06/06/2012

Market Turmoil a Relief for Tail-Risk Vehicle

Pine River Capital’s tail-risk fund posted a whopping 10% return last month, partially offsetting sharp losses earlier in the year.

Pine River Tail Hedge Fund takes extremely bearish positions in equity and credit indexes with the idea of protecting investors against a financial catastrophe on the scale of what took place in September 2008. The upside is a potentially huge gain if markets crash. But the downside is a projected 2.5% monthly “premium burn rate” during less-volatile periods — or an annualized decline of 30%.

Through April 30, the vehicle was down 18.4% — nearly twice the loss investors were told to expect. But with last month’s gain, the fund is now down about 10% for the year.

Tail-risk strategies are highly volatile by their very nature. A vehicle run by Boaz Weinstein’s Saba Capital, for example, ran up a year-to-date loss of 19.3% as of Feb. 24. But recent developments in the European debt market led to a series of windfalls that left the Saba Capital Tail Hedge Master Fund down just 0.8% as of May 25. Among the vehicle’s positions: being on the other side of some of the trades that cost J.P. Morgan a couple of billion dollars.

Through May 1, the Pine River fund had posted a 17% average annual loss since its inception in June 2010. It is currently managing about $295 million on behalf of investors who use it as a kind of insurance policy against sharp losses elsewhere in their portfolios — symbolized by the left “tail” of a bell curve displaying the normal distribution of returns. A typical investor might allocate 5% to a tail-risk strategy with the aim of netting a 50-100% gain when the rest of its portfolio suffers a 10% loss.

Pine River operates nine vehicles. The multi-strategy Pine River Fund, with $1.2 billion of assets, was up 6.2% as of May 1, while the $2.5 billion Pine River Fixed Income Fund had gained 11.3% for the same period. Only the tail-risk fund is running a year-to-date loss.

The tail-hedge strategy is overseen by Nikhil Mankodi. The fund charges a 2% management fee, but no performance fee. It permits monthly redemptions, and investors can withdraw profits at any time by giving notice just five days in advance.

Pine River, headquartered in Minnetonka, Minn., was founded in 2002 by chief investment officer Brian Taylor. Strong performance both during and after the financial crisis has helped the firm grow from $1 billion under management in 2007 to the current $7.6 billion. Just since November, Pine River has doubled the number of separate accounts it runs to 10, with a total of $1.3 billion of assets. And two of its vehicles began trading in the past six months: Pine River Liquid Rates Fund, which launched in December and has grown to $314 million of assets, and Pine River Financial Services Fund, which set sail in January and now has $115 million under management.

CORRECTION (6/13/12): This article mischaracterized the expected returns of Pine River Capital’s tail-risk fund. The vehicle, Pine River Tail Hedge Fund, is designed to lose 2.5% a month when markets are flat but is susceptible to heavier losses when markets rally, as they did in the first four months of this year.

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