Hong Kong Hedge Funds Club
Evening Reception, 7 Nov 2019
Tokyo Hedge Funds Club
Year-End Reception, 2 Dec 2019
Tokyo Hedge Funds Club
Dialogue Luncheon, 3 Dec 2019
Singapore Hedge Funds Club
Evening Reception, 25 Mar 2020
Shout It Out Loud
Hedge fund industry interviews
In addition to our daily news feed, Hedge Funds Club’s Shout it out loud publishes interviews with interesting hedge fund managers and other senior industry figures that have something to say.
Jeff LeVeen, Managing Director and Head of Outsourced Trading at JonesTrading talks with Himali Kothari, Founder of Aquamarine Value.
Can you tell me how you entered the outsourced trading space at JonesTrading?
I joined Jones in August of 2014. As I left my previous firm to join Jones, I noticed a growing interest in outsourced trading in our industry. When I got to understand Jones and the legacy business better, it became obvious that an outsourced trading platform would be a great fit and complement the trading that was being done by the firm already. I also found that in my travels I spoke with many emerging managers that were currently outsourcing with a competitor and had frustrations with their current providers. What became obvious to me was there was room for another platform and there was a strong interest in something better than what was currently offered by our competitors. I started making a list of items we could do not only differently but better than my competitors. I wanted to build a platform that put the needs of the emerging manager and their investors first. We spent a lot of time listening to the challenges of not only the launching and emerging managers, but their investors as well. We looked at ways where we could improve execution, source liquidity, consolidate the research budget and get our managers access to as much of the sell-side resources as they could possibly get.
What is the primary reason why small emerging managers will outsource their trading? Is it regulation, rising costs or keeping pace with technological changes?
Fee compression has driven the initial demand for outsourced trading. Launching managers have much smaller management fees to work with to run their businesses. It’s not just small emerging managers, we have been approached by funds managing well over US$500 million in AUM wanting to discuss our offering. Outsourcing is not just about managing costs, although hiring a trader and paying for an expensive order management system creates additional expenses for an emerging manager. We spend many hours working with our managers to help them build research budgets. We provide that manager a team of global coverage so that at all hours of the day he or she has access to an experienced trader. I think the emerging manager has realised that they’d have to hire two or three traders to replicate the experienced and comprehensive coverage from an outsourced trading desk.
And if emerging managers do outsource their trading, what type of strategy usually outsources?
We’ve seen many different equity strategies outsource their trading. It’s mostly your traditional long only, or equity long/short manager that engages an outsourced trading platform. We trade on behalf of both generalists and sector-focused funds.
Outsourced trading also makes sense if a fund wants to enter a new geography and/or a new asset class. Outsourced trading is a relatively low cost for the funds to enter new markets or an asset class. Has the MiFID II directive increased outsourced trading for JonesTrading thus far in 2018?
We have had a number of inquiries from European clients about our platform, but MiFID II hasn’t been the cause for our new client base in the US. The first quarter of every year tends to be an active quarter for new launches. Many of these new launches will outsource their trading and we’ve been fortunate to win a number of new opportunities this year. We do think as MiFID II continues to unfold in the US, clients will focus more on execution, driving even more interest in outsourced trading.
I agree, as MiFID II adoption increases, we will see more firms targeted on the unbundling of research and execution costs benefiting outsourced trading as we have seen a growth in outsourced third-party research firms based in the US, India, and Singapore. Can you dispel some of the common reasons or beliefs why emerging manager firms do not outsource trading?
I think there are a number of reasons managers choose to not outsource their trading. I think the first concern is that some managers don’t rank execution quality as a high concern for their new business. Many of these managers trade small and mid-cap stocks where spreads are wider and liquidity is thin. Execution performance could vary dramatically and poor execution could lead to hundreds of basis points of unnecessary performance slippage. I also recognise that outsourcing requires building a level of trust with the coverage team. Allowing an outsourced trading firm to understand the names you are trading, the timing, the style of trading is a sensitive relationship. Some managers never get to a point where they feel comfortable sharing this much information with another firm. The reality is every broker-dealer handles sensitive client information and sensitive client orders every day. Outsourced trading is no different than the normal trading that broker-dealers handle currently. There are strict compliance and surveillance in place to make sure we are handling our clients’ orders properly and protecting their anonymity.
The current break-even cost for emerging funds that manage less than US$500 million is US$86 million. In addition, investor reporting is the second area to outsource after middle-office processing over the next few years. Firms will continue to monitor their break even as operating and regulatory costs increase in order to remain competitive especially in their early years of survival which will increase the overall demand for outsourcing.
OP Investment Management recently invested in an equity stake in the company FundSeeder. HFC’s Stefan Nilsson decided to check in with OPIM’s CEO Alvin Fan to find out what this is all about.
You keep evolving OPIM’s fund business. You recently bought a stake in FundSeeder. Tell us about it. Why did you decide to partner with FundSeeder?
Our mission has always been to seek out undiscovered talent is Asia, and then help them gain exposure in the institutional space. Having interviewed hundreds of managers last year alone, we’re acutely aware that talent can come from anywhere – financial and non-financial backgrounds. However, the system is inherently biased against those without pedigree, capital, or an audited track record – all of which are expensive privileges. And this is where the gap begins. We came across FundSeeder having spotted Jack Schwager’s startup in social media. His books have been immensely influential to traders and managers including myself. Out of curiosity, we met with the team in 2016 during a promotion trip they were running in Shanghai. It was pretty obvious that we shared the same vision and their technology could bridge the gap between emerging managers and investors.
What can FundSeeder do for newer managers in Asia?
As I mentioned, investors gravitate toward track record and pedigree, but the hedge fund industry in Asia is still young. You can count on one hand the number of managers with more than $50 billion AUM. So by definition, most of managers and traders are filtered out by a Western-biased filter. FundSeeder ignores this and re-focuses the priority on analytics, performance. A verified track record makes allocation a meritocracy again – the way it should be. Just look at the advent of Chinese fund managers – there are thousands of AMAC registered private funds onshore, many with strong risk management skills, but without an expensive due diligence process, it’s very hard to assess their credibility as offshore managers. These new managers who link up to FundSeeder will gain otherwise impossible exposure to institutional investors.
As you mentioned, Jack Schwager, the man behind the “Market Wizards” books, is one of the co-founders of FundSeeder. How important is it for a new firm like FundSeeder to have a well-known name such as Schwager onboard when it comes to creating awareness?
It’s important, not just because of the name, but because of his ethos, intensity and purpose. This is a man whose dedicated his life’s work to demystifying the psychology of greater money managers. It takes the same commitment to build a successful company and attract the right talent. It permeates into the product and the message. This is true not just of Jack, but of his partners, Emanuel and James as well.
What does OPIM bring to the table in this deal?
Access to Hong Kong and China. Hong Kong is the pearl of asset management with the largest regional AUM in the hedge space. China’s asset management industry is at an early inflection of a renaissance period. OPIM’s strong brand in the region draws more talent to the partnership.
Have you localised or amended anything in the FundSeeder product/service for the Asian markets or is it exactly the same as it in the US?
In the initial stage, OP Fundseeder will be localised including Chinese interfaces, but once we have more regional talent appear in the database, we’ll be able to rank traders and licensed managers based on their local peers. We’ll also have new analytics and functions for investors interested in talent in this space.
What is the biggest challenge in introducing this new concept in Asia?
Language will still be a major hurdle. Getting lost in translation is an underestimated barrier to allocation. The managers’ ability to articulate their edge is just as, if not more, important than the strategy itself. This is especially true with distributors who need to communicate the same to their investors. Even with good performance and high ranking, this is just a starting point. It doesn’t guarantee allocation. We still need to conduct extensive due diligence on traders and managers. To manage money in Hong Kong or China you still need to be licensed, and this means running a business that answers stringent DDQ scrutiny.
What are your long-term plans for FundSeeder in Asia?
It still early days, but the natural evolution is to build out stronger analytics to help traders improve discipline and build a feedback system to help them grow. This also means providing analytics to help investors make better decisions about their existing portfolios.
What will be your next acquisition?
If I told you, I would have to kill you.
His day job is in operations at Australia-based fund manager Global Commodities Limited, but in his spare time, James Smith, aka The Walking Creative, is an emerging artist creating some eye-catching modern art from his base in Adelaide. HFC boss Stefan Nilsson checked in with Smith to talk about his bold and playful art and inspirations.
How would you describe your style of art?
My style is predominately neo-expressionism and abstract.
What inspired you to start creating art?
My creative flair began at about seven years of age. My grandfather taught me how to draw after I discovered ink drawings stashed in his cupboard he had drawn when he was a young man. I was so fascinated by them and then knew I wanted to learn more!
What inspires you nowadays?
For me I really love immersing myself within the arts, whether it might be at a gallery, an exhibition or even live music! There’s always something that I can take away from that experience to improve my skills as an artist. There’s also times where I am inspired by risk. Starting with no idea and just using my own imagination to see where it leads.
You’re an Aussie lad from Adelaide. Do you find any local inspiration for your art?
I support a lot of local artists and always love to see what new projects they’re working on. Again, back to experience, there’s an idea or something I can take away from it and utilise. There’s a lot of stuff happening around Adelaide at the moment and the city has become very supportive of the arts especially emerging artists. It’s great to see young and old talent out there inspiring others like myself.
What techniques do you use to create your art?
I am very experimental when it comes to using my creativity. I do vary it up and switch between different media. I tend to use acrylic or oil paint but there are also times where I like to get the Posca pens out and draw something too. Sometimes I might even do a mixed media piece where I’ll paint a layer of acrylic and use bright-coloured Posca pens over the top. It just depends on what I’m feeling or what I’m inspired by at the time.
You recently took part in your first exhibition in your hometown Adelaide. How did that go?
It went extremely well! It was a really big event because it was artists of all categories including fashion, makeup, photography, visual and music. My friends and family came along to support me. I had lots of people come up to my display to talk and appreciate my work. I priced all my art work well in an affordable price range so I sold plenty of pieces which was a good result. I met some really talented artists of all kinds all doing great things. It was sure a busy evening!
This is the beginning. Keep an eye on The Walking Creative because this young artist will clearly go on to bigger things.
Privium RKR is fast growing its Asian business by providing investment teams with an institutional infrastructure right from the start. HFC’s Stefan Nilsson had a chat with industry veteran Clayton Heijman about Privium RKR’s business.
Tell us about Privium RKR’s services for fund managers and investors?
Since 2008 the final industry has seen an increase in regulations, compliance and checks. At the same time investors have started to conduct more due diligence on infrastructure and potential risks while applying pressure on management fees. We are also seeing regulators worldwide implementing more rules for the asset management industry. As a result of these developments, the barrier to entry for new asset management initiatives is increasing. The full scope of services that we are offering provides portfolio managers an institutional infrastructure that will allow them to be set up with a limited investment and full transparency. At the same time, it is scaleable for growth and globalisation.
How did the two firms Privium Funds and RKR Capital come together in this Asian venture?
Privium had developed a business in Europe with an AUM of over US$1.5 billion and offices in London, Luxembourg and Amsterdam. Our ambition is to grow our business also into Asia met with the regional expertise of RKR Capital. These conversations resulted in a strong combination that was welcomed by the market.
Where are you currently at with your Asian business and what are you trying to achieve?
We already knew that there was a desire from portfolio management teams to work with a global player. However the response has exceeded our expectations. The positive responses came both from international managers that want to grow, again, in Asia as well as Asian managers locally. All are reviewing the benefits we provide them. We have a very compelling business case for them. Privium RKR can help them to set up a solid infrastructure and provide access to various service providers and markets. Asian portfolio managers should want to set up their funds allowing them to reach investors across the globe. With our global coverage we can help them to achieve these goals.
What kind of funds do you currently have on your platform in Asia? Can you give us some examples?
We have seen a lot of new initiatives over the last 12 months. This is an encouraging signal for the overall asset management industry. The teams managing private equity and venture capital are experiencing new regulation for their activities. In addition there are several funds starting with an equity long/short strategy, a quantitative strategy and a macro strategy. We have also seen traditional long-only managers and there is also a renewed interest for funds of funds. As for the location of the activities we obviously review initiatives that have a link to mainland China but basically see initiatives all over the Asian region.
You have chosen Hong Kong as your Asian headquarters and recruited an experienced team to manage it. Was Hong Kong an obvious choice?
Hong Kong has long played a role as a large asset management hub in the Asian region. The decision for a Hong Kong location was further strengthened due to the longstanding history that many people in our firm had with Hong Kong. For me personally it felt like I was coming home.
You personally have a solid background in alternative investments. Tell us about what you have done before you set up Privium and what led you to set up the business.
The set-up of this business has only been possible because of the different previous roles and experiences I had. Learning the ins and outs of the fund industry by working, amongst others, in the prime brokerage and equity finance group of Goldman Sachs in Asia, Europe and the US, having experience in fund operations at MeesPierson and setting up investment vehicles at Fortis. These experiences were all essential in Privium RKR becoming the single point of contact to discuss different matters for teams that want to set up or expand their asset management initiative. Our global team has a broad experience in the different areas of the asset management industry.
If you hadn’t been working in the fund management industry, what do you think you would have been doing?
Exploring and supporting new initiatives is part of my DNA. As a result I am a big fan of Sir David Attenborough and his work. My alternative career would probably have been accompanying him on his travels across the globe and unravelling the mysteries of nature.
Three years ago, Mohammed Ali-Reda founded Darkhorse Capital in Hong Kong to manage his own bottom-up emerging Asia and Middle East and North Africa equity long/short strategy. HFC’s Stefan Nilsson decided to have a chat with him about this journey so far.
You manage an equity long/short investment strategy focused on Asia as well as the Middle East and North Africa. What can you tell us about it?
Our strategy focuses on identifying quality companies that are run by honest and capable management who value shareholder creation. We look to capitalise on discrepancies between perceived value and underlying fundamental value of a company by adopting a rigorous and disciplined bottom-up research process. Our focus is on protecting capital while maintaining a sustainable long-term return profile. The portfolio is concentrated and will typically hold around 15 positions and currently has an estimated return on invested capital of 40%. In addition, virtually all my personal net worth is invested in the fund and I view all my investors as true partners in the fund.
What’s your edge? What sets you and your fund apart from the pack?
We focus on a business’ long term prospects, concentrate our holdings and focus on high-quality companies and management teams. This approach means we are able to delve deeper into a company versus a fund that has a shorter holding period. In essence we are looking to maximise the return on time invested for each position that we own and our target holding period is five years. Our investable universe is focused on companies between $500m and $10bn in market cap, with a preference towards ~$1bn range where there is little or no analyst coverage. This allows for us to really conduct differentiated primary research and unique view on the stock. We spend a lot of time on the ground talking to companies, suppliers, industry experts, regulators, other investors, etc. to help form that view – as an example I took over 40 flights last year. We are extremely focused in various sectors such as consumer, specialised manufacturing and specialised financial companies and our focus on the industry value chain provides a better understanding of the industry and competitive dynamics. I’ve spent a decade investing in Asia and most of my career looking at consumer companies. When you look at the world through the lens of trade and business as opposed to what the MSCI and other indexes outline, you find that the Asian and Middle East regions are very interconnected and show signs of further integration. In addition, the development of the capital markets and certain industries are following similar paths as they move from frontier to emerging to developed markets. We believe that ignoring benchmarks while focusing and analyzing companies using this approach provides us with a differentiated view and edge.
What can you tell us about your career prior to launching Darkhorse in 2014?
Prior to Darkhorse I was managing money for Asiya Investments in Hong Kong as Head of Consumer for the group, where I ran various portfolios that consistently generated alpha. I had joined the firm in early 2007 as the third member of the investment team and helped build out the firm. During that time the Kuwait government wanted to provide a way for the public to invest in Asia’s future, instead of opening another office for the sovereign wealth fund, Kuwait Investment Authority, in China. So the KIA and a few other institutions along with the public capitalised the firm. That’s how I got started and focused my career on Asia. Before that I was managing propriety capital for a large bank in Kuwait where we had a global mandate. Over the years I have also been actively involved with the CFA Society. I was a board member and treasurer of the Kuwait chapter.
You have launched your fund on the OPIM platform. Why did you choose to work with OPIM?
I found the OPIM platform was more focused on making sure all the middle and back office functions were taken care of by capable team members and systems. This allows me to focus on the portfolio and investing. The onboarding process was simple and having other mangers around also makes setting up the business part of the fund easier as you can talk to them about any questions, etc. Recently they have been helping a lot more on capital introduction and getting us in front of investors. I also like the people I work with, which is a big plus.
Why did you launch the fund with Hong Kong as a base?
Hong Kong geographically is situated well within Asia with a best-in-class airport infrastructure. Most cities are within a three-hour flight and a flight to Dubai is now around six-seven hours, so traveling is easier than if I lived in another city. The regulatory landscape in Hong Kong is very efficient and recognised globally, which is very important at a time when regulation is becoming more stringent. I also love the food and culture in Asia so I enjoy living here.
If you hadn’t been a fund manager, what would you have been doing?
Growing up I had started a few small businesses, the earliest already in middle school, so I always thought I would be an entrepreneur. I looked up to many successful entrepreneurs and read all their biographies. The notion of running my own business was very appealing to me. In a way I consider running a fund as an entrepreneurial venture within the financial services industry. On top of that, I get to be a part owner in many great companies through our investments as opposed to managing only one which can be a lot more interesting.
HFC’s Stefan Nilsson decided to have a chat with Scott Treloar about Noviscient, the Singapore-based investment company he founded in 2016. Treloar has a solid background working in hedge funds, private equity and banking, where he has primarily worked on portfolio management and risk management, much of it focused on quantitative analysis and systematic trading strategies. “At Noviscient we offer something new and better” says Treloar.
Firstly, can you tell us about Noviscient and what you are trying to achieve?
Noviscient is a next generation investment manager. We are based in Singapore, but work with partners from around the world. We are aspiring to become a trusted partner of our investors by offering alignment, performance and transparency. Our first product is a dynamically allocated portfolio of systematic trading strategies called Liquid Systematic Trading.
Last year was the worst year for hedge fund start-ups and closures since 2008. Why are you are starting a fund now?
As it happens, we think now is the perfect time for us to start Noviscient. We see three big themes impacting investment management and we aim to take advantage of all three.
1) Technology wave – Cloud computing, big data and machine learning are driving fundamental change in all businesses. Investment management, as a pure information processing business, is particularly affected. These technologies are changing the basis of competition. Alpha no longer comes from privileged access to information, but rather from finding new sources of information and then using non-standard approaches for analysis and prediction. Smart use of modern technologies also enables companies dramatically lower their cost of doing business.
2) Partnering over employment – We also see great change in how people work. The gig economy, where people want to partner and consult rather than become employees, has been on the rise for several years now. It enables new and more flexible ways for companies to access the best global talent. We see many prospective traders and portfolio managers looking for new ways to offer their skills and work together.
3) Alignment of interests – Investors are frustrated with the current situation. Investors see that outsourcing their investment requirements to managers is expensive and producing lacklustre outcomes. There is a sense that investment managers are focused on building assets to increase management fees rather than on generating out-performance. They are losing faith in their investment managers and pulling out their money at an increasing rate. For want of better alternatives, this money is going to passive managers.
In summary, the traditional model of active management is coming to an end. At Noviscient we offer something new and better.
So, if the traditional model of active management is broken, how can Noviscient help investors?
At Noviscient we are building a new and innovative business model that acknowledges and addresses these three themes of technology, partnering and alignment. Our business model is a coherent system that creates value for our investing partners while being difficult to replicate, particularly for incumbent managers. Firstly, we were born digital. Our technology exists in the cloud and has been built to be modular and to take advantage of open source software. This allows us to operate at very low cost. It also enables the use of machine learning techniques both for finding alpha, using alternative data and for optimising our operations. A second element is that we partner with our systematic traders rather than employ them. We offer modern infrastructure, capital and attractive profit sharing. This positively selects for systematic traders who are very good. Interestingly, often our traders are from non-traditional backgrounds. The final element is our focus on alignment. We have no management fee. We have first loss protection. Profit sharing is only on performance. In other words, we are strongly aligned on both the upside and the downside with our investors. We want to signal to them that we are on their side as true partners. Our success is tied to our investors’ success.
If you hadn’t been a fund manager, what would you have been doing?
Well, I was a ski instructor in Austria for three years. That profession held a certain attraction. Alternatively, and completely orthogonally, I would have liked to have become a mathematician. I find mathematics very interesting and very influential in an understated way.
Hong Kong-based OP Investment Management (OPIM) keeps growing and helping some interesting hedge fund managers to launch their own funds. Former banker Michael Wegener, now Managing Partner of Case Equity, is one of them. HFC’s Stefan Nilsson decided to have a chat with Wegener about his event-driven investment strategy.
What can you tell us about your global event-driven strategy?
Case Equity is a global event-driven investment firm across merger arbitrage and special situation equities. Its philosophy is one of a global CIO office investing in best-in-class event-driven situations; defined as value-oriented, event-driven – hard or soft catalyst – with shareholder momentum overlay.
What sets you and your strategy apart from all the other emerging managers in Hong Kong?
Case Equity is the one and only event-driven hedge fund running a global strategy out of Hong Kong, Asia; as event-driven requires the key success factors of information transparency, board accountability and corporate governance. Intra-Asian investing were to add a political dimension coming with elevated risk beyond many investors control; hence our focus on Western markets, many of which trans-Atlantic deals, e.g. Johnson & Johnson’s recent US$30 billion acquisition of Actelion.
You have launched your fund on the OPIM platform. Why did you choose to work with OPIM?
I was keen to start on a multi-manager hedge fund platform allowing me to a) focus on investing and being in front of investors, b) know that the operational and regulatory aspects of the business are being taken good care of, and c) allowing me to keep full equity ownership, brand building identity and future growth support as a stand-alone entity.
Why did you launch the fund with Hong Kong as a base? You run a global strategy, are there advantages to being based in Asia?
I happen to be in Hong Kong, where Case Equity becomes one of the few choices for Asian high net-worth and family office investors looking for a) global equities diversification, b) absolute return strategy (9%-12% IRR target/run-rate) uncorrelated from broader equity markets (<30% beta to market), and c) exposure to global M&A activity (front-page, large-cap, cross-border, complex). Also, event-driven is not a day-trading strategy as an entry point depends on the right week or month – not day – with the investment exits predominantly sold in to the event at M&A (tender) offer price.
What did you do before you launched Case Equity?
I started my career as an investment banking analyst as part of Salomon Smith Barney’s (later Citigroup) Analyst Class 2000, having since focused on M&A/advisory for 15 years globally across multi-industries; prior to Case Equity’s Opportunities Fund launch in March 2016.
If you hadn’t been a fund manager, what would you have been doing?
Possibly M&A/strategy at a global corporate/diversified industrial group; though the skill set to anticipate M&A deals happening is best employed as an event-driven fund manager, delivering attractive risk-adjusted returns for investors.
Hedge funds and other market participants are paying close attention to the changes going on in the Treasury markets and the role of futures. HFC’s Stefan Nilsson recently had a chat about this and other trends in the FX and rates space with CME Group’s Ravi Pandit.
Singapore-based Ravi Pandit serves as Executive Director, Foreign Exchange and Interest Rate Products, Asia Pacific, for CME Group. He is responsible for expanding CME Group’s existing FX and interest rate business and developing new opportunities across the region. Pandit joined CME Group in 2015 and has 25 years of experience in the financial markets. Prior to joining CME Group, Pandit was a consultant to Singapore Exchange, where he provided strategic advice and project management for its launch of listed FX futures. Before that, Pandit worked for 12 years in Dresdner Bank and subsequently Commerzbank post-merger, where he headed up the local markets trading team and helped build up its Asian presence in interest rate and FX derivatives trading. Pandit also worked in various trading roles at Barclays Bank in Hong Kong, Singapore and Tokyo, and in operations and technology at Citibank in Hong Kong and Mumbai. Pandit holds a master’s degree in Chemical Engineering from Syracuse University and an MBA in Finance from the University of California, Berkeley.
What is your outlook for the treasury market? Will we see futures having a significant impact on the cash markets?
Treasury cash market liquidity has been impacted by banking regulations such as the leverage ratio and consequent lack of growth in bank balance sheet. This can be evidenced by negative swap spreads which have persisted since September 2015, shrinkage of the repo market, and increasing price impact of trades. In the face of these challenges, Treasury futures offer market participants a capital efficient, off-balance sheet instrument for exposure to Treasuries. We have seen reports by market commentators which talk about how the liquidity in Treasury futures has become comparable to, if not superior to, liquidity in the cash Treasury securities markets, and that futures are especially resilient during non-US trading hours. Treasury futures daily volumes are now 77.8% of the cash market (on a 52-week moving average), up from 56% in 2012. This shift is expected to continue as participants realise the value proposition provided by Treasury futures from a round-the clock liquidity and capital efficiency perspective.
How can treasury notes be used as effective hedging tools?
Treasury futures provide an effective risk management tool that is liquid 24 hours a day. These instruments are listed with a variety of maturities, based on current market conditions. Their effective durations are approximately 2, 5, 7, 10, 20 and 25 years. Additionally, participants needing exposure at another maturity point can use a combination of these instruments to create a hedge. In a basic hedging strategy, Treasury futures can be bought – to hedge for a short cash bond or paid IRS position – or sold – to hedge for a long cash bond or received IRS position. The number of futures to be used for hedging is generally determined by matching the BPV (basis point value) of the Treasury futures contract to be used, with that of the underlying exposure being hedged. Besides directional hedging of a single exposure or a portfolio, Treasury futures can also be used to trade spreads versus other assets, such as corporate bonds or interest rate swaps, as well as targeting curve exposure for relative value positions, such as 5-year versus 10-year spread. In response to strong client demand, in January 2016 CME Group introduced the Ultra 10-Year Future, providing close proxy for cash 10-year Treasury note exposures, with an innovative application of the classic deliverable basket structure of Treasury Futures. This capital efficient instrument is highly complementary to existing benchmarks, enabling new spread and curve trading opportunities. In the 10 months since launch, we have seen wide market adoption with over 300 clients participating globally and open interest growing to 250,000 contracts.
What has the impact of uncleared margin rules been on bilateral trades?
Uncleared margin rules, imposed by the BCBS, have been implemented starting from September 2016 in a phased manner and are expected to cover most counterparties in all major jurisdictions by September 2020. The main thrust of the rules is the imposition of initial margin and variation margin for all non-centrally cleared derivatives. The imposition of the rules is expected to increase the cost of trading bilaterally on an uncleared basis due to the cost of posting initial margin with all bilateral counterparties – netting benefits are not achievable for bilateral trades – as well as the operational complexities of calculating and settling these margins. In the rates and FX products space, the products most likely to be affected include non-deliverable forwards (NDFs), FX options, cross currency swaps, swaptions, other OTC options and inflation swaps. Where the cost of trading bilaterally becomes prohibitive, we could see these market shrink or migrate to a centrally cleared or listed alternatives.
What other major trends are you seeing or expecting in the rates and FX space?
There is a great deal of interest from market participants in looking for capital efficient listed or centrally cleared solutions for replicating bilateral OTC trading. This has resulted in a significant increase in the clearing of non-mandated products. CME has seen evidence of this in the tremendous uptake of interest rate swaps denominated in Mexican peso and Brazilian real, and is beginning to see increased interest in clearing U.S. dollar swaptions and clearing FX non-deliverable forwards clearing. CME is also working on solutions to help reduce the margin impact for other products affected by regulations, including OTC FX options, additional interest rate swap currencies and a solution for clearing the repo market. We also expect a parallel increase in trading of listed FX and rates options, given the growing number of participants using these standardised instruments for managing risk. Related to the trends in OTC products is the evolution of the execution models as a result of growing client demand for more centralised and efficient forms of price discovery. History shows that when products begin trading electronically, the increased transparency and access expands the overall client base, particularly from international markets, and therefore the liquidity and trading volumes improve as a result. We have seen this trend manifest itself in listed interest rate options, where new firms have started participating in the electronic markets and, as a result, the percentage of options traded electronically has increased. In October 2016, this metric reached over 73% for Treasury options and 25% for Eurodollar options, a substantial uptick from a year ago.
Australian fund manager Global Commodities Limited has a long history of managing commodities in its long-only flagship strategy. Now the firm has a long/short strategy as well. HFC’s Stefan Nilsson had a chat with portfolio manager Dr. Gavin Bowden about the new alpha strategy.
What can you tell us about Global Commodities’ new risk premia long/short strategy?
Global Commodities has a long track record actively managing commodity beta. However, we were often asked by investors if we could apply our strategy in a market-neutral approach to reduce the volatility associated with the commodity asset class. Historically, we have successfully captured commodity risk premia with our flagship Active Global Commodities (AGC) strategy, but reducing dependence on the economic cycle and isolating commodity alpha was something that was attractive to some of the investors we were speaking with. This was the catalyst that resulted in the long/short version of our commodity program. We call this approach the Global Commodities Risk Premia (GCRP) strategy. GCRP is an absolute return strategy designed to capture commodity factor premia over time. In the current zero interest-rate policy and negative interest-rate policy environments that we find ourselves in, the hunt for yield is paramount and GCRP provides a unique source of yield that is uncorrelated to the major asset classes and other forms of alternative risk premia.
What are the main differences between your strategy and a standard CTA?
The GCRP strategy capitalises on how commodities are stored, transacted and valued. Momentum is the premier market anomaly and most CTAs have a heavy reliance on trend following. GCRP not only looks at price signals such as momentum and mean-reversion but also at a range of commodity factors as diverse as carry/roll, seasonality and relative value. This results in return drivers that are more diversified than a typical CTA. In addition, GCRP focuses exclusively on commodity markets whereas most CTAs also have large exposure to bonds, equity indices and FX. GCRP is also unleveraged compared with CTAs that generally employ leverage and often carry greater volatility in their return profile. When we performed the analysis and looked at the correlation between GCRP and the SG CTA Index since January 2000, we found that there was effectively no correlation at all. Even over rolling three-year periods the correlation remained consistently low and oscillated around zero.
What’s the thinking behind running the investment strategy in a systematic fashion with a discretionary overlay?
The commodity factors that we have identified have been the basis of many years of research. Since they are readily quantifiable it makes sense to have them combined in a quantitative model to capture the return in a systematic fashion. The discretionary overlay only applies when we move into tail events that the model has not seen before. In these situations there are benefits to having a portfolio manager taking the system off of autopilot and managing risk appropriately. The outlier events are also quantifiable and we want to avoid situations where the model would be generalising too far beyond the range of the data seen during model development.
Some commodities markets have started to pick up this year – is it still a good time to invest in a long/short commodities strategy?
Commodities are certainly on the move in recent times and we have seen natural gas up over 50% in Q2 2016, with the entire energy sector rebounding strongly from the lows set in February. Soybeans, cotton and sugar have also put in very impressive rallies. Brexit and increasing global uncertainty has seen safe haven demand for precious metals increase with silver soaring in recent times as it also has industrial uses. The beauty of the commodities complex is that the return drivers are very diverse and there are generally always opportunities. Now is the time for an investor to be seriously looking at commodities as bonds and equities are in overvalued territory, especially in relative terms as commodities have been pushed lower over the last five years while other asset classes have been trending higher. Just recently former U.S. Federal Reserve chair, Ben Bernanke, the architect of U.S. quantitative easing and the subsequent “tapering”, held meetings in Tokyo with both Prime Minister Shinzo Abe and Bank of Japan governor Haruhiko Kuroda. It is likely talks were about the logical extension of current monetary policy, the adoption of so-called helicopter money. The next huge fiscal stimulus in Japan and then in other parts of the world will most likely be an expansionary move focused on infrastructure, which will bode well for commodity prices. With the adoption of helicopter money comes an increased risk of unexpected inflation at some point and it makes sense for an investor to look towards commodities to help protect against such risk. This is part of the case for commodity beta, however, the advantage of the GCRP strategy, which uses a long/short approach, is that it is agnostic to the economic cycle and it exploits cross-sectional opportunities rather than relying on directional market timing. So while there is stratification in the yield of each constituent in a given basket of commodities, there are always cross-sectional opportunities that the GCRP strategy can benefit from. It just depends on what the investor’s needs are. GCRP is really about providing a consistent source of yield that is uncorrelated to other styles or asset classes.
How do you divide up the work between you, as PM and head of research, and the firm’s founder, Greg Smith?
Since we have built the strategy to be largely systematic, it is a case of looking at the various metrics each day and ensuring the portfolio is tracking as expected. Greg and I have worked together for a long time and have a good understanding of how each other thinks and manages risk. When decisions do need to be made, we have a standard process for how that is determined. However, for most of the time the strategy is automated. As PM, I sign off on orders on a daily basis. In addition to both of us reviewing the portfolio daily, I spend a substantial amount of time in research to ensure that we remain at the forefront of latest developments and have incremental improvements in our technology and strategy, while Greg spends a large portion of his time in market analysis, client relations and marketing.
You have been with Global Commodities Limited since 2010. What did you do before that?
After completing a PhD in engineering, I undertook a postdoctoral fellowship at Harvard University. My work there involved utilising NASA’s remotely sensed satellite data and developing models based on artificial intelligence algorithms to forecast environmental variables, such as droughts. After completing my work at Harvard, I moved into the fund management industry where I worked in research and strategy development for two CTA hedge funds. It was a natural fit as I was able to keep developing the statistical and numerical modelling skills I had gained from my years working as an engineer, but in these roles I was able to apply those skills to the markets, which has been both challenging and fun and has suited my analytical mind.
You’re based in Adelaide, Australia. What do you get up to when you’re not running money?
I have a young family with two boys aged three and five and I love spending my free time with them. We are blessed in Adelaide with a great climate and we like to get outdoors as much as possible on the weekends. We have a family beach house down the coast where we often get away to enjoy some time fishing and surfing. I also enjoy cycling and love going for long bike rides through the Adelaide Hills or along the many scenic coastal routes that we have in South Australia. Each year I participate in the Tour Down Under cycling event where recreational riders are able to ride an actual stage of the UCI World Tour event before the professional riders complete the stage. I am also passionate about Australian Rules football and I’m a keen supporter of the local AFL team, the Adelaide Crows, so I like to attend their games with my family and cheer them on whenever possible.
If you hadn’t been a fund manager, what would you have been doing?
As I mentioned, my background is in engineering where I predominantly focused on artificial intelligence and machine learning. I think if I wasn’t a fund manager I would most likely be working in this area and would be applying the latest robotic and AI technologies to solve environmental problems or perhaps in medical research applications. I think that would also be rewarding and would satisfy my desire to keep learning while solving interesting problems and technical challenges.
Clare Flynn Levy, during her stint at Beauchamp/Linedata, was one of the very early sponsors of the Hedge Funds Club. A decade later she is the talk of the town with her new fintech venture Essentia Analytics. London-based Clare Flynn Levy is a former fund manager and current financial software entrepreneur who uses behavioural data analytics to help fund managers do a better job of investing. Stefan Nilsson decided to have a chat with Flynn Levy about who she is and what she’s up to.
You’ve got an interesting career path so far – from asset management to fintech, back to asset management and, again, back to fintech. Tell us about your journey so far.
I started my career as a tech stock picker in the late 1990s, and was a long-only fund manager during the internet bubble. In 2001, I launched a long/short tech fund and I slogged away at that for a good four years, running very hard to stay in one place, and continuously aware that I probably wasn’t using my energy as efficiently as I could. I was always an early adopter of technology for fund management and while there was a lot going on in the electronic trading space at that time, what I really wanted was a data-driven feedback loop that could tell me exactly what I was good at, so I could do more of it, and exactly where I was repeatedly destroying value, so I could do less of that. No one could give me that, and without it, running money felt increasingly futile. When I joined Beauchamp Financial Technology, my hypothesis was that a tech company serving fund managers that was actually run by a fund manager would have a competitive advantage – and I was right. We sold Beauchamp to Linedata, and once we’d finished our earn-out, I joined Tisbury, a large European event-driven fund, this time on the business management side. The founder of Tisbury could see the need to diversify his investor base, and therefore his product offering, and he hired me to make that happen. My business plan got the green light in July 2007 – just in time for the first major rumblings of the financial crisis. By necessity, my business strategy focus switched from offence to defence, as we tried to stem investor redemptions. When I left Tisbury it was the end of 2009, I was pregnant with my first child and keen to get some distance, to figure out where the intersection of my skills, my passion, and my network lay. Essentia is the result of that soul-searching.
Your current firm, Essentia Analytics, is focused on using behavioural data analytics to help fund managers. How can you best describe what this means and how fund managers can benefit?
As a fund manager, you’re continually under pressure to perform, but there is very little assistance available when it comes to telling you how to do that. It’s like being a runner who can see his final times, and maybe even his lap times, but has no insight into what he could be doing differently in order to win more consistently. You’re focusing on the result, not on the process. And in fund management, so much of the result is outside your control, that the only way to really develop skill is to focus on getting the process right – yet you can’t do that without in-depth, ongoing data analysis. Professional athletes figured this out decades ago – now you have no chance of competing if you’re not using a data-driven feedback loop to continuously raise your game. Essentia is a data-driven feedback loop for investors. It uses data about your past trading behaviour and its context, along with data about the current state of affairs, to tell you exactly where you’re adding value and exactly what is repeatedly tripping you up. Then it alerts you when it notices one of those patterns re-emerging in your behaviour. Unlike most performance analysis software, it is designed primarily to help the fund manager make better decisions, not just to report on him. It’s proven to help fund managers make significantly more alpha, effectively by holding up a mirror and giving them precise feedback on how to play to their strengths and avoid their weaknesses.
How did you come up with the idea for this business?
It was really born of my own frustration as a fund manager. When you’re making money, no one asks too many questions, but when you’re not, the pressure to turn it around is intense. Yet no one has any advice for you on exactly what, if anything, you should be doing differently. It’s up to the organisation to offer that support, and yet most organisations don’t have a platform that makes analysis easy, repeatable, and user-friendly for the portfolio manager to reflect on his own behavior.
You have gone down the cloud-based route. Was that the obvious way to offer access to your service?
Yes, the cloud simply is the most effective way to deliver software in this day and age. And the infrastructure available from the likes of AWS is far more secure than most companies can ever hope to be with their on-premises technology. A big part of why buy-side technology is so antiquated is the fact that it is mostly local-install and can only be upgraded once every few years, at great expense.
What have been your biggest challenges with setting up this business?
The biggest challenge has probably been the status quo. To the new generation of fund managers, what we do at Essentia is a must-have – they understand that our technology can empower them to make more money. But the old generation has been doing things the same way for 20 or more years – to them, what we’re doing sounds scary. They are used to technology being forced upon them, normally for the sake of compliance or reporting. It takes some patience on our part to help them realise that Essentia is a competitive advantage, not a threat or an admin burden.
What kind of fund managers have you mainly won as customers so far? Is it a service that can work both for major asset managers and smaller start-up funds?
Today, our customers are almost all equity managers, but they range from $200m AUM hedge funds who are keen to prove their skill to investors, to $300bn long-only managers who are trying to stem the flow of assets from active to passive funds. The patterns that our software identifies are unique to the portfolio manager, and the automated nudges we send them are based on those patterns, as well as on their personal workflow. In each case, our goal is to make the PM’s life easier, while helping him make measurably more alpha.
How do you anticipate Essentia’s business developing over the coming years?
I expect what we do at Essentia to become as standard in the fund management industry as “Moneyball” has become in professional sport. It’s common sense, really, but I expect the adoption of it to be driven by both the generational shift that is currently taking place in the industry and the growing threat of cheaper, passive investment strategies. Survival of the fittest is the name of the game if you’re a fund manager – more so than ever before – and Essentia is the key to investment fitness.
If you hadn’t worked in fund management and fintech, what would you have been doing for a living?
When I was a kid, I wanted to be a newsreader. I still think I would probably be good at that – I enjoy communicating. But I think I would miss the satisfaction that comes from building something and watching it grow.