On October 21, we commented that Professor Harry Kat, developer of a “hedge fund replication” technique commonly called “distributional replication”, seemed to downplay his tool’s usage in replicating hedge fund returns and emphasized how it can instead be used as a risk management technique.

“He’s apparently trying to move away from a direct attack on hedge funds and is instead proposing that his dynamic trading method can and should be used to create custom return distributions to complement existing long-only portfolios.”

Well today German-based Aquila Capital, a 1.5 billion Euro manager of alternative investments, did just this.  They announced the launch of a market neutral fund that uses Kat’s technique as a risk management overlay.  According to the firm’s press release, its Statistical Value Market Neutral (SVMN) fund uses ”a combination of multi-asset investing and a behaviorally driven tactical asset allocation overlay” to actually generate alpha.  Then it uses Kat & Palaro’s “FundCreator” software ”to ensure a stable and predictable risk profile over time”.  Specifically, this means the fund is designed to have a volatility of 7%, a skew and kurtosis of zero and a correlation to the S&P 500 of zero.  In addition, the fund aims to deliver a maximum monthly drawdown of 4%.  The zero correlation to the S&P 500 provides what Aquila calls “super-diversification”.

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