“For us, mean reversion is the key to the game.” – Peter Kambolin (Tweet)
Imagine if your assets under management went from $721 million to $50 million….
Would you have the courage to stick with your system?
Our next guest was able to weather that storm and come out even stronger. In fact, he gives credit to the fall in assets because it was an important component to improving their processes and efficiency today.
We’re excite to share with you, the second part of my interview with CEO of Systematic Alpha Management, Peter Kambolin.
In This Episode, You’ll Learn:
- How many markets Peter trades and the number of different spreads
- The three points during a day in which volatility is elevated
- What triggers an exit from a trade when profit levels haven’t been reached
“If we hold positions for hours, it’s extremely important to take into account intraday seasonality.” (Tweet)
- How Systematic Alpha Management makes decisions relating to sizing market positions
- The number of daily trades Systematic Alpha implements
- How much of the P/L comes from the hedge component of spread decisions
“The best time to invest is not at the new high water mark. The best time to invest is during a drawdown if that manager has a long enough track record and has shown an ability to improve and recover.” (Tweet)
- What kind of Risk Budgets that Systematic Alpha Management runs
- How to drawdown profile has changed over the last few years
- Estimating and predicting Black Swan events
“We strongly believe in our ability to recover and that is exactly what happened.” (Tweet)
- How Peter personally balances the challenging feelings of managing a portfolio in drawdown
- Exploring mean reversion and how the hedge ratios change daily
- On the value of being located in the heart of New York
- The biggest challenge for Peter in running Systematic Alpha Management
“On one hand we try to be dynamic in how we hedge as we trade, on the other hand, if the changes are too strong we will ultimately cut the risk and stop trading.” (Tweet)
- Peter’s opinion on why success in the CTA industry has shifted from the United States of America to Europe
- Why individuality is critical in success in the CTA industry
- Peter Kambilin’s biggest failure and what he learned from it
- Some fun facts about Peter that you probably would never have guessed
“To me investors are too focused and concerned with headline risk.” (Tweet)
Sponsored by Swiss Financial Services and Saxo Bank:
Connect with Systematic Alpha Management:
Visit the Website: www.systematicalpha.com
Call Systematic Alpha Management: +1 646 825 8075
E-Mail Systematic Alpha: email@example.com
“I would say it’s more art than science. We would look at which countries are behaving normally, which ones are generating positive returns and we would re-leverage those first.” (Tweet)
Peter’s questions for the next guest on Top Traders Unplugged:
“What percentage of your gains come from cash returns?” (Tweet)
Niels: You're listening to Top Traders Unplugged, episode number 018, where I continue my conversation with Peter Kambolin, Co-founder and CEO of Systematic Alpha Management. This episode is sponsored by Swiss Financial Services.
Introduction: Welcome back to Top Traders Unplugged. Where the best traders in the world come to share their experiences, their successes and their failures. Let's rejoin the conversation with your host, veteran hedge fund manager, Niels Kaastrup-Larsen.
Niels: Fascinating. Tell me Peter, how many markets do you trade all together, and how many combinations of spreads to you have in your portfolio?
Peter: Yes, well, we trade approximately 20 to 25 different markets that include major global equity indices, major currencies, and we just use three commodities for hedging. We trade about 20 to 30 different spread combinations, but each spread we trade in a variety of different sub markets up to maybe 20 actually. What that means is that, let's say you have a spread that fluctuates - goes up and down, etcetera. We apply different logic, different rules when we place trades, because we don't know... the sign wave that a spread could experience, moving up and down, is not always the same. The amplitude of the move would be different, the time it takes could be different, etcetera, so, we have models that on average would hold positions, say 3 hours. Some other models will have holding times of say 10 hours, and others will hold somewhat longer.
We try to exploit short term mean-reverting moves in the spreads and longer term mean-reverting moves in the spreads, all within a day and a half, two days. What's interesting is that by diversifying our holding time, the returns that are generated they are often uncorrelated to one another. So, let's say we could be trading S&P, FTSE, and British pounds spread and hold for 3 hours, and it will have almost zero percent correlation to the same spread that actually is the same, but which we would trade using a different holding time model. So this is one way to diversify.
We have other ways to diversify our trading. For example, this is getting more technical, but we look at so called intra-day seasonality of the volatility of the spread. What that means is that there are three points within a day when volatility is elevated. At the early morning hours in Europe volatility is high in the spread because S&P could be mispriced. Late trading hours in the US volatility is high because the European markets could be mispriced, because it is after hours, and around 9:30, 10:00AM New York time volatility is high because that is when most price actions are taking place, news comes out, and that's when volatility is typically elevated during the day. So we have models that are taking into account these intra-day seasonalities over the volatility. Again for a long term CTA these intra-day moves are totally irrelevant, because they hold positions for months, or weeks, etc. If we hold positions for hours it's extremely important to take into account intra-day seasonalities. So this is another way that we have different signals, different models that we trade, and we have a number of others, so my point is that we are, to answer your question, we trade anywhere from 20 to 30 different individual spreads, but each one is traded in up to 20 different ideas, for some models, so the total number of signals...individual signals that we monitor and trade is about 200.
Niels: Excellent. Now, from what you have explained, it appears to me, at least, that part of the way you are getting out of a trade is based on your target being reached or the spread coming back to the expected level. But you also talk about the average holding periods of 3 hours, or 6 hours, so on and so forth, what triggers the exit, if you haven't reached your profit level and you haven't been stopped out? Is there a time exit?
Peter: We don't have a time stop. Imagine a moving average, or mean of the spread and you can... if you're lookback window for the moving average is long, that moving average will be changing very slowly, every minute, but if your lookback window is very short - let's say it's 1 hour, or 3 hours, it will be moving with the spread very rapidly, so if the spread goes up the moving average will go up as well. So our so called fast models, the ones that hold only 3 hours on average, they have a very short lookback window for estimating the mean or moving average of the spread, which means if the spread goes up and there's a small reversal, it will touch the trigger point. That's how it's done. So we don't have a particular time stop. We tested that idea and it doesn't work as well as trying to come up with a different moving average lookback window to estimate your fair value of the spread itself.
Niels: Sure. Now, staying just again with the trade and the model and so on and so forth, I wanted to ask you about how do you size your position, how do you work out how much to put on in terms of these signals?
Peter: The way it works is from the top to bottom. We know our overall assets under management. We also know what is the maximum exposure we would like to have if, let's say, all the models hit the trade in the same direction. This is our...some target that we have that we will not reach. That defines how much risk we would like to trade overall. Then we'll look at three geographical regions, I mentioned before we trade Asian to US, Europe against US, and US against US, or Canada as part of North America, so we would break our risk among the three geographical regions, and that is done based on historical returns, our expectation of returns, the quality of the returns, and for historical reasons I would say 55% to 70% has been allocated to European spreads, anywhere from 0% to 10% to Asia, and the balance is North America. Once we determine that, and that review is done roughly every 3 months, we assign individual risk level to each country that would trade within a particular zone. Let's say in Europe we currently trade UK, Switzerland, France, Germany and EuroStoxx50, so 5 markets. Risk is assigned to each one, maximum risk again. Depending on our historical P&L, our back tests and various other tools that we use, and then within each country we have a number of different signal spreads, as I described before - there could be up to 20 to 30 for each country, and then risk and longs - these individual signals is allocated using an optimizer that we use that looks at 1 minute real return of these spreads for the last 4 or 5 years and it tries to assign more risk towards those models that, not only produce the best returns, but also that are uncorrelated to the other models in the same type of portfolio within same country. So we do not have even risk allocation, to answer the question, we have certain preferences in terms of the geographical zones, in terms of the particular countries. For historical reasons we like US, UK spreads the most because they are the most stable and the most highly correlated. And then within each country, we allocate risk based on our optimizer that we have built proprietarily.
Niels: How many trades do you end up doing in a day on average, with all these models?
Peter: Yes, so out of 200 signals maybe, depending on the volatility, on average we would have maybe 20 trades a day. Most of the models actually stay in cash, so what that means is that, if say S&P and FTSE are fairly priced in relation to one another, and they are moving exactly or more or less the same up and down, there's no opportunity for us to trade at all. We'll just stay out. We will not have any positions at all while we could be detecting a lot of positions or trades, let's say in Swiss SMI, the Swiss frank, S&P trade, so if you look at our portfolio, day after day, it's not stable, it's changing all the time. We are not invested in all these markets all the time. We are arbitrageurs, so if we detect a mispricing we will come in and provide liquidity.
Niels: Sure. And you gave a good example before where you had the FTSE, the S&P, and then you had the currency side to things, which you mentioned was kind of a hedge component. Is there always this hedge component in the models, and if so, when you look at the P&L over all, how much of the P&L of return stream actually comes from the hedge component of the spread, if I can put it that way?
Peter: When we look at the P&L, we look at the P&L for the full spread, we do not try to understand, or we don't care if the P&L came from the equity market or the currency market. For example, we could be losing on the currency leg, but that currency leg will generate extra return via the index leg, so we don't dissect the returns coming from all three legs of the spread. We'll look at the spread itself.
Niels: OK. In terms of open risk, I mean, I don't know whether it's possible to give an indication, but if you operate stops on all your positions, which is my understanding, can you say something to the point about what is kind of the daily open risk budget, because you might used valued risk, I don't know, as kind of something that you look at, but my experience is that valued risk works great until the point where it doesn't work, and it usually is when the markets get very volatile and there's a crisis. So can you talk about how much open risk, meaning if everything got stopped out in a day, what kind of risk budget do you run?
Peter: Well, let me talk about the average risk that we're running and the worse outcome that we've had over the last 14 years. So the average exposure, in our single leverage share share-class of the fund, we have single a double leverage, so in the single leverage share class, which has a 7%, roughly, annualized standard deviation. We are, on average, 60% in notional exposure, long 60 short. So let's say on a 10 million dollar account we would have positions notional exposure of 6 million long, 6 million short - that's on average. That translates into a margin to equity to ratio of about 12%. Why so high, because we have to pay full margin for the long side - we spend about 5% on the long side, 5% percent on the short side, and about 1% or 2% for the currency or commodity hedge on top. That's how we arrive to a 12% average margin to equity. And this margin to equity cannot be compared to a long term directional trader. They pay 1 margin for 1 position in a direction - a directional position. So our stop loss levels are set around app. 2% from the entry price. So let's say we put on a spread position, we can potentially lose 2% of the risk given to that spread, not on the portfolio but to that particular spread. In terms of the worst day that we have had, and I think it happened in 2008, when I remember the S&P was moving by 40 points in maybe 1 minute, there were days like this, so the worst daily P&L was -2.2% realized, but on average our daily returns are .2%, .3%, .4% of down days.
Niels: Sure, sure. Now I wanted to shift gears a little bit by staying on the point about risk. I want to touch upon drawdowns, because perhaps a lot of people are not aware of it, but CTAs in particular spend most of their time in some kind of a drawdown, and probably only 20% of the time reaching new equity highs, so I wanted to understand a little bit about the drawdowns that you've seen, that you've experienced, what you've learned from them, I know you mentioned earlier that you made some changes after one of the drawdowns, and what you've learned from them? And also, whether you thing the drawdown profile of the program has changed with the changing of the environment that we've seen in the last few years?
Peter: Yes, one of the important modifications that we introduced in 2011 was a deleveraging mechanism, where if we reach a 5% drawdown intra-month, not necessarily at the end of the month, we will start reducing risk. Initial deleveraging is done by 25% and it is done in those markets or spreads that are causing the drawdown, if we are reaching a 7.5% drawdown on the portfolio level, we will increase the deleveraging to 50% and then the deleveraging is done across all the spreads, not necessarily only the ones that are losing money. By doing that we are basically trying to control the depth of the drawdown, because if you are trading less risk, it's harder to lose more and more money. Of course, on the other hand, it's harder to recover the losses, and our policy is that we will not wait for months until we re-establish the risk back. If we're seeing a recovery, if we're seeing some positive statistics, we will slowly put the risk back on with the expectation that the recovery will be in full force and we'll quickly recover from a drawdown. So, we believe that such a deleveraging approach is helpful, especially during crisis times, because sometimes there will be these black swan events, like for us in 2011, which were never part of the history, and estimating them or predicting them is sometimes next to impossible. If you don't have these deleveraging mechanisms, you could be having major problems in your drawdown.
Niels: Sure, sure.
Peter: So this is what we're doing following the 2011 experience that we had. In 2011 our drawdown reached 19% at the worst point, although we ended the year -11% because we had a strong recovery in the 4th quarter of 2011. By the way, that was the time when most other CTAs were entering the drawdown, and we were already recovering from ours.
Niels: Yeah, absolutely, and the re-leveraging, going back to normal leverage, is that also a fully automated process, or do you have to have a little bit of a role in setting the leverage, because you said that you are looking for some improvements?
Peter: I would say it's more art than science. We would look at which countries, which spreads are behaving back to normal, which ones are generating positive returns, and we would re-leverage those first, and then if we see a recovery across the board, we would put risk back to all the models. It's very difficult to fully systematize it, although we try to use as much data, as much tests and allowances as we possibly can.
Niels: Sure. Another question relating to drawdowns, and this goes probably more to you and your partner as human beings, and that is that the drawdowns certainly add to the emotional roller coaster that we all go through, and I wanted to ask you how do you balance that when you go through a drawdown and maybe in particular, if you wouldn't mind, take us back to 2011 a bit because what seems to me to have happened is that you go through your drawdown, which we all know is a difficult thing because you don't want to lose money for your clients, but at the same time you subsequently receive huge outflows of assets, which I can only imagine really adds to that emotional roller coaster. How did you cope with that situation and stay on track, because clearly your performance recovered, but talk me through that, because I think there's so much to be learned from this?
Peter: Yeah, we're fully recovered from that drawdown in July of 2013, and we ended last year at the new fresher new high watermark. Very few CTAs can say that they have those returns. Well, I would say that, on the personal level, the feelings that we had entering 2011, before the drawdown was...if we could survive the 2008 market environment when the VIX went to 90 at some point, so our models were trading totally out of sample environment We did not have prior data to back test the models during the time when VIX was at 90. And they continued to perform extremely well. We had this sense of invincibility, we thought, "what other market conditions possibly could happen out there that will derail our program." If we were able to do well in 2008 and 2009. Then, of course, the European debt crisis hit, which was impossible for us to predict or to prevent, and a totally new risk factor was introduced, which is credit defaults, swaps on certain countries, but we do not trade credit default swaps. They're liquid and we never had to in the prior years.
When we were going through our initial drawdown in 2011 - in the first couple of 2 or 3 months, we thought that, well, once in a while we do have negative months, obviously, we have some bad streaks of returns and we did not think that we could eventually have a drawdown that would last for six months. Then after two or three months, we realized that this is something totally different, we have to address the situation. It took us some time to come up with some modifications and ideas that we introduced in early September of 2011. So it took us probably 2 months. I wish we could come up with them earlier, but we just, no, it takes time. Plus I wish we had these deal averaging rules then, that would prevent us from experiencing such a deep drawdown, but again, I think I mentioned this point before. The experience of 2011 made us stronger as a firm, I believe, and even though we have less assets under management, as a firm we are a better manager, and I would...if there's some new managers coming out with two or three year track records that look outstanding, I would be very cautious, because every manager that has a 10 year track record had a difficult time at some point, and the question is how do they react to a drawdown, how do the react to a situation like this, and are they strong enough to withstand, are they smart enough to improve?
In our case, before 2011 we did have one drawdown of about 10% in late 2007, early 2008 so that was our second drawdown, and we recovered from both in a very strong way, and my point is that going forward, for example in 2014, right now, we are having a drawdown, and I believe that if you believe in a manager, if you believe in their ability to stay in the game, the best time to invest is not the new high watermark, the best is during a drawdown if that manager has a long enough track record and has shown an ability to improve and to recover. So, we are at this point right now, we are speaking with our clients and we are trying to explain to them that this is maybe a good time to allocate. You don't need to wait until we have a new high watermark maybe some time in the future.
Niels: No, I agree, Peter. Just one final question on drawdowns before we move on, was there any time during 2011 when you were experiencing this drawdown, due to circumstances that you in a sense had not foreseen and could not foresee, that you doubted this system and said, "if we are going to be dealing with these kinds of situations - countries going into default, etc. etc. maybe this is not the right way of approaching it", or how did you convince yourself that actually it was?
Peter: Well, we had a choice in 2011 to shut down, because we made good money and we had the choice whether to continue or to shut down, and the adjustments and improvements that we introduced in September 2011, even though we continued to see outflows, we really believed, at that time that these changes will produce good - good things for us in the future. And we strongly believe in our ability to recover and that is exactly what happened. But when you go through a drawdown, especially if it's a lengthy one, of course you feel doubts and you feel like, "oh my God, this strategy doesn't work", and that's how investors think also. They think this strategy worked before and it doesn't work now and it will never work again in the future. What we can see on our end is that it doesn't work now, but we do not agree with the decision that it will never work in the future. So, yes, if we're losing money, that is correct, the strategy is not working now, absolutely correct, but the difference is investors often believe that it will never work again, while we strongly believe, because we have inside knowledge and we have inside skills and a better understanding of what we do, that this strategy will perform again, and it will become again, at some point, one of the best strategies that we can invest in. So with this idea in mind, we continue, we improve, we fought, we work extremely hard - we worked around the clock, 24 hours, again, it's a lot easier to take a trade and two months later to realize a loss or a gain, in our case, every day we work extremely hard. At the moment, for example, we are having a drawdown, the strategy at the moment, over the last few months was not working, but it doesn't mean that it will not work again. We strongly believe that it will work again and, if we have investors that are convinced of that, they would be long term investors and they will benefit at the end of the day, because if you buy at the top and sell low, by definition you will lose money. You believe in the manager and you could buy at the top, but if you stay with them and at some point, the NAV will be higher than were you bought it.
Niels: Definitely, definitely, and obviously part of your insight, part of the reason why you have this strong belief in the strategy is down to research, and research is actually the next thing I wanted to touch upon. Now research is an interesting thing because investors, they want managers to continue to innovate, but they don't want managers to change, so how do you balance these two things, and how does research really work inside your firm?
Peter: We're doing something that very few managers, I believe are doing, we are estimating our parameters, not necessarily on in-sample data, but we try to use walk-forward out-of-sample tests, and scenarios to test how robust our parameters are. The biggest criticism of quants is that they tend to over optimize their parameters that will look excellent on paper, and then they start trading it and the return is very different. So in order to avoid that we are using different tools that we developed in house here to make sure that our parameters that we choose are not just some over picked results, they are based on a lot more fundamental reasons why this should continue working.
So this is the main area for us, to make sure that the models are robust, to make sure that mean reverting statistical tests that we do are still looking good, and we'll look at each country individually. We'll look at how these mean reversion tests change over time, for example for the full say 10 year history, or the last three years, or the last 6 months, and what we ideally want to see, we want to see no deterioration in the mean reversion tests, because for us mean reversion is the key to the game, and that's what we've seen. If we are seeing some signs that things are changing, that's when we would potentially deleverage our allocation to a particular country. That's why these once in two, three months rebalancing our risk is so important, because once in awhile we have to intervene and make certain adjustments.
Niels: Now I'm certainly no expert in mean reversion as a strategy, so help me understand, how quickly can these kind of relationships change, and how easy is it to...or difficult is it to realize that something has changed which is a little bit more structural or fundamental, however you put it, than just something that has gone a little bit differently for a short period of time?
Peter: Well, when we estimate hedge ratios. Again I think I mentioned this before. We have a certain lookback window. If the hedge ratios...and by the way, we are recalculating hedge ratios daily...if the hedge ratios are changing rapidly in a certain direction, that means that markets are no longer correlating, or break down in the relationship between the two. So on one hand, by estimating hedge ratios daily and adjusting them we are making sure that we are trading the most recent relationships between the markets, on one hand. but on the other hand, it could be an indication for us to move away from that market all together. I'll give you an example: for a long time we traded NIKKEI, Japanese yen, S&P relationship. It was one of our best relationships in the first 10 years of our existence. Over the last almost 2 years now, we noticed that correlation to NIKKEI and the rest of the world really disappeared after the new economic policies were introduced in Japan. So, instead of waiting to lose money before we cut the risk, we actually did it before that happened. We noticed that correlations were weakening, the spreads are no longer stable, or another way to explain it, hedging NIKKEI with S&P no longer works. We stopped trading that relationship, although, overall it produced, before that we had strong returns for us. So on one hand we try to be dynamic in how we hedge as we trade, based on the most recent relationships, on the other hand if these changes are too strong we will ultimately cut the risk and stop trading.
Niels: Sure, and just one question to that example that you just mentioned, now clearly you would have noticed in the data that the relationship between the NEIKAI and the S&P was changing, but in order for you to stop trading that relationship, do you have to go and look for the fundamental reason why it stopped working, and in this case looking at economics as the cause?
Peter: Often we would look at the data first, and then we would try to explain to ourselves looking at the fundamental analysis. It's rarely the other way around, because it's often the mental analysis that tells you one thing, but data is continuing to tell you something totally different, we would believe the data, we would not believe the fundamental analysis. So data is number one, and then of course we would try to explain it to ourselves, what's the meaning of all of this, but we trust the data first.
Niels: Yeah, yeah, now just looking on the business side of things. Clearly you and your partner are crucial to this, but do you consider yourself as a firm to have a key manned risk, or is it all so automated, that actually, to a large degree the company could continue without one or both of you?
Peter: I would say for six months or so you wouldn't notice a change if either one of us disappears (laugh), but ultimately clients have liquidity, our clients have weekly liquidity, managed accounts have daily liquidity, so they can very easily take their money away from us. Yeah, everything is automated, everything has certain systems in check, how to do the research, how to do the marketing, etc. so longer term, of course, you will feel an impact, but not in the first three to six months.
Niels: Now, what's interesting...I wouldn't say it's becoming the norm, but certainly a lot of managers have chosen to set up their business a little bit outside the financial hubs, but you are right there, you're located in the middle of New York. Do you think being right in the center of the financial world helps you in any way, or does it not really matter where you would be going to the office every day.
Peter: I think it helps. It's easier for clients to come see us when they are in New York. We do have a lot of meetings in the office. Plus the overall energy of the city, the competitive spirit, you work harder every day. Our lease, for example expires in May of next year, and we plan to stay in New York although it will be cheaper to go to Jersey for example, where we do have, actually, a secondary office as a backup facility, but I believe staying in New York is very important.
Niels: I think I may know the answer to the next question, but I want to ask it anyway because I think, again, it's important for people to better understand, and that's really the challenges that you face as a business owner and as a manager, and what would you say the biggest challenge has been in the last 10, 14 years for you and how did you overcome that?
Peter: Well, the biggest challenge is, I would say, to first convince clients that what we are doing is very, very beneficial to their portfolios, and it's quite upsetting to see them leave sometimes, after a drawdown because if they believe in the story, if they believe in the long track record, and they believe in our uncorrelated properties, they should expect us to have sometimes negative months when there are other managers doing fine. So what we've noticed is that they like the uncorrelated property of your program when you make them money and everyone else is losing money, but when everyone else is making money and you're flat to negative, all of a sudden they don't like it any more. I guess it's human nature, but we highly, highly appreciate those investors that are in for the long haul, and we hope that in the future we will get more of those managers, especially given the fact that we have 10 years of audited track record in the fund, I think smart institutional investors will recognize it and will have a better understanding of our turns going forward.
Niels: Yeah, I think on that note, which is quite interesting. I think, as an industry, maybe we haven't been good enough at explaining to investors why they should invest with us, because it's been the same argument that has been used, and clearly they're not strong enough because we know that money has been flowing out, and I think actually today, in our conversation, what you've done so far is quite important because in my experience, at least, a lot of people, a lot of managers are very good at explaining how they make money and what they do, but they never really explain why they do it. I think that's actually one of the challenges for the CTA industry is to become better at explaining the why. I think if people understand why you do things, and agree with them, they are more likely to stay through the good times and the bad times because they have something that they truly understand as to why people do what they do. But anyway, that's just my own observation. I wanted to ask you a slightly different question and that is, this industry started as a very US dominated industry and certainly most of the famous managers 10, 15 years ago were predominately based in the US. It seems to me that the last 10 years European managers have actually created much bigger firms than many of the US legends have. Do you have any observation as to why the European managers have become more favored, or have been able to grow their businesses much better than US based managers?
Peter: Maybe it's related to the investors, and investor's appetite, because when we were starting the fund, up until 2007 or 2008, most of our clients were European investors. We gathered US assets after we had five years in the fund, in track record, so I think European investors are more open minded they're willing to look at different things, and maybe that's related to that. That's just from our experience. Other than that I don't know. Maybe in Europe they have smarter brains (laugh). It's a joke of course.
Niels: (laugh) Sure, sure, now I've got a couple of more questions in this section and then I wanted just to go on to the final area of my questions, but I wanted to ask you firstly: you know the CTA industry well, I accept that you do things in a different space compared to many other CTAs, but if you were going to ask a question of my next guest here at Top Traders Unplugged, about their strategy, or their firm, what would you ask them?
Peter: Well, I would ask the trend following CTAs why do they think trends will develop and the strategies will start working again after five years of fairly bad returns? That would be my first question. The second question would be related to where are these returns coming from five years...if we go back to before 2008, because as you know CTAs do not use most of their cash for trading, they margin to equity on average, let's call it 15%, which means that 85% on average is sitting in cash or allocated to some instruments that produce some yield. Before 2008 we all know that if you were to buy a T-bill, let's say a 90 day T-bill, it would pay you 3%, 4%, and at some point even 5% return annualized. Over the last five years returns on cash holdings are zero, so my biggest question is to CTAs in general is what percentage of their gains before 2008 came from cash returns, and in my estimation it could be well over 50%, which is a problem, because if the low interest yield environment stays, it means that for the next five years CTAs might not produce this extra cash return that they were generating on the T-bills.
Niels: Sure, true. Now I also wanted to ask you another question, which I think is really, really important, and that is you've been in hundreds of due diligence meetings, and you've probably had as many conference calls and so on and so forth with investors and potential investors answering thousands of questions, but I want to ask you, what is the question, in your mind that investors should ask you, but they never do? And this is in a sense to help them better understand your strategy, is there something they're missing, because part of why we're having this conversation today is trying to ask different questions than the typical questions that you get.
Peter: Even investors are too focused and too concerned about so called headline risk. If they invest with Blue Chips they know that if they lose money with Blue Chips then no one will say a word because, well, a big firm lost their money...no...things happen. If they lose money with a smaller manager it could be a problem, because people around them might say, well, why did you allocate to this manager, and why did you lose money with that manager? So I think investors should first be concerned about how liquid that investment is. Are they controlling the money? Let's say it's a managed account, they clearly control the money. They invest via the platform, let's say at Deutsche Bank, they clearly are safe. Even if they invest in the offshore fund, or a domestic fund, if the third parties involved in this fund are very reputable institutions like KPMG the auditor, or SS&C the administrator, and the custodians are Bank of America and Wells Fargo and Newedge, clearly they have very limited risk in term of some kind of fraud or ability to get their money back. So they should not be, I believe (it's my opinion) as concerned about the so called reputational risk, they should be more concerned about how to build their portfolios and partially the reason the fund of funds business model failed is because unfortunately the managers that were running the fund of funds, they were not building the right portfolios. They were either too much concentrated on similar means that have 60% or 70% correlation to one another, or for other reasons. If they were doing a good job, if they were really building portfolios that would stand difficult periods for different managers. I think the whole concept is a good concept, just it was not applied properly. I would say if investors are convinced that their money is safe, they should be more concentrated and concerned about the particular strategy and how it performs and how it adds to their portfolio rather than looking at some potential headline risk that might never be realized. At the end of the day they could be suffering in terms of the real returns for their investors, that's a pity I believe.
Niels: Sure, sure. Now the final section that I have is something I call general and fun, so a little bit outside the norm and not specifically related to a model or trading program, but I just want to ask you a couple of things that might be useful for people to understand, and one of the things I wanted to ask you is just for the benefit of people who are listening to this and hoping to become the next Systematic Alpha, and that is what does it take to become a great trader or great CTA in your opinion?
Peter: I think you have to have an edge of some sort. In our case we are occupying a certain niche - a certain trading model that we believe is sustainable, but I'm sure there could be other interesting niche ideas that are not exploited at the moment. So for new people that are entering this area, if you have the right idea, and if you believe that you are better at that idea than others, and you work extremely hard, ultimately you will become successful. The road is not easy, by any means, but if you are different from others that's the only way I believe to succeed.
Niels: Sure, sure, and since, as I said in the very beginning, this is also about getting to know you as a person to the people listening, so I wanted to ask you a sort of different question, and that is, do you have any sort of personal habits that you think have helped you become successful in this business over the years?
Peter: Well just try to keep my head clear. As I said before, Alexei and I have very different skills. I do not have quantitative skills at all, even though I talked about our research and other things, but I'm scratching the surface, Alexei is the real quant. My biggest strength is, I mentioned it, so called common sense trying to understand what is good what is not good, what makes sense, what doesn't make sense, and sometimes I am involved in our research process by simply directing our research where to look at, or what kind of ideas to possibly exploit. I personally cannot back test them myself. I don't have the skills, but I have this ability to see things and to challenge certain things that we do and to pinpoint some other areas that we could be overlooking or should improve. This is my contribution to the research.
Niels: Sure, sure, and as a business person, if we look at it that way, but also as an entrepreneur, which is obviously a part of the journey you have been through, what do you think has been your biggest failure? I know we talk a lot about successes and people celebrate that, but often failures are the ones where we learn the most. If you look back on your path, what would you say was the biggest failure and what would you have done differently today?
Peter: Well the biggest failure, no question, happened in 2011, when we were unable to hold the assets that we had. We should have probably intervened earlier, which would have reduced risk earlier. We should have been more proactive with our clients explaining what is happening. So, before 2011 we had very few mistakes, I would say, and that's why we were able to grow our assets to a very sizable amount, and in 2011, as you mentioned before, it was a combination of bad performance, totally new environment and assets leaving that unfortunately we did not handle the way we should have in retrospect. At the same time all the changes and improvements that we have implemented made us stronger. Our team is intact. Most of our member have stayed with us for 6, 7, 8 years, so I'm happy about that. Overall, and again I will repeat myself, I strongly believe that we are a better firm, a better manager and will do better things today compared to 2011, when we were a lot bigger, but it comes with experience and I think we have a lot of potential.
Niels: Absolutely, and in order to end on a high note, my last question to you where I've had some interesting answers, let's put it that way, from other guests, I wanted to ask if you could tell me a funny fact, or a fun fact about yourself that most people don't know about you? And I can reveal that some people have told me that they have been in movies, or they do impersonations, so it's been very varied, but if there's something out there where you say, "this is something that most people wouldn't know about me." Is there anything that you can share?
Peter: About 10 years ago I was writing lyrics which I believe are very, very good, although I started writing them in 1994 and I stopped writing them in 1995, so twenty years ago, and when I read some of these lyrics to some of my friends they are shocked how good they were and they asked me why don't I do it again, and it's hard to say. I had inspiration and it disappeared 20 years ago. I'm a business person now, I was a young boy then. I play guitar. I like to sing. I have lots of things I can tell you that is personal, but maybe some other time (laugh).
Niels: (laugh) That's for our next pod cast. Peter, I wanted to, before we finish, I wanted to ask if you could tell the listeners what's the best place to reach out to you and learn more about your firm and, of course, the new offering that you are coming out with in terms of the UCITS fund?
Peter: Well, we do have a web site: systematicalpha.com. We also have our marketing director Sandy Chotai who can be reached at +1 646-825-8075. He is very good in explaining what we do, how we do things. We are coming out with the UCITS project - with the UCITS fund. Very few CTAs have a UCITS because their programs do not apply under the UCITS rules, because a lot of them trade commodities. In our case, most of the trading that we do is in global equities and currency futures, and basically we will be doing the UCITS project for two reasons, A) demand from European investors, and B) from the regulatory standpoint it's becoming more and more difficult for US base managers to come to Europe and to market themselves. Once we have UCITS it's not a problem at all, so this is why we're doing it. But yeah, we have our website, we have a very good in-house marketing director that can answer any questions, so please reach out and we will respond.
Niels: Sure, fantastic, Peter. Thanks ever so much for your time today, and also thanks for I think a great conversation. I really appreciate that you've been very open and willing to share your insights and your views on the evolution of your firm and your strategy as well as the industry as a whole. I think that is so important, so I appreciate that and I hope that our listeners will find a way to thank you as well, whether it is social media, or by contacting you directly, and of course the listeners can find a lot of details about our discussion today in the show notes, on the website TOPTRADERSUNPLUGGED.COM and I hope we can connect at a later date and see where you are in all the great work that you do.
Peter: Sounds excellent, thank you.
Niels: Thank you so much, take care Peter.
Ending: Ready to learn more about the world's top traders? Go to TOPTRADERSUNPLUGGED.COM and sign up to receive the full transcripts of the first 10 episodes of the show, and visit the show notes where you can find useful links to other amazing resources. Thanks for listening, and we'll see you on the next episode of Top Traders Unplugged.
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Date posted: 31 Jul 2014no comments