Losses in LJM Partners' Funds Spotlight Suitability, Risk Management in Complex Mutual Funds

Investors who lost money investing in LJM Partners Ltd and associated funds, including the LJM Preservation and Growth Fund (LJMAX, LJMCX, and LJMIX), may have been exposed to far too much risk and accordingly may be able to claim damages if a broker or financial adviser has unsuitably recommended the LJM mutual funds, which disclosed its potential involvement with volatility futures contracts (VIX futures).

According to its SEC prospectus filing, the LJM Preservation and Growth Fund—offered as Class A LJMAX, Class C LJMCX, and Class I LJMIX—was designed to "preserve capital, particularly in down markets (including major market drawdowns), through using put option spreads as a form of mitigation risk," in order to "reduce or prevent losses and to take other potentially profitable positions." LJM further advertised "various mitigation order to generate returns regardless of market direction."

The fund's indicated investment adviser was LJM Funds Management, Ltd., with portfolio managers Anthony J Caine and Anish Parvataneni.

Although the LJM Preservation and Growth Fund thus downplayed risk ("Preservation") while advertising moderate growth ("Growth"), the fund ran into trouble in early 2018, losing 80% of its value in just two days in early February, when its strategy of investing in VIX futures while holding a large proportion of uncovered option contracts-to-covered contracts proved disastrous.

Caine wrote to clients several days later, blaming market volatility for the losses: "Volatility and options markets experienced an extreme outlier event...Monday [Feb 5]'s losses were so severe because as volatility spiked exponentially in the afternoon, the illiquidity in the markets severely limited LJM's ability to reduce risk."

Speaking of the volatility to which Caine's letter refers, volatility-linked VelocityShares Daily Inverse VIX Short-Term Exchange-Traded Note (XIV) lost 95% of its value in early February, leading to liquidation, when volatility itself grew out of control. In the aftermath, XIV issuer Credit Suisse's CEO, Tidjane Thiam, stated that XIV's risk disclosures were adequate, saying in an interview that, "[XIV] is not an appropriate investment and you should not invest in it for any period of time superior to one day because you risk losing all or a substantial portion of your investment."

Though LJM's prospectus did not contain such a strong statement and instead discussed LJM's attempts at risk management—and although some investors are suing LJM itself for inadequate risk disclosures, including allegations of false and misleading statements or misrepresentations—brokers and financial advisers could have discerned several key risk factors portrayed within LJM's prospectus that suggested a complex product patently unsuitable for conservative, unsophisticated, and risk-averse investors, such as "the Fund holds more uncovered option contracts than covered," "the Fund may assume greater risk through the selling of short call option premiums," and the fund's habitual use of "selling (short) 'out of the money' call and put options on S&P futures contracts."

Perhaps the biggest suitability hint in LJM's prospectus concerned VIX futures: "The Fund may purchase and sell futures contracts ("VIX futures") that track the level of the CBOE Volatility Index," with a warning that the LJM Fund would encounter greater exposure to volatility as it purchased and sold VIX futures.

A look through the prospectus turned up such a reliance on volatility that an astute adviser could have spotted red flags that left investors vulnerable to rapid changes in VIX itself.

From the aforementioned volatility virus catastrophe known as XIV, we know that VIX-linked products were unsuitable for, as Thiam put it, anyone but "very sophisticated" investors. Nonetheless, even sophisticated, well-informed sellers lost money on XIV.

As for LJM's involvement with VIX futures, it appears from Caine's letter that LJM's volatility futures strategy failed when the fund couldn't absorb the rapid volatility growth on February 5 and 6 (when it lost 80% of its value), with Caine's letter to investors blaming volatility dated several days later, on February 9, after the damage had been done.

The LJM prospectus further disclosed risks including, but not limited to, active trading risk, call option risk, management risk, leverage risk, and liquidity risk.

For example, while the fund itself did not advertise that it employed the use of leverage, the prospectus stated that the derivative instruments held by the fund did use leverage, which could cause the fund to lose amounts greater than that invested in the derivative.

By late February, the liquidity risk came to pass as LJM Funds Management announced plans to liquidate the LJM Preservation and Growth Fund.

If a broker or financial adviser recommended you invest in the deceptively risky LJM Preservation and Growth Fund (including shares classed A [LJMAX], C [LJMCX], or I [LJMIX]), and this unsuitable recommendation proved harmful to your investments or interests when the Fund lost 80% of its value and liquidated in early 2018, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for an investigation and consultation.

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