Hedge Fund Interview with Dharmin Mehta, COO of Capveda Asset Management Limited

Dharmin Mehta discusses the strategies deployed by Capveda Asset Management Limited. The Capveda Emerging India Fund is owned and managed by Capveda Asset Management Limited (CAML). The asset management company and its fund are both domiciled in Mauritius. CAML specialises on the development and implementation of market neutral strategies and fund management. It has recently launched an India-centric market neutral fund for global investors. The fund derives its alpha from market volatility and inefficiencies and not market trends. The fund is based on the algorithmic trading model. “AT” refers to the strategies that give automated trading signals based on the proprietary algorithm/formula built on certain mathematical models.

The name “Capveda is inspired by the venerable Indian Vedas, which are believed to be the root of mathematics; thus, Capveda stands for its capability to apply mathematical techniques to generate alpha.

  1. What is it that draws you to invest into India? Have you previously managed any India-focused funds or investments? Most funds that employ quantitative models invest globally, why is it that you choose to focus on India specifically?

    The main objective of the fund is to generate alpha from the inefficiencies and mispricings among the Indian-listed equities and not the trend/direction of the Indian equity markets. At Capveda, we strongly believe that Indian equity markets offer immense opportunities to exploit inefficiencies in a number of ways:

    • Algorithmic trading is a relatively new concept in Indian equity markets. It is at a very nascent stage in India.
    • Markets are volatile around 70% of the time while trending for around 30%.
    • Out of 252 single-stock futures, only 40-50% are highly liquid. With options, only 20-25% have liquidity.
    • Indian equity market is momentum-driven, mainly due to higher retail participation compared to institutional participation, which affects short-term prices without any rationale and thus, creates significant opportunities.
    • Global investors are willing to diversify their portfolio by participating in emerging markets like India.

    Thus, it clearly indicates that there are immense opportunities in the Indian equity markets that can be exploited through our successful strategies.

  2. Given the strong gains made in the Indian equity markets as well as in the Indian hedge funds during 2009, what sort of performance/returns are you targeting in the near future? Most Indian hedge funds are long/short equities with heavy long-bias and suffered heavily in 2008, the Eurekahedge India Hedge Fund Index was down 50%. While the industry had recovered remarkably in 2009, do you feel your quant-driven market neutral approach will help to raise assets from new and existing investors to the region?

    Capveda utilises a multi-strategy market neutral approach, back-tested in all situations of trending markets as well as volatile markets. The fund targets uncorrelated risk-adjusted absolute returns in excess of 15% per annum while maintaining low volatility.

    Considering the 2008 downturn and poor performance of these India-centric hedge funds, we became more confident to run these market neutral strategies in such market scenarios.

    Currently, we are raising funds from Middle Eastern and European markets and so far, the reception for these kinds of strategies has been quite satisfactory.

  3. The Sensex has gained 63.6% October YTD while the Eurekahedge India Hedge Funds Index 42%, what do you think is the reason for this underperformance?

    The objective of the fund is to deliver uncorrelated consistent returns in any market situation and being an absolute returns fund, we do not benchmark our performance to any particular index.

  4. The strategy description of your fund states that it is a multi-strategy fund. How many different investment strategies do you normally use and on what basis do you allocate assets to each of the strategies? How much of your fund is quant-driven and how much through selection?

    The allocation between each model/strategy is well-balanced to ensure that we maintain a constant and optimal risk profile. Typically, this is an allocation of 40-50% to relative value, 30-40% to system trades, 15-20% to volatility arbitrage and 10-15% to miscellaneous arbitrage, but these allocations can vary up to 5-10% as and when risk changes in each market.

    The fund deploys all the strategies based on the proprietary discipline which fuses technical, statistical and quantitative models to generate alpha.

  5. Statistical arbitrage is one of the various strategies that you use to deploy your fund’s investments into the markets. To what extent is your investment team involved in this strategy and what portion of the investment research, process and execution do you bank on electronic models for?

    Statistical arbitrage is allocated about 40-50% of the fund’s investments.

    Positions are initiated using proprietary technical, statistical and quantitative algorithms that attempt to identify price trends at their early stages, unlike most systematic trend-following systems that employ technical indicators, such as moving averages or Bollinger bands to identify trending markets.

    Capveda has a high win/loss ratio with strike rate of above 80% because of the correlation matrix employed in evaluating technical and statistics indicators.

    In other words, trades are elected when indicators that have little relation to each other tell the system to go long or short. Capveda believes that the key to using such indicators successfully lies in the way they are interrelated and applied in combination.
    Due to the nature of trading in futures, there is the ability to go long or short. There are equally likely opportunities to follow a bullish trend or bearish trend as long as the magnitude of the trend is significant.

    A key to Capveda’s success is the potential to limit drawdowns by daily maintenance of stop orders. In this way, if a trend reverses – any loss is theoretically limited; while if a trend continues – profits are theoretically protected. By this measure, Capveda seeks to optimise winning trades.

    Capveda has devised a mechanism to get automated buy/sell signals based on the algorithmic programme.

  6. Do you have a pre-determined sectoral breakdown in mind for your fund’s investments? How many sectors would you be diversifying its portfolio across?

    The Capveda portfolio is diversified into 13 sectors that cover all major sectors in the Indian markets.

  7. Do you plan on using leverage to enhance the returns of your fund? If so, how much?

    The gross exposure is up to a maximum of 200%, ie up to 2x leverage. The fund does not take any additional leverage through financing/borrowing. It is in-built leverage based on the margins paid to the exchange for buying futures on Indian stock market.

  8. At any given point in time, how many positions do you typically hold? How often do you review each of these positions?

    At any given time, from the universe of 180 listed stock futures and indices, Capveda scans and monitors 75-90 most liquid stocks. The portfolio would generally have 50-60 positions at any time. Each position is individually evaluated to have a low correlation to other positions in the portfolio. These positions are reviewed real-time and on a daily basis.

  9. Could you walk us through the risk management tools that you have in place for your fund?

    Risk management is the most important aspect of Capveda’s trading methodology. Risk management procedures are in place with specific time horizons, stop-loss limits, liquidity parameters and catalysts for realising value being determined before entering a particular trade. We place a high degree of importance on the risk-control measures to limit the downside by employing broadly four techniques:

    a) Limited use of leverage

    The gross exposure is up to a maximum of 200%, ie up to 2x leverage. The fund does not take any additional leverage through financing/borrowing. The net exposure is +20% long and -20% short. All the strategies are hedged to an extent of 80%. As all our investment strategies are market neutral; it minimises systematic risk.

    b) Tight stop-loss policy

    Stop-loss placement plays a key role in each and every trading strategy; stop orders are placed for all open positions and the systems continuously screen volatility and signal adjustments of portfolio exposure accordingly. When a trade goes against us, positions are stopped out for a pre-calculated limited loss. If a trade goes in our favour, it naturally becomes a greater percentage of the portfolio.

    The ideal situation is to let a winning trade run and to adjust the stop order on a daily basis. Again, stop-loss is constantly monitored on a real time basis at four different levels following the same pre-defined parameters. With a real-time MIS System in place, stop-loss is monitored at analyst level, at execution level, at risk manager level and at custodian and broker level.

    On a real-time basis, we have a system in place which flags us to avoid excessive concentration in any particular stock, sector and exposure. This is critical since we do not want to become the market in any particular contract.

    c) Portfolio diversification

    The portfolio is well-diversified with capital being dynamically deployed broadly in four different uncorrelated strategies.

    The allocation between each model/strategy is well-balanced to ensure that we maintain a constant and optimal risk profile. Typically, this is an allocation of 40-50% to relative value, 30-40% to system trades, 15-20% to volatility arbitrage and 10-15% to miscellaneous arbitrage, but these allocations can vary up to 15-20% as and when risk changes in each market.

    d) Portfolio optimisation

    Portfolio optimisation is an important tool to control excessive concentration in a particular sector/stock. At any given time, the fund’s portfolio will not have more than 30% exposure in any single sector and not more than 10% in any single stock.

    To minimise operational risk, we outsource all non-core functions to independent known business partners with good standing in the industry and we have implemented a multiple prime broker approach to minimise credit, custody and counter-party risk.
  10. Based on the risk/returns profile of your fund, which classes of investors (HNW clients, institutional investors, fund of hedge funds, etc) is the fund best suited for? And ideally, what time horizon must an investor have in order to consider investing in a fund like yours?

    We are targeting an investor base of about 70% of ultra high net worth private clients and family offices and about 30% institutional clients.

  11. How do you foresee the amount of stress laid on tightening regulations across the hedge fund industry to affect your fund and asset raising?

    The regulatory environment is very fluid at the moment and seems to be dominated mostly by speculation and rumour and therefore, we are waiting to see what proposals emerge, if any, before considering how they might affect us.

  12. Could you give us your outlook on the Indian equity markets both in the near- and medium-term? Any sectors that you are particularly bullish on at this point in time?

    Unfortunately, we cannot predict how markets will perform. The success of our strategy lies in the fact that we do not predict the future; we react to real market information and follow price trends while employing a systematic risk management which aims to ensure capital preservation.

  13. Are there any marketing trips on the horizon and if so, which countries will you be visiting?

    Two weeks back, we had a very successful road show in the Middle East. Currently, our team is in London for fundraising activities. We have a planned road show in Hong Kong in January 2010.

Contact Details
Dharmin Mehta
Capveda Asset Management Limited
Level 11, One Cathedral Square
Port Louis, Republic of Mauritius
+1 516 841 3184