Investment Process 

The investment philosophy of 36 South is that markets are generally efficient but we perceive a gap in the mis-valuing of derivative assets, mainly due to the mis-estimation of future volatility. This leads to the mis-valuing of assets which depend on future volatility as a variable input to calculate their price such as options.

The reason for this mis-estimation is relatively simple: estimation of future volatility is counter-intuitive. Volatility is generally mean reverting but over long cycles. Even seasoned professionals tend to look at recent history to provide a guide to the future. So if volatility has been low for a while they come to expect it and vice versa. Almost like a turkey which, on the basis of 11 months of excellent relations between turkey and human, is the most bullish on his life expectancy just before Christmas! Other factors can also result in mis-valued assets such as model assumption flaws, structural flaws in the way options are marked-to-market, and incentive biases.

The managers at 36 South are constantly scanning the global markets looking for mis-valued assets.

The fund managers make use of a proprietary model, the Quadrivium Approach, which identifies ‘high potential’ ideas. The four pillars of this approach are thematics, technical analysis, market sentiment and volatility. We start with the premise that good investment must have two characteristics: it must have the odds of success in one's favour and it must be weighted as a percentage of the portfolio to reflect the risk associated with the opportunity. A 50-1 bet which pays 500-1 is a good bet but if one placed 100% of capital in the opportunity it would represent a poor "investment" because it was badly risk managed. If only 2% were invested it would be a great investment because the "risk of ruin" is now zero and the expected return is (0.02* 500*2%) = 20%.

Ideas are generated from the application of the Quadrivium approach. Utilising screens/filters in order to distil these types of favourable trades from the universe of possible positions, we produce a short-list of opportunities which are then further ranked by the remaining Quadrivium factors e.g. if a screen of low volatility threw up a potential trade in Google options, we would then analyse how the idea ranks from a technical, fundamental and sentiment point of view, i.e. the remaining factors. This ensures that only the most robust “high potential" ideas are proposed for the portfolio.

All positions are ‘risk managed’ to produce superior returns for a given level of risk.