Queensland Investment Corporation (QIC) has increased its allocation to Pengana Capital’s global volatility hedge fund by $US50 million to $US200 million, incorporating the fund within two of its multi-manager products.

The Pengana fund performed well in recent months while evidence of a US economic slowdown and announcements from some major US investment banks revealing damaging subprime debt exposures undermined global markets. It posted a return of 10.04 per cent between November 1 and January 18, in comparison to its benchmark, the sixmonth US Treasury Bill, which yielded 4.25 per cent in the same period. “The fund has performed within our expectations,” Greg Clarke, senior portfolio manager within the implemented equities division of QIC, said. QIC, a $70 billion institutional manager whose clients include the Queensland Government, increased the mandate so that the volatility fund could be included in the QSuper investment trust no.1 multi-manager fund, an accumulation product. Previously, the fund only featured in the QIT 2 multimanager fund, a defined benefit vehicle run for the Queensland Treasury.

In addition to seeding the volatility fund, QIC worked with the portfolio manager Al Wilkinson for two years to construct the vehicle. It has a segregated mandate with the manager, and views it as an “outright alpha-generator in up and down markets,” Clarke said. Across QIC’s broader alpha-beta separation strategies, the fund is part of the manager’s global equities alpha allocation, Greg Liddell, QIC head of implemented equities, said.

The fund is designed to maintain a low correlation with equity markets while outperforming during periods of volatility. In catastrophic market conditions – defined as a rapid fall of 15 per cent or more in the underlying index – the fund aims to outperform. Overall, it targets a return of 20 per cent each year over rolling three-year periods. In a strong market, however, in which the underlying index return exceeds 15 per cent, the fund will probably underperform the market return.

The recent distress in the US economy has been fortuitous for Wilkinson, who is based in Chicago. Notably, he predicted the US Federal Reserve’s cut in the benchmark interest rate, by 0.75 per cent to 3.5 per cent, on January 22. His preceding trades netted a hefty sum from the inevitable market rally on the news. “He did very well out of it,” Clarke said.

In implementing their volatility strategy, Wilkinson and his team trade equity index futures, options and other instruments, aiming to exploit mispricings. These mispricings are found in the differences between measurements of the instruments’ implied and historic volatilities. Wilkinson expects securities to revert to their fair value, and formulates positions in response to this view.

Among the trading techniques used are statistical arbitrage between stock exchanges and indices. “The key component is arbitrage. As long as mispricing occurs in index options, the process can deliver significant returns,” Clarke said.

The strategy draws from a universe of options derived from indices, rather than stocks, since indice-derived options are not affected by company-specific events and tend to be more liquid, readily priced and host a larger range of strike prices and expiries.

The strategy does not usually assume directional views on volatility, but it may do so during periods of extremely high or low market turbulence. It did not undertake a major directional play during January, Clarke said.