From the December 01, 2009 issue of Futures Magazine • Subscribe!

Splendor: The art of equilibrium

Ruhong Huang and Tom Weiye Tang prefer the gentle, fluid movements of Tai Chi over the vigorous blows of full-on Kung-fu, and it shows in their trading style. As the two principals of Shenzhen, China-based commodity trading advisor Splendor Capital Management Ltd., they’ve developed a strategy that invests 100% in spreads and has been boasting a 44.4% annual return since launching in January 2008, with a Sharpe Ratio of 2.75.

Their partnership flows from Ruhong’s fascination with economics that he developed while studying journalism at Shanghai International Studies University in
the 1990s.

“The library collected many economic books directly from the U.S. and UK,” explains Tom. “Ruhong claimed that he had read almost all of the economics books there, and that’s when he realized that his real life interest lies in economic activities.”

They had each enrolled in the university’s journalism program in 1991, and even shared a dormitory but it wasn’t until the third year that they began having deep, long talks, largely because Ruhong had come from a rural area where Mandarin wasn’t spoken. “We all learned English the first two years, but he had to learn both English and Mandarin,” Tom says. But once Ruhong’s Mandarin kicked in, Tom realized they had plenty in common.

“Both of us agreed with the Taoist philosophy that the world was created and can only be maintained by the combination and balance of Yin and Yan,” he says. “Human beings should not work against the rules of nature.”

That means acknowledging the interconnectedness of all things and laws of causality. “Nothing in the world is random, and what appears to be random activity comes from limitations in our knowledge-seeking process,” he says.

Instead of trying to understand every detail, they believe the best we can do is infer something about the workings of the world by observing it holistically and then trying to identify imbalances. When they learned the country was going to revive its commodity futures exchanges, they got to thinking.

“We agreed that the market was a great place to test our philosophy, because it sent out clear feedback as to the correctness of our trading approach,” says Tom. “From the start we felt that doing things in pairs had a great advantage, but we weren’t fully convinced that 100% spread trading was the answer because shorting was always a scary business for greenhorns, and spread positions were not easy to construct.”

Indeed, shorting and margining were illegal in stocks, but not in futures. So in 1998, Ruhong saved about 10,000 RMB (about $1,200), which he put into Zhengzhou wheat, while Tom headed to San Francisco to complete his master’s at Stanford and took a job with a Chinese newspaper there.

“We soon found that the U.S. commodity markets had much better liquidity and offered way more contracts for our experiment,” says Tom. “We were bold enough to borrow $100,000 from a close friend and opened our joint account.” Over the next six years, they experimented with something Ruhong called “fundamental relative value,” essentially taking positions when anecdotal evidence indicated something was out of whack. That usually meant looking for commodities that were trading below the cost of production, like Robusta coffee in 2002.

“We read a story about children dropping out of school in the mountainous coffee-growing areas in Vietnam,” says Tom. “Our judgment was that since the farmers could not afford the tuition of their children, they would face hunger if the price kept falling. Over-supply could not last with the growers facing life-threatening conditions.”

But it was one of the last directional plays they made, especially after taking a hit in cotton in the months following 9/11.

“After the terrorist attack, we watched the contract slide all the way below its historic low of 30¢ per pound,” Tom says. “The lesson we learned was that macro-economic incidents could impact the market in a profound way, and traders had no power to control this, but to hedge their risks with opposite positions.” They began experimenting with spread strategies built around relationships among markets, and in 2004 began accepting money from friends and relatives. As China’s reforms created more trustworthy markets, they closed their own U.S. accounts to focus on their clients in China.

By late 2007, they were ready to set up their own commodity pool operator, Credence Oriental Partnership, and launch Splendor in its current form.

“The best proof of the effectiveness of our 100% spread trading approach is that our portfolio successfully hedged the macro-economic impact of the financial crisis in 2008,” says Tom.

Early next year, they will move to Singapore, from where they plan to apply their fundamental relative value trading to more than 50 markets worldwide.

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