Cinque Partners LLC A Managing Equities in a Fat Tail Risk - - PowerPoint PPT Presentation

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Cinque Partners LLC A Managing Equities in a Fat Tail Risk Environment

April 16, 2014

Prepared for the Houston CFA Society

Presented by Alan Adelman Cinque Partners LLC www.cinquepartners.com Capitalizing on Change

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Investment Thesis

Market volatility can be translated into an alpha contributor in an active equity framework.

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Source: FactSet 1. The CBOE VIX index is not intended to be investable or otherwise be used, in and of itself, to determine which securities to buy or sell. It is merely a quantitative tool used by Cinque Partners to inform decisions about investor sentiment and market volatility. There is no guarantee that similar investments will be available in the future. Past performance is no guarantee of future results. For additional information about the referenced indices please see the attached Glossary and Disclosures.

CBOE VIX Index - Daily Close December 2010 – March 2014

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The Volatility of Volatility1

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Glossary of Terminology

VIX: X: A ticker symbol for the Chicago Board of Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward-looking and is calculated from both calls and

• puts. The VIX is a widely-used measure of market risk and is often referred to as the “investor fear gauge”.

Please see Important Information section for important disclosures regarding the use of indices Impl mplied ied Vola

• latil

tility ity: : The estimated volatility of a security's price. In general, implied volatility increases when the market is bearish and decreases when the market is bullish. This is due to the common belief that bearish markets are more risky than bullish markets. Buy-Writ ite/Co /Covered d Call ll: : A trading strategy that consists of writing call options on an underlying position to generate income from option premiums and reduce downsize risk. Prot

• tectiv

tive e Put: A risk-management strategy that investors can use to guard against the loss of unrealized

• gains. The put option acts like an insurance policy - it costs money, which reduces the investor's potential

gains from owning the security, but it also reduces his risk of losing money if the security declines in value. Source: www.investopedia.com

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Academic Pathway To Our Strategy

Harry Markowitz “Portfolio Selection”. The Journal of Finance. (March 1952) “Portfolio Selection: Efficient Diversification of Investments”. New York: John Wiley & Sons. (1959) Bill Sharpe “Capital asset prices: A theory of market equilibrium under conditions of risk”. Journal of Finance. (1964) Fischer Black / Myron Scholes “The Pricing of Options and Corporate Liabilities“. The Journal of Political Economy. (1973) Robert Whaley "Derivatives on Market Volatility: Hedging Tools Long Overdue," The Journal of Derivatives. (Fall 1993) “Return and Risk of the CBOE Buy-Write Monthly Index“. The Journal of Derivatives. (Winter 2002) Andrew Lo “The Adaptive Markets Hypothesis: Market Efficiency from an Evolutionary Perspective”. (August 2004) André Perold “Risk Stabilization and Asset Allocation”. Journal of Investment Management Conference. (September 2007) 1952 1952 1959 1959 1964 1964 1973 2004 2007 1993 1993 2002

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Market Volatility as a Hedge

Source: Factset. This presentation is not intended, in and of itself to determine which securities to buy or sell. Port rtfo folio

• holdi

dings, gs, sector

• r allocations
• ns and other

her characteri erist stics of the Portfo folio

• are subject

ect to change, ge, and these se invest stments s show

• wn may

y or may not be e availabl ble e in the e future

• re. Past perfor

erformance e is no guara rantee of future re results.

• s. This graphs are for illustrative purposes only. The graph above compares realized 30-day market volatility (or standard deviation of

daily returns) to the ERP. This depiction is not representative of actual investments or intended to reflect performance of any portfolio. For additional information regarding the referenced indices please see attached Glossary and Disclosures.

Equity Risk Premium Vs. Volatility Avg Annual ERP: 8.0% - Average Realized Volatility: 17.2% (Correlation -0.31) January 1995 - March 2014

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Market volatility as an Alpha Contributor

Mispricing of short term volatility provides potential arbitrage opportunity.

VIX VS Realized Volatility December 1994 – March 2014

Source: CBOE, FactSet

• 1. This graph is for illustrative purposes only. See important disclosure regarding risk in connection with investing in options. These

ese depictions

• ns are not

repre resen sentative ve of actual invest stmen ents s or inten ende ded to reflect ect perf rform rmance e of any port

• rtfo

folio.

• . The output of the prop
• priet

etary ry risk model is not inten ended ded to be invest stabl ble e or to otherw herwise se be e used , in and of itsel elf, f, to determ ermine e which securi rities es to buy or sell. For additional information regarding the referenced indices please see attached Glossary and Disclosures. There is no guarantee that similar investments will be available in the future. Past perfor erformance is no guara rantee

• f future

re results. s.

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Translating Volatility into an Alpha Contributor

Total Risk Reward December 31, 1998 – March 31, 2014

10 11 12 13 14 15 STANDARD DEVIATION 7 8 9 10 11 12 RATE OF RETURN

Standard & Poor's 500 More Return Less Risk Less Return Less Risk More Return More Risk Less Return More Risk

BXM Index BXM Index BXY Index 2% OTM BuyWrite Index 50SPX 25 BXM 25 BXY Standard & Poor's 500 ROR Std Dev Pop Alpha Beta Upside Cap Ratio Dnside Cap Ratio 9.43 10.42 1.60 0.62 62.46 56.43 10.79 12.24 1.87 0.78 81.52 75.57 10.23 12.72 0.87 0.85 85.74 83.71 10.24 14.73 0.00 1.00 100.00 100.00

RISK BENCHMARK USED FOR THIS ANALYSIS: STANDARD & POOR'S 500

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Translating Volatility into an Alpha Contributor

Total Risk Reward March 31, 2009 to March 31, 2014

8 9 10 11 12 13 14 15 STANDARD DEVIATION 16 21 RATE OF RETURN Standard & Poor's 500 More Return Less Risk Less Return Less Risk More Return More Risk Less Return More Risk BXM Index BXM Index BXY Index 2% OTM 50SPX 25 BXM 25 BXY Standard & Poor's 500 ROR Std Dev Pop Alpha Beta Upside Cap Ratio Dnside Cap Ratio 12.15 10.06

• 0.90

0.64 54.70 65.03 17.22 11.69 0.76 0.78 76.26 78.76 17.93 12.07

• 0.04

0.85 82.24 86.42 21.16 13.88 0.00 1.00 100.00 100.00 RISK BENCHMARK USED FOR THIS ANALYSIS: STANDARD & POOR'S 500

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Translating Volatility into an Alpha Contributor

Volatility Expected Return Risk Model

Source: Chicago Board of Options Exchange (CBOE). See important disclosure regarding indices.30 days at-the-money S&P 500 index call options. Long call or put

• position. This data is for illustrative purposes only, and relative allocations to referenced positions are subject to change. This data is not inten

ended ded to be e used, d, in and of itsel elf, f, to deter ermine e which securi rities es to buy or sell. . It is merel erely a quantitative e tool

• l used by Cinqu

que e Partners ers to inform rm decisions about the market’s expected volatility y implied ed by option

• n prices.
• s. There is no guarantee that similar investments will be available in the future. For additional information about the referenced

indices please see the attached Glossary and Important Information. Please see Important Information regarding the significant risks associated with investing in

• ptions. For more information on tax complications of trading in options, please see CBOE website (www.cboe.com). Past performance is not indicative of future
• results. This presentation is not intended, in and of itself to determine which securities to buy or sell. Portfolio holdings, sector allocations and other characteristics
• f the Portfolio are subject to change, and these investments shown may or may not be available in the future.

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Additional Source of Distributable Income

Growth of $100 net of 4% target annual distribution (taken quarterly) December 1995 – March 2014

Source: FactSet. This graph is for illustrative purposes only and is intended to reflect performance of the Policy Benchmark adjusted to account for a target annual distribution of 4%. No distri ribu butions

• ns can be expect

ected.

• d. There

ere can be no assura rance e that this or any strategy gy, accou

• unt, or the benchm

hmark rk will be able e to implem ement its invest stmen ent obj bject ective ve or avoid d subst stantial losses ses. . This graph is not representative of actual investments or intended to reflect performance of any portfolio. The Policy Benchmark is not investable, and is not intended to be used, in and of itself to determine which securities to buy or sell. Please see disclosures section for information regarding use of indices, including those that make up the Policy Benchmark. Past perfor erformance e is not a guara rantee ee of future re results. s.

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Conclusions Market volatility can be translated into an alpha contributor in an active equity framework.

• Solid academic framework.
• Potential for low or negative correlation to equities.
• Mispriced short-term volatility arbitrage.
• Robust tools.
• Seeks to improve risk and return.
• Potential source of distributable income.

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Disclosures

This document is strictly confidential and is intended solely for the information of the person to whom it was delivered. It may not be reproduced or redistributed in whole or in part. Cinque Partners, LLC is a registered as an investment adviser with the U.S. Securities and Exchange Commission. Registration as an investment adviser does not imply any certain level of skill or training. Neither the SEC nor any state securities administrator has passed on or endorsed the merits of Cinque Partners or any investment vehicle or strategy described herein, nor is it intended that they will. More information about Cinque Partners can be found in Form ADV, Part 2, which is available upon request and at http://www.adviserinfor.sec.gov. This presentation is not an offer to buy or sell or solicitation of an offer to buy or sell any securities mentioned. The investment funds represented are private placement funds restricted to “Pre-Qualified Investors” only. This document is not a solicitation for investment in any fund. More information about the Cinque Partners Funds is available in the Private Placement Memorandum, available from a Wells Fargo representative. The Private Placement Memorandum should be carefully read before investing in the funds. Past st perfor

• rma

mance ce is no guarantee tee of future results

• ts. All investments in securities involve a risk of loss of capital and no guaranty or representation can be made that an

investment will generate profits or that an investor will not incur loss of invested capital. There can be no assurance that the investment objectives of any account or fund managed by Cinque Partners LLC will be achieved or that its historical performance is indicative of the performance it will achieve in the future. Individual investor performance may differ based on date of investment, security availability and price, and actual fees paid. The value or income associated with a security may fluctuate. There is always potential for income as well as loss. Investments discussed in the presentation are not insured by the FDIC and may be unsuitable for some investors depending on their specific investment objectives and financial position. The Cinque Partners strategy uses options sales, both covered call writing and collateralized put writing, in an effort to generate income and manage risk, as well as support the rebalancing of the underlying long equity portfolio. From a portfolio perspective The Cinque Partners policy target is to be 50% written. A combination of calls and puts is utilized to seek to achieve this policy target based on meeting specific criteria for the alignment of strike and target prices along with requirements for static returns, if exercised returns and probability of exercise. No investment strategy can guarantee investment returns or eliminate risk. There can be no assurance that the investment objectives of any account or fund managed by Cinque Partners will be achieved or that its historical performance is indicative of the performance it will achieve in the future. Individual investor performance may differ based on date of investment, security availability and price, and actual fees paid. For a more detailed description of fees and expenses charged by Cinque Partners, see Form ADV Part 2. Subjec ect t to change. The target allocations, portfolio allocations and holdings of the Cinque Partners strategy may change over time at the discretion of Cinque Partners. There can be no assurance that any allocations or underlying securities discussed herein will remain in the portfolios managed by Cinque Partners or, if sold, will not be repurchased. Investmen estment t Risk

• sk. Securities investments including the investments discussed in this presentation are NOT INSURED by the Federal Deposit Insurance Corporation

(FDIC )or any other federal government agency, and MAY LOSE VALUE. The investments discussed in this presentation may be unsuitable for some investors depending

• n their specific investment objectives and financial position.

Cinque Partners Funds’ strategy uses option sales, both covered call writing and collateralized put writing, to generate income, manage risk, as well as support the rebalancing of the underlying long equity portfolio. With options, an investor has the potential to earn profits while limiting risks of loss. From a portfolio perspective,

• ur policy target is to be 50% written. A combination of calls and puts is utilized to achieve this policy target based on meeting specific criteria for the alignment of

strike and target prices along with requirements for static returns, if-exercised returns and probability of exercise. Opti tion

• ns

s carry a high gh level of risk sk and are not t suita table for all investo

• estors. An option holder runs the risk of losing the entire amount paid for the option in a relatively short

period of time. An option writer may be assigned an exercise at anytime during the period the option is exercisable. The writer of a covered call forgoes the opportunity to benefit from an increase in the value of the underlying interest above the option price, but continues to bear the risk of a decline in the value of the underlying

• interest. The writer of a put option bears a risk of loss if the value of the underlying interest declines below the exercise price, and such loss could be substantial if the

decline is significant.

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CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution

Disclosures (cont’d)

No Warranty.

• ty. Cinque Partners, LLC does not warrant the accuracy, adequacy, completeness, timeliness or availability of any information provided by third-parties.

Nothing in this report is intended by Cinque Partners LLC to be the giving of investment advice to any single investor or group of investors and no investor should rely upon or make any investment decision based on the contents of this presentation. This presentation is not intended to be used in connection with the offering for purchase or sale of any security. Cinque Partners LLC makes no representation as to the appropriateness of the strategies discussed herein for any investor . Before adopting any investment strategy, including any strategies discussed herein, investors should consult with a recognized investment adviser familiar with their particular financial circumstances. The views discussed herein with respect to specific securities, indices and markets are not intended to constitute investment advice with respect to same and should not be considered a recommendation to buy or sell any particular security. Particular securities referenced are not necessarily held in the Cinque Partners LLC portfolio, and if held, do jot represent its entire portfolio and, in the aggregate, may represent only a small percentage of its portfolio. There is no assurance that any security listed will remain in the form portfolio. It should not be assumed that any security listed has been, or will be , profitable. Indices ces. . Each index provided in this presentation is for comparative purposes only and is not available for investment. The methodologies for any indices referenced herein are the property of the respective owners of the relevant index and may be covered by one or more patents or pending patent applications Indices do not incur management fees, transaction costs or other expenses associated with a private fund. The performance of the Fund will lag the performance of its respective index by the amount of the fund fees and expenses. Please read the Private Placement Memorandum for more information on fund fees and expenses. The S&P 500 Index is an unmanaged index of 500 stocks and represents broad-based stock market investments. The Chicago Board of Options Exchange (CBOE) BXM Index is a passive total return index based on selling the near-term at-the-money S&P 500 Index call option against the S&P 500 stock index portfolio each month, on the day the current contract expires. VIX is the ticker symbol for the CBOE Volatility Index, which shows the market’s expectation of 30 day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 Index options. This volatility is meant to be forward-looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the ‘investor fear gauge’.