Diggle has over 16 years of experience in trading equities and equity derivatives in both Asia and Europe. He was formerly Head of Asian Equity Derivative Trading as well as former Head of European Emerging Markets at Lehman.
The Artradis Barracuda fund is an Asian equity arbitrage fund. It employs multi-strategy market neutral trades such as warrant arbitrage, index arbitrage, stock class arbitrage, convertible bond arbitrage, volatility arbitrage, volatility dispersion and dividend arbitrage.
The Artradis Barracuda fund was down 0.7% for September 2002 and is up 4.9% since inception in May 2002.
Interview with Steven Diggle
- What are your views on the convertible bond (CB) arbitrage strategy at the moment? Though the strategy has underperformed (even with record volatility in the US and Europe) there have been no major blow-ups; do you think one will occur?
You can't predict a blow up - all you can do is make a judgment of risk/reward in the market. Even in the past, when we believed Western companies' reporting, the market would repeatedly surprise us, it seemed to happen every four years and the last blow-up was 1998, so we are due for one. The risk of a blow-up is perceived to be higher at present and I think that's right, particularly in the US where the issuers have been of lower quality. I can't predict whether a market meltdown will occur but we don't like the risk/reward in convertibles at the moment and have largely avoided them.
The Asian convertible market is badly in need of some new issuance- many, if not most, of the bonds out there are really trading as debt instruments and have little embedded optionality which is what really interests us as we are equity players and don't pretend to be credit experts.
Having said that, we are very optimistic about the prospects for convertible bond arbitrage in 2003 if the issuance environment improves. The maturity and flexibility of credit-hedging instruments in Asia has improved significantly and that should allow us to specify the risks we take in CB's a lot more accurately than in the past.
- What are your opinions on the viability and profit potential for the depository receipt/local share arbitrage strategy?
I think it is viable and, in fact, has worked well this year; but it's a dangerous strategy full of cautionary tales of markets staying illogical longer than people could stay solvent. Unlike a lot of other arbitrage trades it is usually a pure convergence trade and that calls for a different, more cautious, approach than other strategies.
What are the current levels of volatility in Asia and where do you see them heading?
Asian implied volatility levels vary widely at present; with Korea pretty high at 41% but Australia seemingly stuck at 14% and India is also really low when it trades. Japan is above its long-term averages, but given the market is near 19-year lows and that the possibility of major policy change exists, it's really surprising it's not higher.
The thing that has confounded all of us, however, has been that Asian volatility has been so much lower than that in the US or Europe. You could have got yourself very good odds on S&P implied volatility exceeding Hang Seng volatility for a prolonged period but that's exactly what's happened. Asia seems to have become a safe haven of late.
Selectively we see implied volatility in Asia rising in the short term and expect the relationship of Asian volatility to the rest of the world to return to a more normal pattern of generally being higher.
- What strategy or strategies have worked best since the launch of the Fund?
We started trading in May and, as I mentioned previously, we've largely avoided convertibles. The strategies that have disappointed us the most have been the volatility strategies where we have generally been long volatility and there has been a surprising absence of volatility in Asia despite rampant volatility elsewhere in the world. Other strategies have performed well - warrant arbitrage and index arbitrage in particular have done well for us.
- You traded similar strategies as a proprietary (prop.) trader, what are some of the surprising differences between being a proprietary trader and a hedge fund manager?
You're always told that you'll miss the information on flow you get when you work at a brokerage firm, but we've found that that isn't really the case which has been a nice surprise. In fact, the broking flow can distract and confuse you as often as it enlightens you, and I think we're happier without it.
Of course being at a very small organisation with self-built infrastructure is completely different from being part of a hugely resourced machine and you do miss having some of those resources to call upon. But the biggest difference for us, I think, has been the discipline of efficient asset allocation you have to employ within the context of a fund. As a prop. trader if you need more capital you can always make your case for more - unwinding positions you like to make way for positions you like even more has been a new, and somewhat strange, experience which has taken some adjusting to.
On the whole, however, the ability to focus solely on trading and risk/reward has been a great experience as there are a lot of other factors coming in to play when you are a prop. trader.
Have the execution systems at the hedge fund been to the level that you would like?
This is one area where things have improved hugely for hedge funds. Direct market connectivity has started to revolutionise institutional execution and there are some very competitive offerings available now. We've invested a lot of time and money in our execution systems and have a passion for reducing our latency. As a trader you'll never be fully satisfied with your execution systems but we are pretty happy with what we've got available today and are confident it will only get better, faster and cheaper.
- Asia and Japan have historically been an equity long/short game for hedge funds; there have been very few multi-arbitrage funds. What are the reasons for this?
That's a bit of a mystery to us as we see the market as full of opportunities compared to Europe or the US although the number of Japanese listed vehicles are fewer. It's certainly a more complicated and perhaps compromised playing field in Asia and one in which experience is vital because of the numerous pitfalls. Most of the long/short managers in Asia have come from traditional asset managers that have generally not done much arbitrage-type activity in Asia so this may be a contributing factor.
- Some investors believe that it is very difficult to monitor risk in a multi-arbitrage strategies hedge fund because new risks always "pop up" unexpectedly (and the manager realises it too late). Do you believe this is a legitimate concern?
Concerns about risk are always legitimate as they lie at the heart of the hedge fund industry. I believe it is harder to measure and specify the risk in a multi-arbitrage fund which uses a lot of derivatives as most of the traditional tools of analysis like Value at Risk (VaR) don't really work that well; but there are plenty of other established risk measurements that can do the job and are used in the derivative industry. These can monitor and measure mathematical risk perfectly well. We've been trading derivatives in this part of the world for a while and feel we've seen quite a lot of things that can go wrong.
However, we believe that 'risk is the thing you haven't thought of and aren't prepared for and I think that applies to any asset manager regardless of strategy. We spend a lot of time stressing the portfolio as well as thinking up possible scenarios that could cause problems but you'll never imagine them all, as we saw on September 11th.
For investors I think the biggest risk usually comes from choosing a manager, their skill and integrity are of paramount importance, rather than the style of the fund.
What were the reasons for running the Fund from Singapore?We thought it was essential to run the fund from Asia - the style of the fund pretty much requires that. We liked Singapore for a number of reasons: the costs of good premises and good people are very reasonable here and the telecommunications and air links are excellent. It is a solid regulatory, banking and legal environment and we were also attracted by the authority's attitude to markets. Some financial centres seem to have a somewhat ambivalent attitude to hedge funds and the normal hedge fund activity of shorting stock. There is no such ambivalence here. Added to that both Richard Magides (co-manager) and I have young families and the housing stock, schools and lifestyle here make it an attractive place to raise a family.
What do you find are the negative factors of being based in Singapore?The only negative we've found so far to being in Asia is that we don't yet have a large enough Asian investor base in alternative assets. The big investors in the US and Europe are a long way away and I think this has been a general obstacle for investment into Asian-based hedge funds, but attitudes in the US and Europe are changing and we see it as a diminishing problem as investors become more comfortable with the concept of Asian-based managers.
Are there any current marketing trips planned for you or Richard Magides (co-manager)?We haven't done that much marketing yet - we've been very focused on getting the trading and systems operating effectively and markets have been very unforgiving of late. I'm in Tokyo next month for the big Goldman Sachs' Hedge Fund Symposium; but generally we've found committed managers want to visit us and do due diligence on our operation here in Singapore anyway. We would prefer to spend an absolute minimum amount of time marketing and a maximum amount of time trading.
Does the current asset level of the fund impede your strategy?Being small does have advantages in terms of being nimble but we've found that our current small size restricts what we can do on the OTC side. There are a couple of very attractive trades we're keen to do but a lack of listed vehicles means that OTC is the only efficient way to execute them, and the minimum size requirements of those trades have been prohibitive. It's a frustration for us but one we knew we'd meet when starting.
Artradis Fund Management (Pte) Ltd
+65 6538 1998