Methodica fund shifts between S&P 500 and FX on volatility forecasts

Methodica Capital Partners Fund I, a Copenhagen hedge fund, shifts its portfolio between S&P 500 exposure and proprietary currency trading based on one-day-ahead forecasts of equity market volatility. Assets, fees, redemption terms and the share of trading days in each market state were not disclosed.

When high volatility is forecast, the portfolio moves predominantly into FX, and when lower volatility is forecast, it sits predominantly in the S&P 500, founder Andreas Junge said. The switch is driven by an automated allocation protocol that projects equity market volatility one day ahead, with the goal of keeping much of the equity market's long-term return while holding a sleeve that can produce returns during sell-offs.

For a fund selector, the split between high-volatility and low-volatility days determines whether the fund substitutes for equity exposure or acts as a hedge. A client owns S&P 500 beta on calm days and a proprietary currency strategy on turbulent days, so the split sets the fund's average equity beta.

Junge is a mathematician with more than 25 years in systematic trading, and he built the FX models over more than a decade. His earlier work covers risk management, commodities and freight derivatives, including hedging and systematic trading for shipping and energy companies. The fund grew out of studying how those FX algorithms behaved across different market environments.

That study produced the strategy's core observation. “We saw very clearly that our FX strategies have an inverse relationship with equity indices in general, and that their performance is highly dependent on volatility,” Junge said. He said the FX book performs best in moderate-to-high volatility. “When the S&P has a bad day or sells off sharply, we tend to perform pretty well on the FX side. When the S&P has a particularly strong day, our FX strategies tend to perform less well.”