Zest North America Pairs Relative Value Fund

Marrying carry and convexity

Hamlin Lovell
Originally published on 25 April 2024
  • Above: Pasquale Corvino, Portfolio Manager, Zest North America Pairs Relative Fund

Zest North America Pairs Relative Fund has received The Hedge Fund Journal’s UCITS Hedge award for best performing fund in 2023 and over 2, 3, 5 and 7 years, ending in December 2023, in the US Equity Market Neutral strategy category. The fund’s return target is cash plus 10% with half of the volatility of the S&P 500. The strategy has also performed very strongly relative to a range of Morningstar benchmarks: US Passive Fund Market Neutral, US Active Fund Market Neutral, US Passive Fund Equity Market Neutral, as mentioned on the manager’s newsletter. 

Portfolio manager, Pasquale Corvino, based in Lugano, in the Italian-speaking Ticino region of Switzerland, has devised the unique equity hedge fund strategy, which combines single name US equities, linked to proprietary single stock derivative structures, and US equity index futures and options. US equity derivatives are prized for their unmatched liquidity. The strategy can profit during bull, bear and rangebound markets, and has a wide and dynamic range of linear and non-linear risk and return exposures, which aim to maintain positive carry and convexity. Though the strategy is classified as discretionary, Corvino views it as combining art and science. His philosophy is that “Managing risk is more important than forecasting-based approaches, because outcomes are often binary”.

Managing risk is more important than forecasting-based approaches, because outcomes are often binary.

Pasquale Corvino, Portfolio Manager 

20 years of trading and investing 

This distinguished strategy synthesizes elements from Corvino’s 20-year career in banks, asset managers and hedge funds: active management, alpha generation, derivatives, intermarket analysis and trading dislocations, which have contributed to a multidisciplinary, directionally agnostic approach. 

Corvino’s career began at BCC Risparmio e Previdenza in 2002 as a TMT (technology, media and telecoms) portfolio manager running around EUR 600 million in a dedicated fund and also managing the TMT sleeves of EUR 6-8 billion in global equity mandates. “It feels like a distant memory, especially considering the tech sector was out of favour. I personally met Nvidia’s management in 2005 when rumours spread about a bid from Intel, following AMD’s acquisition of the graphics card vendor ATI, and these stocks were reserved for sector specialists due to their technicality,” says Corvino. 

In his next role he spent five years at one of the giants of Italian asset management, Aletti-Gestielle, which ran USD 25 billion, and where his passion for US stocks continued: “I managed balanced and flexible balanced funds containing more than USD 1 billon in four different products, increasing exposure to US equities at the expense of European equities. I spent 4-5 weeks a year in the US meeting companies and travelling with sophisticated institutional investors, which greatly contributed to my learning curve”.

Moving to MPS Banca Monte dei Paschi, one of the biggest prop trading desks in Europe in that period, Corvino became a proprietary long/short equity trader, managing a trading book and the bank’s most strategic book – AFS (Available for Sale). “I had full discretion for trading single names and futures, with low equity delta and tight stop losses. This made an important contribution to the bank’s profitability”. Prop trading at the bank was “business as usual”, despite the sovereign debt crisis at the time.


One performance objective is to make 10-20% from a stock and derivatives pair, even if the stock itself is flat. This can come from weekly carry of 1.5 to 2%, and there is also some downside protection on each position.

Moving to Switzerland, Corvino served as Deputy CIO at Cramer Asset Management before transitioning to Zest (now LFG+ZEST) in 2015 to introduce a flexible derivative overlay strategy, followed by the US Pairs relative strategy, which was restructured in its current form at the beginning of 2019, with seed capital from a select group of institutional investors linked to the fund manager. LFG+ZEST emerged from the merger between LFG Investment Consulting and Zest SA, operating under LFG Holding, one of Switzerland’s largest independent wealth management groups. Though the North American strategy has an internal sub-allocation, the majority of assets under management are sourced from external investors, reflecting the group’s independence and open architecture. 

LFG+ZEST acts as a focal point for market discussions within Corvino’s network. “I share ideas with others fund managers during our weekly meetings and maintain a diverse network from my academic and prior professional backgrounds, including relationships with experienced sell-side analysts and hedge funds in the UK and US.”

Three sub-strategies

The strategy runs three somewhat interrelated sub-strategies. The typical annual performance attribution split has been 40% single stock alpha, 40% carry from associated single stock option structures, and 20% from e-mini-index relative value trading. The split does, however, move around. “2022 was a negative year for the stocks with a big drawdown partly from some cyclical sector exposures, but positive for the options and index trading. 2022 was also challenging because I did not get more short after the declines seen early in the year. Melt down and melt up is the worst scenario for a time weighted strategy, but week after week I can mitigate and overcome the negative impact,” explains Corvino.

In contrast, 2020 was a stronger year: “I was expecting some weaknesses, so the portfolio was prepared for that, so I was over-hedged. I realized Covid risk could travel from Asia to Europe and the US. The spike in implied volatility was also an opportunity to shorten the payback period from options”. Corvino aims to “crystallize” the option premiums, which means earning them back, and often goes further by collecting some positive carry.

Judgment determines if volatility is good or bad, like cholesterol.

Pasquale Corvino, Portfolio Manager

Stock picking

The portfolio of 45-60 US large and mid-cap stocks sized around 1-2% of NAV is one driver of returns, that also needs to be coordinated with the option structures on each single stock. “I pick relatively defensive and predictable companies including some stable oligopolies, and avoid peak valuations, overly competitive markets, binary situations and small caps,” says Corvino, who views S&P Equal Weight as a better benchmark for the stock picks than the mega-cap dominated S&P 500. 

Earnings and multiples can both feed into the process: “I form a view on earnings estimates based on peer group, data analysis, and whisper numbers, including insights from conferences, and keep an eye on valuation multiple changes. Multiple expansion is never my first reason to be involved in a   story, but I recognize it is a good proxy of sentiment improvement and a good indicator of stock rerating”. 

Though Corvino does form a view on earnings, this is not over-emphasized. The aim is to predict asset price appreciation or depreciation, rather than precisely forecasting revenues, margins and EPS. 

There is no structural bias to any style or factor. “I aim to neutralize factor tilt and I am not particularly devoted to any specific style; instead, I prefer to be pragmatic and opportunistic,” says Corvino. He seeks “antagonist stocks” which means that the overall portfolio of 50 stocks should have different performance drivers to smooth overall portfolio volatility. The top ten holdings on the newsletter have recently included Applied Materials, D.R. Horton, Electronic Arts, Valero Energy, Shopify, Booking Holdings, UnitedHealth Group, Starbucks, Dollar Tree and Bank of America, though they are really trading instruments, rather than long term buy and hold positions.

Weighing and balancing the “Greeks”

Corvino trades various tailor-made calendar, vertical and ratio spreads on stocks, which can add up to a proprietary version of dynamic diagonal option spreads, on weekly maturities. These can both earn time decay and provide positive convexity, though they can have negative gamma (depending on the total position) that needs to be actively managed. “Careful judgment selects and rebalances strikes and tenors to balance intrinsic value, downside protection, earning time value and convexity, which can amplify or mitigate other exposures,” says Corvino. 

Discretion also determines the balance of short maturity and long maturity positions, which is more important than skew in structuring the option spreads. “Time decay accelerates as options approach maturity, hence short puts are short term and long puts long term,” explains Corvino. 

Deltas are usually 0.5 to 0.7 at inception of a structure, though of course they move around. The structures define maximum profit and loss over certain periods, though this also changes dynamically as they are rebalanced. 

Shorting calls and puts have often resulted in being assigned stock, especially when the stock goes ex- dividend, and it is deep in the money. (Surprises in the amounts of dividends have in contrast been a marginal issue.) Assignments can result in closing or reopening the position, which does not incur brokerage fees on single stocks bought from assignment.

Dynamic exposures 

“Short exposures are obtained through options because I find it expensive to finance cash shorts, and managing each single leg of the synthetic position gives me more flexibility,” says Corvino. The top ten long stocks listed in the newsletter, and other positions, could be net long, flat or net short positions after accounting for the DDOS, and these exposures can also change over the life of the trade. 

The exposures can change somewhat passively as option structure deltas move – and actively in response to tactical decisions, for instance as stocks approach price targets. “I am more likely to make contrarian wagers on single stocks than on indices, based on second derivatives of revenues and margins. But in general, I have low confidence in forecasting direction because indexes have many moving parts, making it tougher to identify turning points, despite their heightened sensitivity to the macro environment, therefore I prefer to focus on risk management and alpha generation,” explains Corvino.

One performance objective is to make 10-20% from a stock and derivatives pair, even if the stock itself is flat. This can come from weekly carry of 1.5 to 2%, and there is also some downside protection on each position.

The option position strikes and tenors are rebalanced and recalibrated at least weekly to maintain a convex return profile that might preserve capital from a down move, but profit from an up move.  Portfolio turnover, mainly done on Fridays for the single stock options, but sometimes twice a week or more often, is thus high. “Dynamic rebalancing can prove to be extremely beneficial,” points out Corvino.

The normalization of interest rates over the past two years has also influenced the choice of option structures. “The rise in interest rates has moved up implied forwards, which creates an attractive embedded coupon of 50 basis points per month on deep in the money call options. This is the biggest opportunity I see and is undervalued by the market this year,” says Corvino.

Index strategies

The index relative value strategy trades e-minis on the S&P 500, Nasdaq 100 and Russell 2000. The Nasdaq and Russell are assumed to have the same beta, while the S&P 500 is sized for slightly lower beta. The portfolio will generally have a single digit percentage in these index trades. A mix of futures and the growing ODTE (zero days to expiry) and 1DTE (one day to expiry) CBOE options market are traded to earn time decay on these relatively expensive options. “Increased participation and liquidity on the ODTE market has opened up new opportunities and sources of volatility,” says Corvino. 

There is some portfolio-level hedging with indices, to complement the more specific position hedging. Index relative value trades can be used to express directional or factor views, which might either amplify or mitigate the exposures from the single stock/DDOS pairs. “The Nasdaq 100 and Russell are especially useful for trading factor exposures,” he adds.

Volatility targets 

The fund sometimes overshoots its 10% volatility target but has not surpassed the UCITS 20% monthly 99% confidence level, and ultimately Corvino’s judgment is the most important consideration for risk management. “Judgment determines if volatility is good or bad, like cholesterol. When volatility and the term structure are pretty high, we have a good opportunity to maximise the gamma position,” says Corvino. The prospectus has a 400% cap on gross exposure. 

Margin, brokers and execution

Stocks are usually about 60% and the rest in indices and options. The margin account averages around 20%. Since 2019, ISDAs and listed derivatives agreements have been in place with Morgan Stanley and Société Générale, ensuring high-quality service provision. “Morgan Stanley’s and SocGen’s platform also help to monitor risk management, margins and netting. We build on this with our own proprietary risk management tools,” says Corvino. 

Funds at Zest

Corvino also manages two other strategies at Zest Asset Management SICAV: a long only multi strategy fund called Zest low Var and Zest Derivatives Allocation. But the North American strategy is much more active, trading 6-7,000 times a year versus 20-40 times for the other two.

Distribution and vehicles 

Nearly half of the assets are in retail share classes (EUR, USD and CHF), which may in some cases be used for distribution to institutional investors. The largest market is currently Switzerland. This fund is registered in Italy, Spain and Switzerland (some other compartments in the Zest Asset Management SICAV can also be registered in other and different countries) and of course can be subscribed by professional investors elsewhere without registration according to UCITS rules. “For the Zest North America Pairs Relative fund, we are exploring other fund structures, and we are open to separately managed accounts,” says Corvino.