we approached
We have intentionally kept costs and headcount low for
the past year while we have been running our own fund,
and have called in a lot of favours and outsourced when
it has made sense to do so. We intend to continue to keep
costs to a minimum; however, we have identified two more
individuals to bring on board as AUM rises, one in risk
management and one in office management and administration.
They are both very experienced in what they do and will
make for a very well-rounded, experienced and happy team.
Are there plenty of opportunities for arbitrage in
Asia and which markets present the best?
Our strategy is perfect for today's Asian markets as
short-term liquidity is high, due to the issuance of covered
warrants in Hong Kong, and the large and increasing retail
activity generally across the Asian markets. In addition
dividend yields are high and dividend growth is strong
and above average in many blue chip companies in Hong
Kong and Australia. As institutional and retail interest
continues to return to the Asian markets, we expect the
opportunities for our strategy to continue to increase.
As I mentioned, our strategy is designed to take advantage
of relative value differences in implied volatilities
between say an index and a basket of component stocks.
This strategy is uncorrelated to the markets' direction
and more a function of retail liquidity. If retail/general
liquidity increases it is more favourable for our strategy,
even if, or especially if this means high levels of market
Our strategy performs best in the markets of Hong Kong,
Australia, Korea and Japan where liquidity is high in
derivative markets. Our strategy would perform worst in
say India or other Asian markets where derivative liquidity
is currently limited.
- How extensively have you back-tested your ideas? What
models did you use?
Back-testing has been important for some parts of our
strategies, particularly with respect to fine tuning of
different strikes or expiries in certain specific market
conditions or events like SARS, and also with respect
to market depth. The best 'test', however, of our ideas
is our performance running an identical fund over the
past 12 months. We were up 27.5% for the year with little
market correlation, and our numbers are all independently
verified by Fortis, our clearers.
With respect to models we have really had to develop
our own proprietary models to deliver what we need, and
these obviously dovetail into our risk management models.
- Which of the following strategies do you use: Index
Arbitrage, Warrant Arbitrage, Stock Class Arbitrage, Convertible
Bond Arbitrage, Option Arbitrage, Dispersion? Any others
and to what extent?
Our strategy can best be described as a hedged strategy
designed to take advantage of relative value differences
in implied volatilities between for example an index and
a basket of component stocks or between different strikes
on a particular index. We stick strictly to Market Neutral
Volatility Arbitrage Strategies and are committed to allowing
no style drift into other areas.
What do you see as the main pitfalls in trading Asian
The main pitfalls to trading any market are 1) not understanding
risk exposure, or 2) not quantifying risk exposure correctly.
Even with our 42 years' experience at Lynx, we still
have "Risk Measurement and Risk Management"
as our Mantra. You can't make returns for investors without
taking some risk, but it is all too easy, especially in
Asia, to underestimate the level of risk being taken to
achieve any given "unit" of return.
At Lynx we are totally focused firstly on minimising our
risk exposure and secondly on quantifying the residual
risk we do take. For example, we keep our corporate risk
exposure to an absolute minimum and we minimise our liquidity
risk by investing only in the most liquid instruments
and markets and only investing in Exchange Traded Derivatives
(no OTC transactions).
One of the virtues of our strategy is that it is inherently
"risk-minimising" in that it is non-directional
and we are hedging apples with apples to lock in Alpha
generated by mispricing. If you like, our strategy happily
gives away the "top-slice" of potential returns
in exchange for the significant reduction in risk associated
with those potential returns. We then lock in and maximise
a lower risk return for investors.
Another pitfall very specific to our type of strategy
is the potential cost involved in setting up and executing
derivative-based strategies in Asia. I am not going to
give away all our secrets, but our combined experience
has been extremely valuable in structuring the Lynx model
and keeping our costs to an absolute minimum, which we
believe will pay handsome dividends to our investors going
- In your template you are very specific about the geographical
split of your gross exposure. Under what circumstances do
you envisage that ratio changing?
Our strategy performs best in the markets of Hong Kong,
Australia, Korea and Japan where liquidity is high in
derivative markets and where opportunities exist to capture
Alpha. We select the markets we operate in for the opportunities
they offer, not for any diversification purposes, so should
liquidity collapse in any one of the markets we would
reduce our positions accordingly.
- What are your risk management measures? How is risk
We have three principal risk management processes: our
in-house system; our outsourced subscription system; and
our clearer's risk management system. The outputs from
these three systems are cross-referenced at the end of
each trading day.
I am in charge of our in-house risk management model as
well as utilising a very high quality external subscription
risk management system.
Fortis Clearing (HK) independently runs a daily VAR on
our portfolio since they are our clearing bank, and delivers
the results of this to us at the end of each trading day.
Fortis is also in regular contact during the trading day
should any questions arise.
We measure real-time risk by portfolio delta, gamma, theta
(time decay) and vega (volatility risk). We also monitor
tracking risk on a real-time basis.
What is your edge?
We are unique in Asia, nobody else is doing what we do and
to be honest, the barriers to entry in terms of experience,
qualifications, market knowledge in multiple markets, etc,
are pretty high.
This uniqueness enables us to offer something to investors
which is not otherwise available to them and provides
much sought after diversification away from existing strategies
they are invested in. We also believe we are offering
investors exposure to Asian markets in a
"controlled-risk" strategy at a time when volatility,
and hence standard measures of risk, are likely to be
We also feel that our most recent 12 month performance
and our commitment to investing our own capital to produce
the track record for investors to see, send a clear message
that we have a well thought out strategy - we believe
in it, we have tested it, we know it works, and we are
sticking to it.
Will you be rolling the funds from the pilot fund
into the new fund?
Absolutely yes, it will all be rolled into the new fund.
Interestingly enough, the initial application for this
idea a few years ago was as a low-risk strategy for our
own savings. Now it has become a licensed fund we fully
intend to keep our own money invested in the strategy,
because we believe in it.
Where do you see more interest in your fund coming
from geographically and the type of investors?
Investing in an early stage hedge fund will always have
a personal element to it and we are no exception. Our initial
investors include everyone from family and friends to wealthy
European and Asian private investors to global institutional
funds, with the common theme being people who know us well
Going forward, the people who are closest to being the
next round of investors are not from any one region or
group of investors but are people who really understand
our strategy and are looking for diversification away
from the long/short or long-only funds which are otherwise
available to them. Other investors not so familiar with
volatility arbitrage will understandably take longer to
get comfortable with what we do and will be later stage
How do you find Hong Kong as the base for your fund?
Hong Kong is very much home for all of us at Lynx Arbitrage.
Lesley-Ann and Vivian were both born here and I have been
here for 12 years and we have all been SFC-licensed for
many years, so it is natural for us to be based here.
Having said that, Hong Kong was a great market for us
to start our strategy given our experience and contacts
in the market as well as the healthy derivative market
liquidity and our ability to trade direct with the exchanges.
In addition, Hong Kong is the head office for Fortis,
our clearers and administrators, which has helped us develop
a very good working relationship very quickly that has
been important in the implementation of our strategy.
We note that you are using Fortis Prime Fund Solutions
as your prime broker what are the advantages to this kind
At Lynx we do not have many of the same needs as most
start-up hedge funds because we trade direct with the
exchanges in nearly all of our markets, don't tend to
borrow stock, and have considerable front and back office
experience in what we are doing.
Given our "out of the ordinary" needs, Fortis
has been extremely flexible in providing us exactly what
we require at a competitive price without having to pay
for all the extra things we don't need. This has enabled
us to keep costs down and will contribute significantly
to enhanced returns to investors going forward. So far
this relationship has worked very well for all concerned.
Lynx Arbitrage Limited
+852 2866 3831