8.A Methods of Analysis and Investment Strategies
36 South follows a long volatility strategy. This means that we invest in options across various
asset classes, with a focus on long-dated, out of the money options. Broadly speaking, the
objective is to find positions which are capable of making multiples in the event of an extreme
and/or sustained increase in market volatility.
Ultimately, our goal is to help investors to protect their wider portfolios against market crises
and periods of extreme and/or sustained market volatility.
Our investment philosophy is based on an observation that, although financial markets are
efficient most of the time, certain financial assets are systematically mispriced. This
mispricing provides an opportunity.
The price of an option is based, in large part, on the implied volatility of the underlying asset.
Implied volatility is based on historical data, often with a bias toward recent history. During
long periods of low volatility, option writers tend to underestimate how volatile an asset may
become over the longer term.
Ultimately, this means we can buy options cheaply. We look for positions which can return
multiples, but never lose more than the premium paid.
If a market crisis occurs, an investor’s holding in equities, bonds, and other traditional assets
may suffer, whereas we seek to deliver our best returns during such an event. We aim to
offer protection during times of market turbulence.
This is why we describe our expertise as being in the creation and management of
asymmetrical portfolios with an emphasis on
crisis protection. Our goal is to design portfolios
which are negatively correlated with other asset classes, have an asymmetrical return profile,
and can help to protect our investors when they need it most.
Our investment approach is also based on an observation that volatility is mean reverting.
Whilst markets may experience long periods of low volatility, history shows us that volatility
follows a cycle and is likely to return to higher levels. In our view, the longer volatility remains
below its long term historic average, the greater the opportunity to buy protection against a
resurgence.
We do not try to time the market. We do not seek to predict the volatility cycle or forecast
the timing of the next market crisis. Rather, we maintain a portfolio of long-dated options
that will benefit from an increase in volatility, should it occur. By doing so, we aim to have
protection in place at all times.
Our expertise lies in
finding options which we consider to offer the best value. We seek to
identify the mispricing of volatility and to find options which are undervalued.
It is important to understand, however, that the Funds are expected to experience a decline
in mark-to-market value in stable market conditions and during periods of low volatility. In
other words, absent a market event, the Funds should be expected to decline in value.
Equally, it is important to understand that an investment with 36 South should be viewed as
a long term proposition. More specifically, the investment period should be viewed in terms
of the volatility cycle.
The above is just a high level description of the Firm’s investment strategy and objectives.
There is no guarantee that any Fund will be successful in achieving its objectives.
8.B and 8.C Material Risks of Investment Strategies and Securities Used in Investment
Strategies General Risk Warning An investment with 36 South is not appropriate for everyone. Prospective investors should
be aware that an investment with us will involve a significant degree of risk, including the
potential loss of some or all of their investment. Investors should carefully consider whether
an investment with 36 South is right for them. It is important that prospective investors are
able to understand the investment objectives and strategy. It is equally important that
prospective investors are financially capable of bearing the risk of loss.
Generally speaking, our funds are designed to help an investor protect their wider portfolio
against periods of extreme and sustained market volatility.
Many of our funds are expected to experience a decline in mark-to-market value in normal
market conditions and during periods of low volatility. In other words, absent a market event,
the Funds are likely to a decline in value.
An investment with 36 South is expected to represent a small proportion of an investor’s
overall portfolio, and investors should consider our €100,000 minimum subscription in the
context of their overall net assets.
Below is a list of some of the risks which the Funds may be exposed to, although it should be
noted that this list is not exhaustive:
Investment Risk There can be no assurance that the Funds will achieve their investment objective and
policies. An investment in each Fund involves investment risks, including possible loss of
the whole amount invested. The capital returns of the Funds are based on the capital
appreciation and income on the investments it holds, less expenses incurred. Therefore,
the Funds’ return may be expected to fluctuate in response to changes in such capital
appreciation or income.
Investments in Indices The Funds may invest in certain index products. An investment in an index product is subject
to the risks and opportunities of the underlying securities which compose the index. Although
the index may be managed by an administrator, 36 South will not have control over the
composition of the index, and the Funds may be exposed to changes in value based upon the
performance and management of the reference obligations or securities which constitute the
index.
Operational Risk The Funds will be dependent on the proper functioning of the internal management and
systems of the Investment Manager and service providers.
Limited Number of Investments The degree of diversification will vary over time. The Funds could have relatively few
concentrated positions from time to time which would mean performance could be adversely
affected by the performance of a single position.
The Firm anticipates that the Funds will, in general, be well diversified. However, in the event
of a material demand for redemptions, the Funds could be forced to sell liquid positions
resulting in an over-weighting in a small number of less liquid investments. In such
circumstances, the aggregate return of the Fund may be substantially and adversely affected
by the unfavorable performance of a single investment.
Unidentified Portfolio Because not all of the specific investments of the Funds are identified upfront, the
Shareholders must rely on the ability of the Investment Manager to make appropriate
investments for the Funds and to manage and dispose of such investments. While the Funds
intend to make only carefully selected investments that meet the investment criteria of the
Funds, the Investment Manager has complete discretion with respect to the selection of such
investments.
Liquidation of Fund Securities The method and timing of liquidating investments and of exit strategies are critical elements
of maximizing the Funds’ return. The ability to liquidate investments depends largely on sales
on public exchanges and the varying liquidity available in over the counter markets.
Leverage The Funds may be leveraged through investments in options, futures or other derivative
instruments. The use of leverage creates special risks and may significantly increase the
Funds’ investment risk. Leverage creates an opportunity for greater yield and total return but,
at the same time, may increase the Funds’ exposure to capital risk and interest costs. Any
investment income and gains earned on investments made through the use of leverage that
are in excess of the interest costs associated therewith may cause the Net Asset Value of the
Shares to increase more rapidly than would otherwise be the case. Conversely, where the
associated interest costs are greater than such income and gains, the Net Asset Value of the
Shares may decrease more rapidly than would otherwise be the case.
Illiquidity Whilst Shareholders will normally be able to realize their investment in the Fund by
redeeming their shares or by a transfer to a third party it should be noted that the calculation
of the Net Asset Value may be suspended in certain circumstances and redemption of Shares
may be suspended or deferred in certain circumstances.
Currency Exposure The Net Asset Value per Share will be denominated in the currency of the relevant Class,
whereas the Funds’ investments may be acquired directly or indirectly in other currencies.
The Investment Manager may seek to minimize the exposure to currency fluctuation risks by
the use of hedging and other techniques and instruments, but it may not be possible or
practicable to hedge against the consequent currency risk exposure.
Political and/or Regulatory Risk The value of the Funds’ assets may be affected by uncertainties such as international political
developments, changes in government policies, taxation, restrictions on foreign investment
and currency repatriation, currency fluctuations and other developments in the laws and
regulations of the countries to which the Funds are exposed through its investments.
Interest Rate Fluctuations The prices of securities held by the Funds or to which the Funds may have exposure tend to
be sensitive to interest rate fluctuations and unexpected fluctuations in interest rates could
cause the corresponding prices of the Funds’ long and short portions to move in directions
which were not initially anticipated. In addition, interest rate increases generally will increase
the costs of borrowing by the Funds.
To the extent that interest rate assumptions underlie the hedge ratios implemented in
hedging a particular position, fluctuations in interest rates could invalidate those underlying
assumptions and expose the Funds to losses.
Suspension of Trading A securities exchange typically has the right to suspend or limit trading in any instrument
traded on that exchange. A suspension could render it impossible for the Investment Manager
to liquidate positions and thereby expose the Funds to losses.
Lack of Control and Reliance on the Investment Manager Except to the extent the Articles of Association or laws of the relevant country accord
Shareholders certain rights with respect to company law matters, the Shareholders will have
no right to participate in the management of the Funds or in the control of its business.
Accordingly no person should purchase any Shares unless he is willing to entrust all aspects
of management of the Funds to the Manager and all aspects of selection and management of
the Funds’ investments to the Investment Manager. The Funds’ success will depend
completely on the efforts of the Investment Manager and each of its principals. The death,
disability or withdrawal of one or more of the Investment Manager's principals or financial or
operational difficulties of the Investment Manager could adversely affect the Funds.
Availability of Investment Opportunities The business of identifying and structuring investments of the types contemplated by the
Funds is competitive, and involves a high degree of uncertainty. Furthermore, the availability
of investment opportunities generally will be subject to market conditions as well as, in some
cases, the prevailing regulatory or political climate. Accordingly, there can be no assurance
that the Funds will be able to identify and complete attractive investments in the future or
that it will be able to invest fully its subscriptions or commitments, as the case may be.
Moreover, identification of attractive investment opportunities by the Funds is difficult and
involves a high degree of uncertainty.
Finally, there are other funds sponsored, managed or advised by the Investment Manager
and its affiliates that are or may be seeking investment opportunities similar to those the
Fund is or may be seeking, and the Investment Manager and such other funds have no
obligation to offer any opportunities it or they may identify to the Funds.
Hedging The Funds may utilize a variety of financial instruments, such as derivatives, options, interest
rate swaps, caps and floors, futures and forward contracts, to seek to hedge against declines
in the values of the Funds’ positions as a result of changes in interest rates and currency
exchange rates, certain changes in the equity markets and market interest rates and other
events. Hedging against a decline in the value of the Funds’ positions does not eliminate
fluctuations in the values of the Funds’ positions or prevent losses if the values of such
positions decline, but establishes other positions designed to gain from those same
developments, thus offsetting the decline in the Funds’ positions' value. In addition, it may
not be possible to hedge against certain changes or events at all.
Forward Trading Forward contracts and options thereon, unlike futures contracts, are not traded on exchanges
and are not standardized. Rather, banks and dealers act as principals in these markets,
negotiating each transaction on an individual basis. Forward and "cash" trading is
substantially unregulated; there is no limitation on daily price movements and speculative
position limits are not applicable. The principals who deal in the forward markets are not
required to continue to make markets in the currencies or commodities they trade and these
markets can experience periods of illiquidity, sometimes of significant duration. There have
been periods during which certain market participants have refused to quote prices for
certain currencies or commodities or have quoted an unusually wide spread between the
price at which they were prepared to buy and that at which they were prepared to sell.
Disruptions can occur in any market traded by the Investment Manager because of unusually
high trading volume, political intervention or other factors. The imposition of controls by
governmental authorities might also limit such forward (and futures) trading to less than that
which the Investment Manager would otherwise recommend, to the possible detriment of
the Funds. Market illiquidity or disruption could result in major losses to the Funds. In
addition, managed accounts or investment funds in which the Funds has an interest may be
exposed to credit risks with regard to counterparties with whom the Investment Manager
trade as well as risks relating to settlement default. Such risks could result in substantial losses
to the Funds.
Swap Agreements The Funds may enter into swap agreements. Swap agreements can be individually negotiated
and structured to include exposure to a variety of different types of investments or market
factors.
Depending on their structure, swap agreements may increase or decrease the Funds’
exposure to strategies, equity securities, long term or short term interest rates, foreign
currency values, corporate borrowing rates or other factors. Swap agreements can take many
different forms and are known by a variety of names.
Depending on how they are used, swap agreements may increase or decrease the overall
volatility of the Funds. The most significant factor in the performance of swap agreements is
the change in the individual equity values, specific interest rate, currency or other factors that
determine the amounts of payments due to and from the counterparties.
If a swap agreement calls for payments by the Funds, the Funds must be prepared to make
such payments when due. In addition, if a counterparty's creditworthiness declines, the value
of swap agreements with such counterparty can be expected to decline, potentially resulting
in losses to the Funds.
Counterparty Risk The return payable under derivatives in which the Funds invest will be subject to the credit
risk of the Counterparty (“Counterparty”). Investors should note that not only will they be
exposed to the credit risk of the Counterparty but also potential conflicts of interest in the
performance of the functions undertaken by the Counterparty in respect of the Funds. In such
circumstances, the Funds shall request from a Counterparty an assurance that the
Counterparty has undertaken to use its reasonable endeavors to resolve any such conflicts of
interests fairly (having regard to its respective obligations and duties) and to ensure that the
interests of the Funds and the Shareholders are not unfairly prejudiced.
Derivative Instruments The Funds may invest in derivative instruments as part of their strategy. Different derivative
instruments involve levels of exposure to risk. In particular, investors should be aware of the
following points:
Futures Transactions in futures involve the obligation to make, or to take, delivery of the underlying
asset of the contract at a future date, or in some cases to settle the Funds’ position with cash.
They carry a high degree of risk. The "gearing" or "leverage" often obtainable in futures
trading means that a small deposit or down payment can lead to large losses as well as gains.
It also means that a relatively small market movement can lead to a proportionately much
larger movement in the value of the Funds’ investment, and this can work against the Funds
as well as for the Funds. Futures transactions have a contingent liability, and investors should
be aware of the implications of this, in particular the margining requirements.
Options There are many different types of options with different characteristics subject to different
conditions:
Buying Options Buying options involves less risk than selling options because, if the price of the underlying
asset moves against the Funds, the Funds can simply allow the option to lapse. The maximum
loss is limited to the premium, plus any commission or other transaction charges. However,
if the Funds buy a call option on a futures contract and the Funds later exercise the option,
the Funds will acquire the future. This will expose the Funds to the risks described under
"futures" and "contingent liability transactions".
Writing Options If the Funds write an option, the risk involved is considerably greater than buying options.
The Funds may be liable for margin to maintain its position and a loss may be sustained well
in excess of any premium received. By writing an option, the Funds accept a legal obligation
to purchase or sell the underlying asset if the option is exercised against the Funds, however
far the market price has moved away from the exercise price.
If the Funds already own the underlying asset which the Funds have contracted to sell (known
as covered call options) the risk is reduced. If the Funds do not own the underlying asset
(known as uncovered call options) the risk can be unlimited. Subject to the overall limit on
leverage which may be utilized by the Funds, there is no restriction on the Funds’ ability to
write options. Certain options markets operate on a margined basis under which buyers do
not pay the full premium on their option at the time they purchase it. In this situation the
Funds may subsequently be called upon to pay margin on the option up to the level of its
premium. If the Funds fail to do so as required, the Funds’ positions may be closed or
liquidated in the same way as a futures position.
Contracts for Differences Futures and options contracts can also be referred to, as well as include, contracts for
differences. These can be options and futures on any index, as well as currency and interest
rate swaps. However, unlike other futures and options, these contracts can only be settled in
cash. Investing in a contract for differences carries the same risks as investing in a future or
option. Transactions in contracts for differences may also have a contingent liability and an
investor should be aware of the implications of this as set out below.
Off-Exchange Transactions While some off-exchange markets are highly liquid, transactions in off-exchange, or non-
transferable, derivatives may involve greater risk than investing in on-exchange derivatives
because there is no exchange market on which to close out an open position. It may be
impossible to liquidate an existing position, to assess the value of the position arising from an
off-exchange transaction or to assess the exposure to risk. Bid and offer prices need not be
quoted, and even where they are, they will be established by dealers in these instruments
and, consequently, it may be difficult to establish what constitutes a “fair price”. Any unwind
of OTC Financial Derivative Instruments prior to their contractual maturity may be subject to
bid/offer spreads. Such charges, if applied, will affect the realizable value of the Funds’ Assets.
Contingent Liability Transactions Contingent liability transactions which are margined require the Funds to make a series of
payments against the purchase price, instead of paying the whole purchase price
immediately. If the Funds trade in futures, contracts for differences or sell options, the Funds
may sustain a total loss of the margin they deposit with the broker to establish or maintain a
position. If the market moves against the Funds, the Funds may be called upon to pay
substantial additional margin at short notice to maintain the position. If a Fund fails to do so
within the time required, its position may be liquidated at a loss and the Fund will be liable
for any resulting deficit. Even if a transaction is not margined, it may still carry an obligation
to make further payments in certain circumstances over and above any amount paid when
the contract was entered into. Contingent liability transactions which are not traded on or
under the rules of a recognized or designated investment exchange may expose you to
substantially greater risks.
Suspensions of Trading Under certain trading conditions it may be difficult or impossible to liquidate a position. This
may occur, for example, at times of rapid price movement if the price rises or falls in one
trading session to such an extent that under the rules of the relevant exchange trading is
suspended or restricted.
Placing a stop- loss order will not necessarily limit losses to the intended amounts, because
market conditions may make it impossible to execute such an order at the stipulated price.
Clearing House Protections On many exchanges, the performance of a transaction by a broker (or the third party with
whom he is dealing on the Funds’ behalf) is "guaranteed" by the exchange or clearing house.
However, this guarantee is unlikely in most circumstances to cover the Funds as the customer
and may not protect the Funds if the broker or another party defaults on its obligations to
the Funds. There is no clearing house for traditional options, nor normally for off exchange
instruments which are not traded under the rules of a recognized or designated investment
exchange.
Insolvency A derivative broker's insolvency or default, or that of any other brokers involved with the
Funds’ transactions, may lead to positions being liquidated or closed out without the Funds’
consent. In certain circumstances, the Funds may not get back the actual assets which they
lodged as collateral and the Funds may have to accept any available payment in cash.
Country risks The transactions in which the Funds invest or may be exposed to may be located in, or
affected by, emerging markets and involve cross-border sales and payments. These factors
give rise to risks, including in relation to the predictability and stability of the legal and
political situation; the robustness and ease of enforcement of any security and any other
remedies vendors might have; and issues relating to taxes, export licenses and customs
duties, and currency controls. In addition, currency exchange rates are subject to certain risks
arising from government regulation of or intervention in the currency and interest rate
markets, through regulation of the local exchange market, restrictions on foreign investments
by residents, limits on inflows of investment funds, changes in the general level of interest
rates, changes in other government policies, changes in taxation and other developments in
applicable laws and regulations. Such regulation or intervention could adversely affect the
Funds’ performance.
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