Hot Hedge Fund Loses 21% After Bet on Volatility Goes Wrong

Updated on
  • Ahmad’s Decca Fund dropped 21% amid February turmoil
  • Tumble in 2018 marks reversal after years of out-performance

In December, Shahraab Ahmad shared with his hedge fund clients the principle that helped him trounce peers for two turbulent decades: steer clear of the crowd.

He’d turned $50 million into an operation with more than $700 million over three years and delivered market-beating returns, earning a reputation as one of the hottest hands in the business. Until last month.

The 41-year-old veteran, who started at JPMorgan Chase & Co.’s pioneering credit-derivatives business in 1999, was caught out by a market turn that gave him what could be the biggest drubbing of his career. Ahmad’s London-based Decca Fund lost 21 percent, or $147 million, in the month of February, following its wrong-way bet on volatility.

As the dust settles, questions remain about what went wrong at Decca. Not least: why did Ahmad ignore his own rule.

“To be a successful investor, one needs to be an independent thinker who bets against the consensus and is right,” Ahmad said in his December 2017 newsletter. “One is inevitably going to be wrong a lot, so knowing when to do that (i.e. bet against the consensus) is critical to one’s success.”

Volatility Spiked

He was certainly not the only loser when volatility spiked for a few days in February -- the Quantitative Tactical Aggressive Fund and the PruLev Global Macro Fund also took a beating. But Ahmad, who is known for making large bets and quickly trading in and out of securities, took one of the hardest known hits during the stretch that pounded the traders who’d bet that easy money would keep markets relatively placid.

“The mind boggles at how losses could get that big, but usually there are two reasons you end up with very large losses: a fund makes a naked bet that blows up, or the hedging approach was miscalculated and ended up inaccurate,” said Moorad Choudhry, a finance professor at the University of Kent in the U.K. and former Royal Bank of Scotland Group Plc banker who’s written books on derivatives. “No matter if you manage 10 million or 10 billion, a 25 percent loss is usually ground for most investors to get out sharpish.”

This account is drawn from a dozen people who have first-hand knowledge of the fund and how Ahmad does business. They asked not to be identified because they’re not authorized to talk about it. Neither Ahmad nor anyone at Decca commented for this article.

Credit Swaps

It wasn’t the first time Ahmad has been set back by a taste for risk. He lost money in 2004 in his last year at JPMorgan, where he was a market maker for credit swaps. The graduate of Wesleyan University started out there as a credit-default swaps trader in 1999 as the newfangled derivatives the bank had conceived were about to take over Wall Street.

He switched to the buy side in 2005, going to Connecticut-based hedge fund Sailfish Capital Partners before joining Neil Chriss at the inception of his Hutchin Hill Capital. Ahmad’s liquid credit strategy delivered average annual returns of 32 percent between 2008 through 2013. In 2009, he made 89 percent.

Market-Beating Returns

A hedge fund manager's performance scorecard

Net returns. For 2008-2013 at Hutchin Hill Liquid Credit Master Strategy (2013 performance through June only and partly reflects portfolio liquidation costs), returns for 2015 onwards at Decca Fund (Decca data starts from April, 2015). No performance data for 2014.

Source: Investor presentations and eVestment

Ahmad’s track record meant he had little trouble raising money or attracting talent to London-based Decca, which is the name for a navigational device for ships. Retaining staff proved harder, according to people familiar with the matter.

Two analysts Decca hired last year from London credit hedge fund Chenavari, Lionel Rebibo and Raul Sequera, left after about six months. Edouard Lecieux, a former Millennium Management portfolio manager, departed in 2017 after less than three months. Rebibo and Sequera declined to comment on their departures. Lecieux said he parted ways amicably by mutual agreement because “there was no personality fit.”

Alex Walsh, who worked at Decca from the beginning, also left the firm last year, said the people. Walsh declined to comment.

“The style of the hedge fund industry is often cutthroat and if a CIO’s philosophy is aggressive short-term money-making, then that is how it will be at their fund,” said Kumaran Surenthirathas, managing director of Rosehill Search, a fixed-income-focused headhunting firm in London.

Through the end of 2017, Decca delivered annualized returns of 14 percent. That was helped by the short-volatility trade, the people said. Until last month, betting on market calm was a straightforward way to make money as major central banks pumped cash into the economy.

Explaining Short Volatility and How It Took a Beating: QuickTake

Part of Decca’s short-volatility position was its sale of options, according to people familiar with the matter. Options give investors the right, but not the obligation, to buy or sell at a fixed price.

Decca sold put options on credit-derivatives indexes including the Markit CDX North America High Yield Index liked to 100 companies, according to people familiar with the matter.

Sellers of credit puts are paid a premium at the beginning of the trade and stand to lose money if volatility picks up. A JPMorgan measure of volatility on the U.S. high-yield benchmark rose to the highest in two years last month.

Credit Price Swings

Volatility spike not confined to equities

Source: JPMorgan Chase & Co. VTRAC-X indexes. (JPMorgan says the indexes are effectively a Vix-equivalent for credit-default swap benchmarks and are calculated based on prices for credit options. Readings reflect the market's view of price volatility in credit.)

As volatility rose, banks on the other side of Decca’s trades asked for more margin, according to people familiar with the matter. Ahmad then unwound his trades by buying back the options he’d sold, one of the people said. Margin calls can lead to fire sales and stoke market stress.

Decca says that while it primarily invests in global credit markets, it also makes “tactical use of macro instruments.” In practice, that means very few instruments are off the table. In addition to corporate credit positions, the fund also had positions in commodities, U.K. gilts and Volkswagen AG shares in December.

“In an environment with limited opportunities, funds had been looking for ways to differentiate, and one way to do that was to sell volatility,” said Peter Niculescu, a partner at Capital Market Risk Advisors, which advises financial institutions and law firms on issues including derivatives. “We had a rapid technical unwind and the volatility trade that paid off for such a long time, went against you very quickly.”

— With assistance by Suzy Waite, Tom Beardsworth, and Dan Wilchins

(Updates with another departure in 13th paragraph.)
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