Open Letter Re: MF Global Bankruptcy

To our clients and industry colleagues,

Let us begin by saying that Cervino Capital greatly values your business. We have always strived to put capital preservation and risk management at the forefront of our trading and operational activities.

As you know, on October 31, 2011 MF Global—one of the FCMs though which we cleared many of our client accounts—filed for bankruptcy. Subsequently, it came to light that “sacrosanct” rules, which specifically required client funds to be segregated from the firm’s assets, were not properly followed.

See: http://www.cftc.gov/PressRoom/PressReleases/pr6140-11
See: http://www.cftc.gov/PressRoom/SpeechesTestimony/opasommers-18
See: http://dealbook.nytimes.com/2011/12/28/mf-global-scrutinized-on-moving-of-money/

We empathize with everyone affected by the travesty that has unfolded at MF Global since the end of October, and note that we too were personally impacted by this situation.

On November 22, 2011 we took action by being the first to file a class action lawsuit against Jon S. Corzine and other senior executives at MF Global Holdings Ltd. The case is Accomazzo v. Corzine, 11-CV-8467, U.S. District Court, Southern District of New York. The case is being consolidated with other cases under a single U.S. District Judge, but our attorneys are moving to lead the sub-class on behalf of futures customers.

See: http://www.businessweek.com/news/2011-11-23/jon-corzine-sued-by-mf-global-customer-over-client-assets.html

As a sign of our commitment to our customers, Cervino Capital has decided to waive Q4 2011 fees for clients who were clearing their account at MF Global at the time of the bankruptcy, and who as a result suspended trading. Cervino Capital is respectful of the fact that this has been a painful period for MF Global customers and hope our gesture in a small way eases the burden.

Should you have any questions, please do not hesitate to contact us. In the meantime, we will continue to do what is in our power to ease the frustrations of our clients and business partners.

Very truly yours,

Michael “Mack” Frankfurter, Managing Director
Davide Accomazzo, Managing Director

2012 Outlook: Getting Back to Basics...

THE FOLLOWING ARTICLE DOES NOT CONSTITUTE A SOLICITATION TO INVEST IN ANY PROGRAM OF CERVINO CAPITAL MANAGEMENT LLC. AN INVESTMENT MAY ONLY BE MADE AT THE TIME A QUALIFIED INVESTOR RECEIVES CERVINO CAPITAL'S DISCLOSURE DOCUMENT FOR ITS COMMODITY TRADING ADVISOR PROGRAMS. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

The business of forecasting is often a foolish endeavor. Financial author and finance’s enfant terrible Nassim Taleb likened the process of financial divining to being “fooled by randomness”. And yet every year most financial participants will spend thousands of words dispensing their prognostications about the ensuing twelve months. Admittedly, we at Cervino Capital are afflicted by the same disease, although our discretionary approach to investing and trading allows us a convenient degree of flexibility in changing our positions when it becomes apparent that the assumptions of the original prediction were unfortunately wrong.

This coming year the dynamic of forecasting seems even more treacherous than ever. The European crisis remains largely unresolved and is still centerpiece to every future macroeconomic development. The first quarter in 2012 will see billions of Euro debt to be rolled over and roughly a 1/3 of such amount just from Italy. Should the market continue to keep interest rates above 7% for Italian sovereign debt, the pressure on the ECB to intervene in dramatic fashion will probably prove unstoppable. Any large scale intervention by the ECB should calm markets and ignite a new leg up in gold. A refusal of the ECB to bend to market and political pressures might prove highly deflationary and possibly result in a reformation of the Euro currency.

This structural uncertainty means that most investors will refrain from making significant unilateral bets leaving markets hostage to shorter term fluctuations and volatile action. Given these conditions, Cervino Capital’s option arbitrage approach which is designed to take advantage of sideway markets action should prove a fundamental component in portfolio diversification. Our Diversified Options Strategy 1X and 2X trading programs encompass a strategy which is inteneded to produce absolute returns based on premium capture strategies. The objective is to generate positive returns in most market conditions regardless of whether the underlying asset price is rising or falling. In fact, the Diversified Options Strategy has outperformed the S&P 500 benchmark since its inceptions in 2006. Interestingly, this program outperformed most hedge fund indexes in 2011 as well.

The bi-polar macro-economic outlook (inflation/deflation) may also prove favorable for our Gold Covered Call Writing program. Gold naturally tends to outperform in times of high inflationary pressure but it should also do well, at least on a relative basis, in times of significant deflation.

Our Gold program is built around two major pillars: (1) benefiting from an upward bias in the underlying commodity while containing its traditional unsettling volatility; and (2) benefiting from optimized capital utilization. In 2011, our analysis brought us to overweight risk management controls due to volatility spikes in gold. And while the precious metal produced another yearly positive performance, it was also a highly volatile year. A review of the trading program’s performance for 2011 shows that while we contained most of gold’s price instability, it was at the cost of underperformance. Regardless, we were able to maintain a perpetual long exposure in which many traders were shaken out time and again.

Overall, we believe that gold is still an unfolding story with more upside left; however, the magnitude of the upside is linked to the policy response to the ongoing crisis by governments. In this light, gold exposure in most portfolio allocations is recommended by asset allocators. We are in agreement with this consensus but believe it should continue to be strictly hedged exposure.

On the subject of commodities in general, we expect increased volatility as the result of a few factors: Europe, uncertain Middle East developments after the Arab Spring of 2011 and the MF Global fiasco. The Chicago Mercantile Exchange, the largest commodity market in the world, has seen its trading volume cut by 10% since the MF Global bankruptcy. Decreasing volume and an uncertain regulatory environment may cloud the price discovery mechanism and increase volatility across most commodities for some time to come.
Cervino Capital has long recognized that in today’s brave new world of atypical macro-economic conditions, generating positive risk-adjusted returns is more than ever dependent on actively managing “outliers”. To say the least, in a world of unknown unknowns this task has become increasingly complicated and challenging. The MF Global debacle is just another example of how risk evolves from places unseen.

As the Turner Review (2009) noted, “arguably the greatest crisis in the history of finance capitalism” is half explained by reliance on “the theory of efficient and rational markets”. In other words, the markets forgot that the complexity of human behavior can never be fully modeled. Indeed, “individual rationality does not ensure collective rationality… and that, in consequences, markets can overshoot in both directions.”

Cervino Capital understands that models convey insightful understanding, but real life investors frequently make irrational choices not recognizing that inputs/outputs are reflexive. In a world where prices are more often in a state of disequilibrium than equilibrium, and “everybody relies on their ability to get out the door before anybody else,” a common sense approach is needed to manage risk while seeking returns. This is the central mission of our approach to trading.

--Davide Accomazzo, Managing Director