HSBC HSBC Holdings PLC

By Mia Lamar 

A little-known Singapore hedge fund run by a former professor and an ex-actuary is quietly earning some of the world's top returns with a sometimes stomach-churning strategy that piles on risk.

Quantedge Capital Pte Ltd's hedge fund has gained 40% after fees this year as of June, making it the second-best-performing fund in 2016 in a ranking of more than 350 hedge funds that HSBC Holdings PLC compiles and sends to clients.

The fund gained an estimated 12% in June alone, according to a letter sent to investors and seen by The Wall Street Journal. Bond-related investments led the June gain, offsetting losses on stocks as markets "swung wildly" following Britain's decision to leave the European Union, the letter said.

In an emailed response to questions, the fund said that holding riskier longer-term bonds while betting against short-term bonds--a "term premium" strategy that tends to rise in times of market distress--has been among its profitable bets this year.

Over the long term, which is how many investors evaluate funds, the $1.3 billion fund has produced an average annualized return of 27% since inception, far more than similar hedge funds. Quantedge started trading in late 2006 with $3 million, according to marketing documents seen by the Journal.

The fund's nearly decadelong history makes it one of the longest-running--and most successful--"risk premia" investors, an approach that has been the focus of an increasing number of new fund offerings.

Thierry Roncalli, head of quantitative research at Société Générale's Lyxor Asset Management unit, said this type of strategy appeals to sophisticated, long-term investors looking to earn a return in an era of low interest rates and low expected returns on traditional assets.

"You have to take some risk. This is not a magic formula," Mr. Roncalli said. "It would be very interesting if we found a portfolio which is well rewarded and has limited risk."

Unlike stock or bond funds that build portfolios around a specific class of assets, such funds build portfolios around specific risks, such as owning illiquid, harder-to-trade stocks versus easier-to-trade stocks, or owning riskier long-term debt versus short-term debt.

Such strategies seek to profit by collecting the excess returns--or risk premia--that are typically expected from riskier bets to compensate investors for the greater chance of losses.

Quantedge has a sprawling portfolio compared to many similar investors, using automated computer programs to shift between some combination of over 100 such positions at any time in everything from commodity to bond markets, the fund said in its emailed response.

For the term premium strategy, for example, the fund may short, or bet against, three-month Treasury bills while going long, or betting on gains, for 10-year Treasury notes.

The approach takes a page from the endowment model of investing made famous by Yale University, which also seeks to profit over the long run with a high stake in riskier investments.

Quantedge adds a tweak that can be dangerous. Many investors raise and reduce risk in their portfolios as they change their positions. That helps them to avoid sharp, sudden losses in times of market fear but can also mean they are slower to profit when markets rebound.

Quantedge, by comparison, maintains a common measure of risk known as annualized volatility at a constant and abnormally high level of 30%, two to three times that sought by similar hedge funds, according to investors.

That produces a higher chance for the fund to notch above-average gains. It also raises the likelihood of a big loss, and some investors say that the risk of investing in a high-volatility fund like Quantedge is that losses get so high that an investor pulls out of the fund at a big loss.

Earlier in its history, its risk target was even higher at 40% annualized volatility, according to a 2012 marketing document seen by the Journal.

"Our investment goal is to compound capital aggressively over the long term at a level of volatility that our investors can tolerate," the fund said in its emailed response.

AQR Capital Management LLC--founded by former University of Chicago finance researchers--and Two Sigma Advisers LLC are among firms that have rolled out new funds focused specifically on reaping rewards from risk premia.

The outsize returns set the firm apart in a hedge-fund industry that has struggled for several years with lackluster performance. Since Quantedge started trading in October 2006, hedge funds globally have produced an average annualized return of 3.61% as of the end of June, according to data provided by fund tracker HFR Inc.

Similar quantitative funds have produced an average annualized return of 5% over the same period, according to HFR.

The firm doesn't boast the Wall Street background typical of many hedge funds. One founder, Chua Choong Tze, previously worked as a finance professor in Singapore. The other, Leow Kah Shin, worked as an actuary in Bermuda, according to marketing documents.

Quantedge's rich returns have come with some bumpy rides. This was in display during last summer's global market selloff, when the fund plunged 8.9% in June, and an additional 16% in August.

In an August letter to investors seen by the Journal, the fund called its performance during the global market rout "disappointing."

"To our longtime investors, who have been through a few up-and-down cycles with us, you know this is business as usual," it wrote. "...Our investment model delivers high returns over time, at the cost of unpleasant bumps along the way."

Write to Mia Lamar at mia.lamar@wsj.com

(END) Dow Jones Newswires

July 20, 2016 05:53 ET (09:53 GMT)

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