Podcast Review: TTU #148 (part 1)
Top Traders Unplugged, host: Niels Kaastrup-Larsen, guests: Yoav Git, Rob Carver, Graham Robertson
Link to episode:
CTAs - The Good, The Bad, and The Misunderstood ft. Rob Carver, Graham Robertson and Yoav Git
Two ex-AHL guys, Yoav and Rob along with a current AHL partner Graham. You know this one will be interesting. Also, Yoav and Rob had the same role at AHL as Head of Fixed Income at different times.
It’s a great conversation to listen to, and I would like to highlight a few important aspects of their conversation and opine on those topics myself.
Single vs Multi-Asset CTA
Yoav runs a Fixed Income only CTA at Gresham Quant. He points out that:
Their clients want systematic exposure to Fixed Income
Fixed Income is more profitable, nearly 70% of profits during his tenure at AHL came from this sector
Fixed Income requires more of a specialist approach to risk management, execution and to some extent alphas. He specifically points out that fixed income markets are highly correlated, and Fed is Principal Component #1
Rob runs a multi-asset book on his own, which rivals many high-quality CTAs. He mostly disagrees with Yoav by saying that:
CTAs would be better off making the risk allocation between sectors than their clients
There is no reason to believe one sector is better than another in trend following
Fixed Income may require a specialist approach to execution, but CTAs will likely have specialized people for execution of different asset classes anyways
From an academic perspective, I agree with Rob. As always, he makes excellent points. I completely agree with him that there is no evidence that fixed income sector is any better than others in terms of trending behavior. Gold, Cocoa and Coffee markets’ behavior of late make this point very clear. Also, the profits Yoav mentioned came during the period of Great Moderation which resulted in a 30-year long bond bull market. In other words, a leveraged long bond position would have already delivered strong returns, with Sharpe of around 0.4. Regarding specialized execution and risk controls, well this could be (and already is) done in house at many CTAs. Again, not a great reason to separate out a strategy.
What Rob is missing, and perhaps what Yoav is not mentioning is the business realities. The kind of products clients want is key to this debate. By giving clients more control over which asset class to allocate capital to, Gresham is betting that they can raise more money than selling a single multi-asset product. They have products A (commodities), B (financials), as well as A+B and perhaps some others. Typical CTAs only have A+B, since they argue that diversification dictates you should trade all markets. However, you have the ability to capitalize on clients who want A only, B only, or A+B so the potential AUM available to the strategy is inherently bigger. In short, parts are greater than the sum from a revenue perspective.
Another important alpha related matter that Yoav seems to touch upon is the fact that fixed income markets are indeed highly correlated. At first, this may seem like a disadvantage since it reduces diversification. However, by hedging the first principal component one can develop strategies that bet on the divergent or convergent price moves between markets. For example, one can leverage carry between US bonds and JGBs, or even bet on other supply/demand-based dynamics between countries or across the curve within a country. These would be strategies that I would consider to be in the systematic macro style, which would add alpha to trend following.
From a simply carry perspective, fixed income markets offer the best opportunity of risk adjusted carry. This is mainly because carry in fixed income is related to the shape of the yield curve. In comparison, FX carry is determined by the short term yield differential between countries. So, while EURUSD may offer no carry at all when the short yields are similar, Bunds and US Treasuries may both have significant carry on their own due to the shape of the yield curves in each country. Even inverted yield curves can offer good carry opportunities.
Liquidity and Execution
Both Yoav and Rob are clearly very knowledgeable when it comes to the details of OTC (over the counter) fixed income markets. Of course, Yoav is still very active in OTC fixed income, whereas Rob stopped trading these markets in 2014 when he retired from AHL. It’s possible that there is a bit of a knowledge gap between them, due to the fact that Yoav has been a practitioner in OTC markets during this time period.
Having traded these products myself, I am well aware of the pains one needs to go through in order to represent an OTC market in the portfolio. From a modeling perspective, one needs to determine how accurate pricing needs to be. Since OTC products are not exchange traded, there is no singular “price”. One needs to create their own pricing model (source data for multiple points on the curve, interpolate curves and holiday/cash flow conventions for an interest rate swap), and execution strategy. For example, would you trade multiple coupons for one IRS maturity or just one? Would you allow multiple CUSIPs for a single target cash bond duration, or insist on buying and selling only one? How will you roll your positions, will you compress the book? So on and so forth.
There is a reason why many CTAs stay away from these markets, and it is the operational complexity. One can also argue that the opportunity set is not very large, given the high correlation between these markets, to Yoav’s original point. Then why trade these markets? I think you trade specialized fixed income products because you want to capitalize on opportunities that you cannot otherwise access with simply trading the liquid bond futures. This means while trading specialized fixed income products you should also venture outside of classical trend following in order to make it worth the operational cost. Sure, one can argue that there is better carry and perhaps additional crisis alpha in EM IRS than developed bond futures, but I believe the real juice is in the ability to trade multiple points on the curve in many markets. If leverage is not an issue, even butterfly strategies or bond basis arbitrage (cash bond vs futures)
Part 2 coming soon… (I had to split it since I was at the end of space limit for emails)