cinque partners llc a managing equities in a fat tail risk...

1 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

http://www.cinquepartners.com


Investment Thesis

Market volatility can be translated into an

alpha contributor in an active equity

framework.


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

1

The Volatility of Volatility1


Glossary of Terminology

VIX: 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

Implied Volatility: 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-Write/Covered Call: A trading strategy that consists of writing call options on an underlying position to

generate income from option premiums and reduce downsize risk.

Protective 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


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

1959

1964

1973

2004

2007

1993

2002


Market Volatility as a Hedge

Source: Factset. This presentation is not intended, in and of itself to determine which securities to buy or sell. Portfolio holdings, sector allocations and other

characteristics of the Portfolio are subject to change, and these investments shown may or may not be available in the future. Past performance is no

guarantee of future results. 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


Market volatility as an Alpha Contributor Mispricing of short term volatility provides potential arbitrage opportunity.

VIX VS Realized Volatility


Source: CBOE, FactSet

1. This graph is for illustrative purposes only. See important disclosure regarding risk in connection with investing in options. These depictions are not

representative of actual investments or intended to reflect performance of any portfolio. The output of the proprietary risk model is not intended to be

investable or to otherwise be used , in and of itself, to determine which securities 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 performance is no guarantee

of future results.


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

RA

TE

OF

RE

TU

RN

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


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


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

RA

TE

OF

RE

TU

RN


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


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


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 intended to 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 the market’s expected

volatility implied by option prices. 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

options. 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

of the Portfolio are subject to change, and these investments shown may or may not be available in the future.

http://www.cboe.com/


Additional Source of Distributable Income Growth of $100 net of 4% target annual distribution (taken quarterly)


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 distributions can be expected. There can be no assurance that this or any strategy, account, or the benchmark

will be able to implement its investment objective or avoid substantial losses. 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 performance is not a guarantee of future results.


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.


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 performance is no guarantee of future results. 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.

Subject 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.

Investment Risk. 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 on 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, our 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.

Options carry a high level of risk and are not suitable for all investors. 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.

http://www.adviserinfor.sec.gov/


Disclosures (cont’d)

No Warranty. 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. 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’.

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