Convexity Capital Management LP, the $12.3 billion fund run by Harvard University's former endowment head Jack Meyer, told clients it beat benchmarks by 5 percentage points in 2010 even with "mediocre" trading opportunities.
The Boston firm, whose strategy works best in choppy markets, outperformed targets in all four quarters without being able to rely on "strange bumps in the forward curves," "irrational spreads" and other anomalies, Meyer said in a letter to clients in January.
"We ground it out," Meyer, 65, wrote in the yearend letter, a copy of which was obtained by Bloomberg News. "We uncovered increasingly subtle mispricings across fixed-income and foreign-exchange markets. We spent hundreds of hours refining our calculators."
Meyer exceeded a group of market indexes by an annual average of 7.7 percentage points since he began trading in February 2006, he said, even as volatility fell for a second straight year. Meyer ran Harvard's endowment, the world's biggest, for 15 years before leaving in 2005 with more than 30 employees amid an outcry over pay. Convexity, which attracted a record $6.3 billion from endowments and foundations as a hedge fund startup, got net deposits of $507 million in 2010.
The benchmarks with the most client assets are Barclays Capital More Than Five Years TIPS Index, MSCI EAFE Net Dividends Reinvested and Standard & Poor's 500 Total Return. The Barclays TIPS index, tracking inflation-protected bonds, returned 7.7% last year, while the MSCI index of non-U.S. stocks climbed 7.9%, according to Barclays and data compiled by Bloomberg. The S&P 500 rose 12.8%.
Meyer declined to comment.
The firm, which reported performance versus benchmarks rather than its absolute gain, takes its name from a term used by fixed-income traders in measuring a bond's sensitivity to interest rate movements. Investors stand to win more than they can lose in trades with "positive convexity."
The Chicago Board Options Exchange Volatility Index, a gauge of U.S. stock market swings known as the Vix, dropped to 17.75 on Dec. 31 from a record high of 80.86 on Nov. 20, 2008, amid the global financial crisis.
Convexity seeks to track the returns of indexes selected by its clients while providing an additional gain, known as alpha, of about 4 percentage points a year at each investment pool. Investors can pick from a mix of 15 indexes, using different asset classes for diversification.
Meyer employs 10 strategies centered on options trading and asset swaps, seeking to take advantage of different market climates. His team used a similar approach in quintupling assets at Harvard since 1990.
Market opportunities are likely to improve this year, Meyer said in the letter. The steepening of bond-yield curves over the past month and "continued stresses in Europe and in currencies globally could create opportunities across the board," he wrote.
Meyer's former employees at Harvard Management Co. who joined him at Convexity included bond traders Maurice Samuels and David Mittelman, the school's highest-paid endowment managers in 2003, earning $35.1 million and $34.1 million, respectively. Members of the class of 1969 wrote a letter to its then-president, Lawrence Summers, saying the money would be better spent on scholarships.
When Convexity opened, Harvard Management pledged $500 million to the fund. Endowments make up more than half of Meyer's clients.
Meyer averaged annual gains of 16% in his last decade at Harvard. The endowment rose to $25.9 billion in 2005 from $4.7 billion 15 years earlier, when he became Harvard Management's chief executive. Investments at the $27.6 billion fund, run by Jane Mendillo since July 2008, gained 11% in the past year, rebounding from the record 27% loss of 2009 spurred by the bankruptcy of Lehman Brothers Holdings Inc.
"We do not intend to celebrate with marching elephants and proclamations, but we will make three observations," Meyer wrote. "First, performance has been a little better than expected. Second, our team is much broader and deeper. Third, we are considerably better at this than we were five years ago." Convexity, he wrote, is "quiet about our optimism, but don't think that it's not there."
