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 CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution 1
Investment Thesis Market volatility can be translated into an alpha contributor in an active equity framework. CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution 2
The Volatility of Volatility 1 CBOE VIX Index - Daily Close December 2010 – March 2014 1 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. CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution 3
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 olatil 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 otectiv 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 CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution 4
Academic Pathway To Our Strategy Harry Markowitz 1952 1952 “Portfolio Selection”. The Journal of Finance. (March 1952) 1959 1959 “ Portfolio Selection: Efficient Diversification of Investments”. New York: John Wiley & Sons. (1959) Bill Sharpe 1964 1964 “Capital asset prices: A theory of market equilibrium under conditions of risk” . Journal of Finance. (1964) Fischer Black / Myron Scholes 1973 “The Pricing of Options and Corporate Liabilities“. The Journal of Political Economy. (1973) Robert Whaley 1993 1993 "Derivatives on Market Volatility: Hedging Tools Long Overdue," The Journal of Derivatives. (Fall 1993) 2002 “Return and Risk of the CBOE Buy - Write Monthly Index“. The Journal of Derivatives. (Winter 2002) Andrew Lo 2004 “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) 2007 CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution 5
Market Volatility as a Hedge Equity Risk Premium Vs. Volatility Avg Annual ERP: 8.0% - Average Realized Volatility: 17.2% (Correlation -0.31) January 1995 - March 2014 Source: Factset. This presentation is not intended, in and of itself to determine which securities to buy or sell. Port rtfo folio o holdi dings, gs, sector or allocations ons and other her characteri erist stics of the Portfo folio o are subject ect to change, ge, and these se invest stments s show own 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. CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution 6
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 ons 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 ortfo folio. o. The output of the prop opriet 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 of future re results. s. CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution 7
Translating Volatility into an Alpha Contributor Total Risk Reward December 31, 1998 – March 31, 2014 More Return More Return Less Risk More Risk 12 11 Standard & Poor's 500 RATE OF RETURN 10 9 8 Less Return Less Return Less Risk More Risk 7 10 11 12 13 14 15 STANDARD DEVIATION ROR Std Dev Pop Alpha Beta Upside Cap Ratio Dnside Cap Ratio BXM Index BXM Index 9.43 10.42 1.60 0.62 62.46 56.43 BXY Index 2% OTM BuyWrite Index 10.79 12.24 1.87 0.78 81.52 75.57 50SPX 25 BXM 25 BXY 10.23 12.72 0.87 0.85 85.74 83.71 Standard & Poor's 500 10.24 14.73 0.00 1.00 100.00 100.00 RISK BENCHMARK USED FOR THIS ANALYSIS: STANDARD & POOR'S 500 CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution 8
Translating Volatility into an Alpha Contributor Total Risk Reward March 31, 2009 to March 31, 2014 More Return More Return Less Risk More Risk 21 Standard & Poor's 500 RATE OF RETURN 16 Less Return Less Return Less Risk More Risk 8 9 10 11 12 13 14 15 STANDARD DEVIATION ROR Std Dev Pop Alpha Beta Upside Cap Ratio Dnside Cap Ratio BXM Index BXM Index 12.15 10.06 -0.90 0.64 54.70 65.03 BXY Index 2% OTM 17.22 11.69 0.76 0.78 76.26 78.76 50SPX 25 BXM 25 BXY 17.93 12.07 -0.04 0.85 82.24 86.42 Standard & Poor's 500 21.16 13.88 0.00 1.00 100.00 100.00 RISK BENCHMARK USED FOR THIS ANALYSIS: STANDARD & POOR'S 500 CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution 9
Translating Volatility into an Alpha Contributor Risk Model Volatility Expected Return 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 ol used by Cinqu que e Partners ers to inform rm decisions about the market’s expected volatility y implied ed by option on 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 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. CONFIDENTIAL – For Institutional Purposes Only – Not for Distribution 10
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