IKEN Capital: Engineering A Hedge Fund

Aug 29 2012 | 2:01pm ET

George Hutson earned a master's degree in engineering at Imperial College, London, but it took him only a short time to realize it wasn't for him. But it did offer the future IKEN Capital chief investment officer a chance to pursue something that might be.

“During that time, I started doing a little bit of trading for my own accounts, so I decided to transfer, when I finished up, to a master of finance,” Hutson told FINalternatives. And he not only continued to trade while he studied—he made enough to pay for his degree.

Freshly graduated, with a thesis on grey-box trading strategies, Hutson went to work for Schneider Trading, where he and James Brueton, a former Deloitte business consultant, ran a commodities and fixed-income book. The two also worked with Christophe de la Celle, an alumnus of both Société Générale and Deutsche Bank, who ran his own derivatives trading book at Schneider, and quantitative analyst Tobias Tofari.

In January, the quartet left Schneider to launch their own hedge fund. Its maiden offering, the IKEN Commodity Alpha Fund, is a “market neutral long/short oil strategy, with multi-layered hedging for uncorrelated low-risk returns," the firm said.

The strategy is “quite unique,” according to Hutson, with a relative-value core, a trend-following component and a “long-gamma, long-volatility options overlay” that “allows us to sleep well at night and adds an extra layer of protection.”
“We have a real time model that takes one commodity and prices it against a basket of other commodities. From that we ascertain what we believe to be a fair value for that commodity,” Hutson said. “When the price deviates from that fair value the model identifies this, flags it up and proposes the optimum relative-value trade."

“We then look at the trade in relation to our current portfolio, where it lies along a curve, how correlated it is to our current book and if it passes all our criteria we add it to the portfolio.”

The trend-following component employs “more classic commodity trading advisor-style algorithms,” said Hutson, and those algorithms are Tofari’s responsibility:

“The trend-following algos have a couple of layers,” Tofari said. “The most important thing it looks at is the order flow—the way orders go through, how the orders go through and obviously the volatility attached to that order flow. Whilst it’s aware of that, it’s also aware of the relative volatility and the general price trend of that market and when most of that seems to align. That’s when it gets in."

"That’s the simplified form,” Tofari added, laughing.

“With the trend following algos, we’re trying to identify the big players in the market,” Hutson said. “Generally, the physical guys are less sensitive to price and happy to move it away from equilibrium. When our model identifies a big player, it begins to implement positions and piggyback on some of them."

“So there’s the trend-following part, which is intra-day, which works 30% of the time. Then we have the relative-value strategy that works 60% to 70% of the time, and we protect the whole portfolio with an options overlay and it protects us in times of liquidity crises or Iran-type scenarios, the big black-swan events.”

The fund launched officially in July with $1 million of the team’s own capital, but they’ve been trading the strategy for four years and have a two-year audited track record—returns 56% in 2010 and 38% in 2011. Hutson is targeting annual returns of a more modest 20%, however.

“We were previously running at an average margin-equity of about 40% and we want to bring that down a little bit,” he said. “Our biggest drawdown was 10% and even though we ended up 38% that year we really don’t want to see that again, so we’ve brought our average margin-equity down to 25%."

The fund was up 5.1% in its first official month of trading. Hutson says they’re now speaking to family offices, small funds of hedge funds and high net-worth individuals, hoping to raise seed capital of between $25 million and $50 million. The fund's minimum investment requirement is $50,000.

Advantage Futures serves as prime broker and the administrator is JP Fund Services; the auditor is BDO. Fees are the standard 2% for management and 20% for performance, and the fund offers monthly liquidity—with 30 days’ notice—and no lock-up.

Ultimately, Hutson feels the fund’s capacity is about $750 million.

“We don’t want to become asset-growers returning basis points per month,” he said. “We’re very much traders, we like high returns, we like high performance, that’s where we excel and that’s where we’re happy and that’s what we’ve been doing for the last four years—delivering the best possible risk adjusted return.”

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