Simon Glossop,partner and chief investment officer at CF Partners, a London-based environmental finance firm specialising in carbon advisory and tr

Simon Glossop,partner and chief investment officer at CF Partners, a London-based environmental finance firm specialising in carbon advisory and trading, explains why the firm is launching a carbon emissions hedge fund in November to exploit pricing inefficiencies and dislocations in carbon markets.

HW: What is the background to your company and fund?

SG: Since its launch in 2006, CF Partners has become active in the carbon emissions market as an adviser to many compliance buyers of carbon credits, such as industrial companies and utilities. It also structures and trades OTC transactions among other buyers and traders of emission credits such as carbon funds, banks and trading houses.

Given the arbitrage opportunities that we see through the advisory business, we are in the process of launching the CF Carbon Fund to capitalise on pricing inefficiencies and dislocations in the carbon markets. The fund adopts a relative value and arbitrage-based approach to trading carbon and other related global energy markets.

The fund's principals are myself, Jonathan Navon and Thomas Rassmuson, and the portfolio manager is Tony Walker.

HW: Who are your service providers?

SG: Our fund administrator is Fortis and our law firm is Katten Muchin Rosenman Cornish. We also have a trading relationship for OTC derivatives and futures and options with Deutsche Bank.

HW: What is the profile of your targeted client base?

SG: We are targeting sophisticated institutional investors that are willing to look at new markets and strategies, which require more analysis and work, but in return they expect to be rewarded with non-correlated alpha.

HW: What is the investment process of your fund?

SG: We have a structured investment process, which is scalable. An investment committee led by myself as chief investment officer and staffed by senior members of the investment manager is responsible for setting the investment guidelines and discussing themes for the fund.

The investment committee reviews strategy and monitors performance on a regular basis. Every investment opportunity goes through a rigorous process and must have an expected risk/return that fits the fund on an individual basis but also from an overall portfolio perspective and fit.

HW: How do you generate ideas for your fund?

SG: Investment generation is based on fundamental research, a proprietary carbon supply/demand model, internal models and a well-developed network. Given the firm's position in the carbon market through its advisory and brokerage businesses, it provides the fund management business with internal research and insight.

HW: What is your approach to managing risk?

SG: We have a dedicated risk framework and engine combined with a disciplined trading approach based on significant experience. Our commitment to risk management is that the chief risk officer is a senior partner of the firm not involved on the investment side. A separate risk committee reviews the portfolio regularly and there are well-documented processes for assessing and managing risk.

HW: Has your shadow performance been as per expectations? Do you expect your performance or style to change going forward?

SG: Since June 2, our shadow portfolio has returned 6.58 per cent, which are 21 per cent annualised. Our style will not change significantly. Given the opportunity set in the carbon market, the strategy has not employed leverage to date and does not anticipate that changing in the near future.

HW: What opportunities are you looking at right now?

SG: The CF Carbon Fund is well positioned for investments given the recent volatility in the global markets. The shadow portfolio is currently returning positive returns since trading commenced despite the recent market instability. Carbon is an uncorrelated to equities (-0.43 to the Dow Jones Industrial Average) and fixed-income markets (+0.09 to iTraxx).

Given the current arbitrage and trading opportunities in the carbon market, the fund can generate positive returns without employing leverage. Currently a majority of trades are transacted on exchanges such as ICE, Nordpool, Nymex and EEX, minimising credit counterparty exposure.

HW: What events do you expect to see in your sector in the year ahead?

SG: The investment strategy is based on structural inefficiencies that we believe exist as a result of companies trying to become more efficient with their resources in a carbon-constrained world, and governments balancing the long-term effects of a growing global population consumption with a declining amount of non-renewable resources.

The inefficiencies are a result of lack of clarity with respect to climate change policy, regulation and obligations, companies unable to adjust to new carbon requirements or doing so inefficiently, and a lack of market expertise and transparency available for investors and those who are obliged to comply with policy. It will take some time for these primary inefficiencies to be adequately accounted for by the majority of the companies that the carbon policy is affecting.

The fund will continue to focus on new and emerging sectors in the carbon markets offering the most favourable risk/reward profiles and hence the greatest potential for profitability.

HW: How will these developments impact on your own portfolio?

SG: Increased volatility will lead to greater returns for the trading fund, which is long/short.

HW: What differentiates you from other managers in your sector?

SG: The majority of funds established to date specifically to look at carbon have been accumulators or aggregators, with a strategy to buy and develop carbon credits through early-stage investments and involvement in projects, and to seek to sell the carbon credits at a later date at a more expensive valuation. In effect these funds are long-only.

This fund is unique in that it seeks actively to trade carbon from a relative value and arbitrage perspective instead of being purely directional. The firm has a strong network of contacts through trading and advisory activity to ensure a total overview and insight to the supply and demand dynamics.

HW: Do you have any plans for other product launches in the near future?

SG: Future fund launches will be a water fund and an environmental long/short equity fund.