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This Hedge Fund Turned 0% Yields Into Double Digit Returns

(Bloomberg) -- A small Japanese hedge fund has managed to clamber its way to double-digit annual returns despite focusing solely on the country’s zero-yielding government bond market.

Amulet Capital Management Co. enjoyed an average annual return of 22 percent over the past three years, according to chief executive officer Toshiharu Matsuda, a former derivatives trader with Nomura Holdings Inc. The fund employs a trend-following JGB futures trading strategy and has found itself on the right side of market reaction to policy changes from the Bank of Japan.

“Even with the probability of an imminent policy tweak faded for now, there will always be lingering speculation about the BOJ taking some action,” Matsuda said in an interview last week. “As long as volatility is born out of such speculation, there is an opportunity to make money.”

This Hedge Fund Turned 0% Yields Into Double Digit Returns

Amulet profited from riding successfully the volatility in JGB futures in the two periods when the BOJ adjusted policy -- outside of which trading dried up so much it wasn’t unusual for benchmark bonds not to trade at all some days last year. While its strategy may work for a fund with assets under management of less than 1 billion yen ($9 million), it’s unlikely larger peers or banks could count on the same level of returns.

Yield Curve Jackpot

After deciding what the underlying trend in JGB futures is, seven-year-old Amulet uses a combination of short-term daily bets and those with a longer maturity to momentum trade, as well as attempt to time turning points in the market.

The strategy hit the jackpot in the third quarter of 2016, according to figures seen by Bloomberg, returning over 30 percent when the fund was short as bonds slumped on the BOJ’s yield-curve control announcement.

Performance dipped into the red in the low volatility market of 2017 before returns rebounded last year as Japan’s central bank tweaked policy again, this time with an explicit goal to improve the functioning of the world’s second-biggest debt market.

Banks and dealers though indicate in a survey that they didn’t see an improvement, a result that leaves the BOJ open to criticism that it needs to do more. Though price swings may have picked up, thirty-day volatility in 10-year JGB futures is currently 1.6 percent, compared to 4.4 percent for the U.S. equivalent.

Traders betting that the BOJ may consider more policy tweaks may have to reassess after the central bank cut its inflation outlook on Wednesday, and left its monetary policy unchanged.

Margin Call

Even a fund like Amulet can find itself on the wrong side when the market does take off. An emergency margin call in JGB futures in December, triggered when prices were surging, led to losses according to Matsuda.

“When the rise in volatility is caused by a sudden move, it is inevitable that positions are hit if they happened to be on the wrong side,” he said. “We were riding the trend and making profits until the emergency margin call, and ended up in negative in December.”

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