“Investors confuse trend following strategies with long volatility strategies, which is really not the case.” – Marc Malek (Tweet)
In this year-end review, Marc Malek explains why intervention in the markets affects trend following, but also why trend following strategies are not long volatility strategies. He discusses 2014 from the point of view of his firm, how his program did, and why he is excited about 2015.
Thanks for listening and please welcome back Marc Malek.
In This Episode, You’ll Learn:
- How 2014 treated Conquest Capital.
- How volatility shows itself in a market like oil.
- What strategies performed well and what markets contributed to their success.
- How he prepares himself for extreme volatility and how he dealt with the Swiss Franc move.
- What intervention does to the markets.
“Correlation amongst asset classes are very different in risk seeking periods than they are in risk averse periods.” – Marc Malek (Tweet)
- How his firm would plan for our react to a big market change such as the break up of the Euro overnight.
- Why people use correlation in the wrong way.
Resources & Links Mentioned in this Episode:
This episode was sponsored by Swiss Financial Services:
Connect with Conquest Capital Group:
Visit the Website: www.ConquestCG.com
Call Conquest Capital Group: +01 212.759.8777
E-Mail Conquest Capital Group: email@example.com
Follow Marc Malek on Linkedin
Marc: The question is not whether there is intervention or not. The question is how much intervention is there? We're used to trading and profiting from markets, where if intervention is kind of plus or minus at the same level that we expect from history. The last five years have been unusually difficult for trading strategies because that level of intervention ratcheted up dramatically. The closer we are to the extreme where the central banks are being extremely active, the worse it is for us. The more we go to a point where it's the normal animal spirit of the players in the market that drive the markets, the better it is for us.
This is Marc Malek, Founder and CEO of Conquest Capital Group, and you are listening to my year in review on Top Traders Unplugged.
Introduction: Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences their successes and their failures, imagine no more. Welcome to Top Traders Unplugged. The place where you can learn from the best hedge fund managers in the world, so you can take your manager due diligence, or investment career to the next level. Here's your host, veteran hedge fund manager, Niels Kaastrup-Larsen.
Niels: Welcome back Marc for this review of 2014 where we look at the big events from the point of view of your trading strategies. I want to explore the ups and the downs as well as the big takeaway from what can only be described as a great year for systematic trading strategies, in general. But as you know, just because you're systematic in your trading, it doesn't necessarily mean that the strategy deals with the market events in a similar way. But I want to jump right into it really and hear from you, sort of your perspective of 2014, both from the various strategies point of view and maybe even also as a firm. How did the year evolve for you?
Marc: Thank you for having me again!
Niels: My pleasure!
Marc: It is a pleasure to talk to you and your listeners one more time. The year was overall a very interesting year for us. I would say almost it was for our Conquest managed futures strategy or our trend follower, it was a bit of a tale of two years. I think this is mirrored in the overall CTA trend following space, which is the first half of the year and the second half of the year. Coming into the middle of 2014 trend following strategies were doing pretty badly on the back of still a bad run overall from the last couple of years. But we saw a big turnaround that sort of really started in the April, May period and just between May and December it was one positive month after the other.
Our managed futures strategy after being down double digits coming into May finished up the year around sixteen percent or so on a fairly sort of lower vol type strategy. And this is sort of in line with what we expected to do. Again, following on that theme sort of what we expected to do, Conquest Macro, our other main strategy also did what we thought it would do in the sense that the year, while it started off in a very volatile fashion where Conquest Macro managed a return of over twenty percent in January, it ended up actually then becoming a fairly risk seeking low volatility year overall, and we saw a big rally in risk assets.
Now just to reminder, listeners, Conquest Macro is a strategy that is designed to benefit from high volatility and risk aversion. It tries to provide alpha by being positive in periods where volatility goes down and risk assets rally. So in terms of the performance of Conquest Macro to its mandate, it ended up the year up around four percent or so. This is a really a positive thing given that equity markets and risk assets had a fairly good year. So we were able to add a significant amount of alpha. Now, obviously from an absolute basis we preferred that the markets hadn't done so well and weren't better. But there's really not much we can do about that one.
Now in terms of our other strategies, we had a nice spread in the performance, you know a strategy like our Conquest Risk Neutral strategy finished… It was our top performer, finishing the year up close to twenty-nine percent. Conquest Long Risk was up around sixteen percent. Conquest All Weather was up around twenty percent. So overall I would say it was a pretty good year for our strategy. I would say just one note about the year, visa vie trend following and volatility. A lot of the time, a lot of our investors and investors at large confuse trend following strategies with long volatility strategies.
This is really the case, and actually we've written a paper to that effect that won the Best Paper Award by Institutional Magazine a few years ago, and it was published in the Journal of Alternative Investment. But essentially, the trend following strategies are not long volatility strategies. You could argue that they're long the second effect of volatility, meaning given that the event in the market is sufficiently large from a volatility perspective that it kick-started into place new trends, then in that respect they are.
I think 2014 provided the perfect example of that on the upside meaning, we had a year that was fairly benign volatility wise, but trend following strategies didn't end up doing quite well. Now typically you don’t get significant periods of trending without some volatility, and generally it's either volatility that leads to trend or trend that leads to volatility. It seems like the reversal of this past five, or six-year cycle that we've been in is coming as the trend leading to the volatility. We saw the trend begin in the middle of last year, and we're seeing volatility picking up at the beginning of this year. So, so far I'm happy about what happened in 2014, but much more positive about the prospects for 2015.
Niels: Sure. Now maybe to visualize this for the listeners, if you take what happened in oil, where clearly in the latter part of the summer we, for the first time in a few years, had a break out that became a large trend. How does volatility actually show itself in a market like that? Because I think a lot of people will say, "Oh, but oil is down fifty percent! It must have been very volatile." But maybe when you actually look at it from your perspective, actually it was a very nice orderly trend where volatility wasn't really the issue here. So maybe you can explain some of that?
Marc: Sure I mean that's a fairly counter-intuitive argument, but a fairly simple one meaning, if a market goes down or up a percent a day for a sixty day period, you can imagine that that's a big movement over a sixty day period. But if that change is one percent a day every day, then technically the volatility in that market is zero, because when people look at volatility, they look at return volatility, not priced volatility. So in terms of return volatility when we look at crude oil, return volatility was fairly low in crude oil in the sense that the move was very orderly. When the move is orderly, it's not a volatile event. Now I'm glad you brought that up because in our Conquest Macro program where there is much more of a short term trading strategy with an average holding period of about six, seven days… We don't look at return volatility because we look at price volatility. Precisely take that into account, because we think that from a shorter term perspective that's a more reliable measure. That's a very good point you brought up, and oil is the perfect example.
Niels: Sure, now you talked a little bit about different strategies, in terms of how they performed. If we focus on maybe the two larger ones, the macro and the managed futures… And we probably have to separate them completely because they're very different in style. What markets really delivered in terms of contribution both on the positive side and the negative side when you look at those two strategies, or whatever you have prepared?
Marc: I mean, I sort of tend to look more closely at the macro strategy because it's more of an active management one. But our best performance for 2014 in the macro strategy I would say were German bonds, the E-mini NASDAQ and the Euro. And the worst performers were Euribor, DAX, and E-Mini S&P's. You mentioned crude oil as being one of the nicely trending markets, and that certainly has been a boon through our trend following strategy to accompany FX, that's been one of our best markets. But also in a more kind of stealthy way, we've seen a really nice trend that we're able to benefit from in the dollar... In the Euro and the dollar currency that was... Currencies ended up being a pretty decent performer for 2014. Now as you know, the beginning of this year provided a bit more rock and roll in the currency markets, especially with the SNB action. But at least in 2014 it was a fairly good run in the currencies.
Niels: Sure, I mean I think that's a perfect segue to the next thing that I wanted to ask you about. Clearly the year 2014 was determined by a number of big themes. You already mentioned oil, and obviously Ukraine, Russia, which was probably partly involved in what happened in the oil markets, but then of course the currencies. I don't know whether you trade any of the emerging market currencies, which probably had some interesting moves even last year. But certainly this year as you rightly pointed out a very developed market currency namely the Swiss franc took everyone by surprise. So I wanted to ask you a little bit about, in general, how you prepare yourself for extreme volatility in a situation like that? And of course if you can be specific about the Swiss franc and how you dealt with it last week? That would, of course, be highly appreciated.
Marc: Sure. To really understand this you can't look at what's happened as sort of a discrete event. It's really part of a continuum in the sense that in the markets that we trade, in general, whether it's for the CTA or the macro strategy, sort of we're talking commodities, fixed income, currencies, equities and so on. The question is not whether there is intervention or not. The question is how much intervention is there? So starting from things like the currency markets, that's the poster child of central bank intervention. I mean I guess I'm old enough to remember when the Fed, the ECB, the Bundesbank- we used to see direct intervention by central banks buying or selling certain currencies. The Yen being a big example with the BOJ where literally there'd be either individual central bank intervention or concerted intervention.
We're used to trading and profiting from markets where if intervention is kind of plus or minus at the same level that we expect historically. The last five years have been unusually difficult for trading strategies because that level of intervention ratcheted up dramatically. Meaning when you look at sort of what the Fed did with QE, that was a very blatant intervention. But is it not intervention also when the Fed is taking interest rates up (in the course of managing interest rates in a normal business cycle) taking them up or taking them down? That's also intervention, so we know how to trade markets when there is intervention.
We just have to adjust to the level of intervention of the last five or six years. Because ultimately, if you again look at it at the extreme, if there is zero intervention then markets are completely free to trade based on fundamental economic supply and demand factors, and that would be the best scenario for us. We've learned to live with a limited amount of intervention. But take that to the other extreme where if the intervention is to such a level where everything is fixed by the central bank, then there really is no job for us in trading because there is really nothing to do.
So we know how to trade somewhere along that continuum. The closer we are to the extreme where the central banks are being extremely active, the worse it is for us. The more we go to a part where it's the normal animal spirit of the players in the market that drive the markets, the better it is for us. That's partly why I'm fairly optimistic about the future. For me, it is that I think we have started a... With an exception of what the ECB is doing, and we'll find out tomorrow, but at least I think the BOJ actions are proving to be somewhat unfruitful, and that’s kind of waiting, we'll see. My guess is that the ECB's action will meet the same fate ultimately. But this is something that we have to deal with in the markets.
Now when you look at sort of the way the central banks have been dealing with this, in general, is, one of the goals of the central bank's is to limit volatility in the markets. So central banks have been pretty good at telegraphing what it is that they want to do. And it's been almost like a pact between market businessmen and central banks, and the Fed has been a leader on that. That you sort of let us know what you want to do, and we'll reduce the volatility in what happens in the markets. Because ultimately for the broader market, volatility is not necessarily a good thing.
Now what's surprising about the Swiss National Bank's action going into the fixing of the Swiss E and the freeing of the Swiss E is how surprising it was. This really puzzled a lot of market participants as to sort of… Why would they create so much volatility for no reason? But be that as it may, luckily the action for our strategies was as expected. Our trend following strategy had a position that suffered from the move of the ECB because it's basically trend following, and this was a counter trend move. So we lost about three and change percent on the day of the intervention. Luckily that happened in a month where we were up over five-plus to six percent on the month. So all is well, we're still up over three percent on the month, and we can now put that behind us. On the Conquest Macro side where we do welcome volatility in the markets, we finished the day up about two percent or so, the day of the SNB intervention. So business as usual, nothing to report from the front, it was a day, and it passed.
Niels: Yeah, I mean it's interesting isn't it? Because clearly there's been a lot of headlines about what happened. A lot of people are speculating about who lost money on it. But certainly all of the people I've spoken to and I also think if you look at the indices of systematic traders, etc., etc., the daily return looked no different to any other day. And I think that's a very positive sign.
Marc: And look, that's part of the appeal of trend following strategies is that we're not looking to make any massive bet on any one market. I mean your typical trend follower is trading fifty, sixty markets in values strategies, in various time frames. So you could have a bad day in one market, and it's not the end of the world. Now where you will see more blood on the street so to speak will be probably more in FX only strategies, probably more discretionary type strategies, where there were big bets structured around this. You're going to see some pretty bad secondary effect from this move. I mean we look at the next day reaction to what happened. As you mentioned, we look at the lead tables or whatever, and you can get a pretty good idea of, "How was I doing."
But let's not forget that overnight cost of Swiss products went up about forty percent. Practical things like people going skiing in Switzerland are canceling vacations because prices went up dramatically, this is going to have much wider, much longer effects on the country of Switzerland. Which again puzzles you on why the SNB would deal with it in this fashion. That's not to mention the secondary effect on some of the more sort of Eastern European countries. Here there was a lot of mortgage financing, where they borrowed in Swiss franc to buy local properties and so on. So what you will see in the weeks is the event, and in ten days or so is the first chop. Don't be surprised to see the effect of this move linger over the next few months if not a year or so. Niels: Sure. Speaking about unexpected events, and I know, of course this is what we preach as an industry to potential investors that, that's exactly what these strategies are capable of because they're not trying to predict anything. And what happened last week was, you could say, in one market. So it was an isolated event, the strategies dealt with that event very well, but… And, of course, that is partly because of the way the portfolios are structured, the risk management, the diversification and so on and so forth.
But if we just allow ourselves to speculate a little bit here, and that is what if an event like this happened on a much bigger scale? And to give you… To use an example would be what if we over a weekend, it was announced that the Euro was breaking up? So something that actually would have an impact on many different markets at the same time. How do we, or how do you view the possibility of dealing with extreme volatility that could occur after such an event? Because right now we only had to deal with one market effectively. Okay, it could be that it was translated into maybe Swiss equities, Swiss bonds, and the currency itself, but it was still a relatively small part of the portfolio. But I'm just thinking right here, does something like this give you any reason to go back and think about an issue and say, well if a central bank one week can come out and say this is a cornerstone in our politics, and the next week make a U-turn, then we know and we probably knew this already Marc, that you cannot trust a central banker. You cannot trust a politician, because they will say one thing one day, and then they'll say another thing the next day. That's just the way the game works.
So if we just stick to the thought about something else coming out, a similar event, but on a much bigger scale. Is there anything, based on what happened last week that makes you go back and look into and sit down with your research team and say you know, how would we be prepared for something like this or do we need to investigate doing things slightly differently, given that there might be much more divergence, much more risk, many more black swans coming in the future years?
Marc: You're asking a very interesting and very deep question. It has many ramifications. So allow me to sort of rethink the question.
Niels: Absolutely, sure.
Marc: When we think of risk events there are two types of risk events that we try to envision. You have endogenous risk, and you have exogenous risk. Technically events like the Euro breaking up or central bank action, those most of the time should be endogenous events. And with endogenous events, I think we've reached a certain level of maturity in the capital markets… maybe it was lost a little bit on the SNB, but when everybody tries to reduce the effect of the possibility of endogenous events.
So if the Euro is to break up, there'll be quite a bit of telegraphing for something like that, no one has any interest in taking the market by surprise on something like that. So the news will come out slowly over time, trends will trend slowly over time and the portfolios will organically adjust their position to that reality. And theoretically that should be a positive or a non-event, depending... Or it could be a bad event just depending on how fast it happens. The real issue though is exogenous events, because by definition you cannot model for an exogenous event. Now looking at exogenous events, you also have to separate them between exogenous events where trading is permitted, and exogenous events where trading is not permitted. So if it's an exogenous event where trading is permitted, meaning it didn't happen on a weekend, and the markets didn't gap ten, twenty percent the minute the event happened, then the reaction is very different across different strategies.
So that's an environment where our Conquest Macro strategy has done tremendously well. I mean we were up over ten percent the day of the flash crash. Where for trend following strategies it depends on the makeup of your trend following program. So something like our Conquest MFS strategy (the Managed Futures Select), would actually do very well because our Conquest MFS program is extremely diversified across time frames. So even if on a single day we start seeing large movement in one direction or the other in a market, then our shorter term time frame will kick in very quickly to turn the position around so to speak, and be on the right side.
Now also it's worth mentioning that when an exogenous event happens, it's not given that it's a bad event, it could be a very good event. One, and this is… Now you're sort of going a little bit into part of the reasoning that we use in our paper, in proving why trend followers are not long volatility strategies. Now one of the examples that a lot of the trend followers like to use of the odd long volatility would be something like September eleventh, which is your poster child for an exogenous event.
Now when September 11, 2001 happened, it happened in an environment where fixed income was already rallying, and equities were already going down. So you had an exogenous event that pushed the market in the direction of the prevailing trend. So trend followers ended up doing very well. If that event had happened a year or so earlier, where the trends were the other way, it would have been a very bad event for trend followers. So when you look at exogenous events visa vie trend following, it's really first, 50/50 whether you're on the right side or you're on the wrong side of this exogenous event. Two is whether your systems are sufficiently flexible from a time frame or stop out or whatever to factor in a day move within the broader trend that you're doing. Three, and very importantly, whether we can trade or not. So if it's something that happens on a weekend and markets gap open up or down twenty percent on Sunday night in Sydney, then really there is nothing anybody can do. That's just part of the risk of being in the markets in the first place.
Niels: Now I agree with these things. But I think that it certainly leaves me with one thought that I think maybe investors should bear in mind, and that is the value that true diversification really gives you. And I do know that there are many portfolios out there that are focused in certain sectors. Clearly some people have to do it for liquidity reasons. Maybe some people do it because they have a special edge in those markets. I certainly think that truly diversified, fully diversified CTA or global macro strategies are probably the only safe bet you have against these completely unexpected events. I don't know, but it seems likely to me that they won't be announced… Like we saw in Cyprus a few years ago where suddenly you wake up, and you have ten percent less in your current account. When big things change, usually they come as a surprise, and I think we've seen a few of them.
Marc: The point though, which you brought up earlier in your question is about correlation, is also a very important one. Because… And this is an area where we've done a lot of work on: Which is correlation of various asset classes and various strategies. Correlation is one of those statistics that sort of people love to hate - basically that it's very unreliable and so on. What we found is that correlation is… People use correlation in the wrong way in the sense that they look at correlation of strategies or assets across many different regimes that are both risk seeking and risk averse. Correlation amongst asset classes, and therefore among strategies that trade those asset classes, are very different in risk seeking periods than they are in risk averse periods. So when you're looking at correlation across a data series of ten, twenty, whatever... Ten years or so that has so many of these inactive regimes, in and out risk seeking, risk aversion, and so on, of course you're going to get something that's unreliable because you're sort of garbage in garbage out.
However, if you correct for this and look at correlation in risk seeking periods versus correlation in risk averse periods, you see that correlation is actually a very stable measure. Now what happens is that risk assets exhibit a much lower correlation in risk seeking periods when an investment in fixed income or currency carry strategy or equities are much more governed by the alphas of those markets than the beta of the overall market. However, when you look at a lot of what active managers do, to a large extent you can sum up a lot of hedge fund strategies as buying the risky asset and selling the less risky asset. Now there could be skill in buying the risky asset, there could be on a more systematic approach but generally that's what you're doing.
Now when you apply this strategy across converts, across long/short equity, across fixed income, so in risk seeking periods, these strategies are all behaving differently, but all these strategies have one thing in common that is essential for them to exist which is liquidity. It's… You can't really be long the risky asset and short the less risky asset in a market where liquidity is zero. So what happens in risk aversion is that the first victim in risk aversion is liquidity. When liquidity gets hit, when markets go into risk-averse mode, that's when you start seeing the downside correlation of all these strategies going to one where all of them essentially start losing money at the same time. So when you're looking at investment, and looking at portfolios… you also have to be aware that what looks like a diversified portfolio in risk-seeking periods might not necessarily be a diversified portfolio in risk averse periods.
Niels: Absolutely, absolutely. Very good point, very important point. I want to end it there, because it's a short episode today Marc, but I do want to give you the opportunity,.. I know we've been actually quite far around in our conversation, but if there's anything you want to finish up with, anything you feel you just want to mention? It could be the highlight for you of 2014 or something that you just feel you want to leave the listeners thinking about as we go into 2015? I certainly want to give you that opportunity as well, so I don't know if you have anything in mind you want to bring up before we wrap up today's conversation?
Marc: First I'd like to thank the listeners for indulging me one more time talking about the markets. Second, just an observation, I tend to be a bit of a cynic when it comes to CTA investments in the sense that I think a lot of people over the years have lost a lot of unnecessary money investing in CTA's. What they ultimately end up doing is buying highs and selling lows. I would like to close by saying that CTA strategies and trading strategies, like all other strategies are very cyclical. Where they are different from other strategies is that the returns tend to be very bunched over a shorter period of time. So you go through a period where they do extremely well, and that period could be twelve, eighteen months, two years, whatever. And then they go through two or three years of just flat to not interesting performance. The time to be looking at investing in CTA strategies is before they've hit their high water mark. It's times when, sort of where we are now, where it looks like we've already bottomed out they're coming up, but they really haven't reached their full momentum. So I would encourage your listeners to look at these investments and hopefully make it part of their portfolio because I do think they're going to do very well in the next couple of years.
Niels: Well on that positive note Marc, let's finish up for today. And, of course, the listeners who want to hear much more of you, there is, of course, our previous conversation which is much more detailed, so I encourage people to listen to that as well. But I do want to thank you once again for being on the podcast and sharing your insights and your views, and congratulate you on a solid year over a range of your strategies and of course wish you and your firm all the best for the coming year. I look forward to catching up later on in 2015!
Marc: Thank you very much Niels, I appreciate it.
Niels: You're very welcome. Take care.
Marc: Bye bye.
Ending: Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you, and to ensure our show continues to grow, please leave us an honest rating and review on iTunes. It only takes a minute, and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged.
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Date posted: 06 Feb 2015no comments