2016 in Review

25-Jan-2017

2016 In Review

Bayou City Capital returned +1.07% during December, and -1.80% for the year of 2016. Since surrendering -13% in performance in January as the S&P 500 had its worst start to a year on record, Bayou City capital returned 12% over the following 11 months. Juxtaposed with 2015, this year provided more evidence of a changing volatility landscape in the U.S. equity markets.

The Bayou City Strategy is designed to take advantage of raw emotion in the equity marketplace. That is, fear and uncertainty creates risk premium in the price of S&P 500 options, inflating these derivatives’ costs over their evident empirical value. Since its inception in 2004, the Fund has steered through market hardships in order to exploit this emotion embedded in option prices. These periods were usually contained to a crisis or crash in stocks- a down period in the S&P. The last two years have introduced stock rallies that are equally as violent as the market downturns. Having to steer through volatility on both sides of the coin created a difficult atmosphere that the Fund has adapted through.

The graph below may illustrate the stark contrast in equity behavior in 2015-2016 compared to previous years. The graph shows the number of trading days when the S&P rose faster than predicted by S&P option prices. Historically, equities move upward in a slow, deliberate fashion. As shown below, 2015 had the most volatile up days since the Fund’s existence, even more than 2008 or 2009. In 2016, the first half of the year continued this unique trend, producing as many volatile up days in the S&P as other ‘normal’ years in just half the time span. The graph shows the projected pace of 2016 to illustrate its significance. The S&P’s behavior did subside in the second half of 2016, which is evident in the Fund’s improving performance.


One theory to explain the market’s irregular behavior focuses on the pervasive switch from ‘active’ to ‘passive’ investment over the last 5-10 years. In other words, passive index funds have become a significant portion of the daily flow of capital in the marketplace. Combined with the ever-growing share of algorithmic and high-frequency trading, the increasingly emotionless, machine-like characteristics of the market participant likely contributed to the S&P’s behavior over the last couple of years. 

The Fund’s philosophy remains to strive for improved risk-adjusted returns. Utilizing the risk allocation put in place in Feb. 2016, the Fund should produce durable, consistent performance rather than volatile swings that have been displayed in other years of the Fund’s track record. We are looking forward to continuing the trend set over the last 11 months into 2017.


PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. 

The financial audit is in process and should be completed by the end of February and will be posted to our website. The 2016 tax return and related K-1’s are also in process and should be available within the next several weeks. 

As always please let us know if you have any questions, and we appreciate your support. 


Best Regards, 

Will Monroe 
Vice President  
willmonroe@bayoucitycapital.com


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