Used well, derivatives can deliver better risk-adjusted returns: AIF managers

Noted investor Warren Buffett had once referred to derivatives as “Weapons of Mass Destruction”, alluding to their speculative and risky nature. But in a recent panel discussion, three alternative fund managers (AIFs) spoke about the role that alternative investment strategies could play for better risk-adjusted returns in the future.

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This panel, moderated by Moneycontrol’s N Mahalakshmi was a part of the PMS AIF World’s 5th Annual Summit. PMS AIF World is an alternates-focused investment and wealth platform for HNIs & NRIs.

On concerns about derivatives,  Praveen Kumar,CIO, AlphaGrep said that derivatives can actually be valuable tools for hedging and risk management when used strategically. “In our fund, we focus on (employing derivatives to) creating low-risk alternatives for investors,” he said.

Talking about his AlphaMine Absolute Return Fund, Kumar says that it aims at providing better risk-adjusted returns than traditional investments.  “Our fund targets 7.5 percent to 9 percent post-tax returns by employing active strategies without locking up liquidity.”  Since inception, the fund has been one of the best-performing absolute return funds.

Raman delved into the foundation of derivative instruments, emphasising their two unique properties: return-altering potential and leverage. He explained, “Layering derivative strategies on top of underlying assets can significantly impact returns and manage risk.” Raman’s fund, focusing on both debt and equity components, aims to provide stability and better returns with lower volatility.

Talking about his funds and strategy in the space, Vineet Jain, CEO and Founder of Volvin Limited, spoke about introducing the covered call strategy to the Indian market. “It’s the first fund on a covered call strategy in India. In the US, covered call funds boast investments ranging from $150 to $200 billion, comprising almost 1 percent of the GDP. In India, this strategy is relatively unexplored, presenting a unique opportunity.”

A covered call strategy is an options trading strategy that involves holding a long position in an asset, usually a stock, and selling (writing) call options on that same asset.

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Covered call, Jain explains is a great strategy as it gives good returns with lower risks. “Alternative funds, like our covered call strategy, can strategically avoid full market participation, reducing risks and associated costs.” This is in contrast with mutual funds that face challenges in deploying and withdrawing funds to mirror benchmark performance.

Raman Nagpal is the CIO of AccuraCap. Talking about the scalability of his funds, Nagpal says,  “The absolute return fund which is about 27 months old, holds a corpus of over Rs 1,000 crores. We stopped accepting money a few months ago, not due to capacity constraints, but because we need a well-trained team to interpret signals.” While everything else is algorithmic, he explains, the final call is taken by well-trained traders.

“What seems like a very liquid market, especially in the derivative segment, can change overnight basis regulatory action, basis sentiments, basis global events. Therefore, we are always careful not to operate at the peak of our perceived capacity ceiling,” he said.

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