07.11.2013
By Terry Flanagan

Red Rock and Risk Measurement

Red Rock Capital, a systematic global macro hedge fund, has moved to Chicago’s ‘Magnificent Mile’, and its two partners are planning to launch a commodities index next month.

Founder Scott Hoffman, formerly from the Salt Lake City area (hence the name Red Rock), and managing partner Tom Rollinger, who worked for years with renowned quant Edward O. Thorp, believe the Sharpe ratio is trumped by the Sortino ratio for comparing futures managers’ returns, especially trend followers who tend to exhibit positive skew.

Tom Rollinger, Red Rock Capital

Tom Rollinger, Red Rock Capital

This year, Hoffman and Rollinger co-authored the whitepaper “Sortino Ratio: A Better Measure of Risk.” They compared performance of Chicago commodity trading advisors, or CTAs, and showed that Red Rock, the smallest in terms of assets managed at $7.5 million compared with some funds more than $500 million, has the highest Sortino ratio by far at 1.49.

“Most monthly rankings you see in the industry show only the percentage return, but not the risk or volatility” in managed futures trading programs, Rollinger told Markets Media. “Due to the inherent (free) leverage in the futures markets, risk-adjusted returns are the proper way to compare manager returns.” The concept is “repeatedly misunderstood,” he said.

For Red Rock, just two months shy of 10 years in business, its flagship CTA trading program utilizes momentum and probability theory in attempting to capture the high-value payoff of trending markets.

Target clients for the managed program are family offices and institutions, and moving to Chicago was a calculated effort to get more on the radar as a smaller trading entity. “A couple of local institutions have shown interest in purchasing us to use our track record and turn it into a mutual fund, or to white-label it as a product,” Rollinger said.

So long as they can continue to manage money, Red Rock is not averse to this because they are most interested in the quantitative aspects of the trading – finding patterns in momentum or relative value that are repeatable and persistent with explanations behind them. “We don’t desire to hire a bunch of people,” Rollinger said. “Our goal is to be as effective and efficient as possible and to produce high value at a reasonable cost.”

Over the past decade, the managed futures industry has expanded eightfold, Rollinger noted, adding that benefits of the strategy include diversified returns, liquidity, and inherent leverage of futures via single managed accounts.

Hoffman and Rollinger have created a new commodities index that will be rolled out soon, and say they have a better way of weighting commodity positions than widely used benchmarks like the S&P GSCI, which Rollinger said is expensive for what it offers. He said other entities have equal-weighted commodities indexes that are actively traded, but the management fee of 0.85% is more than double what is warranted.

“The goal of this index is to change the face of commodity exposure for institutions,” Rollinger said. “We offer something better at a substantially lower cost,” and the firm is seeking an institutional partner to build a reasonably priced, exchange-traded product based on the index.

Most comparable indexes on the market over-weight energy, according to Rollinger. “The S&P GSCI’s correlation to crude oil has been as high as 0.93 recently,” Rollinger stated. “You buy the index hoping for diversification, but what you really bought was a huge oil position.”

Since late 2012, Red Rock has seen commodities somewhat reverting back to their historically lower correlation to stocks, a desirable characteristic for investors seeking diversification from traditional asset classes and other hedge-fund strategies.

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