Tuesday, November 18, 2014
Click link for full charts:
Posted by Bud Fox at 11:58 AM
Friday, November 07, 2014
Do computers that trade financial markets ever have nightmares about losing money? It is a question investors have asked in recent years of the hedge funds that use automated algorithms and models to buy and sell billions of dollars of assets.
Having almost consistently made money in the decade leading up to the financial crisis, these so-called trend following hedge funds appeared to have been scrambled by the high correlation across markets caused by ultra-low interest rates and central bank intervention.
While the money being lost was just another data entry for the computers buying and selling assets ranging from pork belly futures to Japanese government bonds, their creators faced the very human stress of investors losing faith in their investment strategy.
As the funds came under huge pressure to remodel their apparently malfunctioning computer programs, some investors even began to argue that trend following systems were permanently broken – that the mathematicians and scientists should close down their spread sheets for good.
“No matter how much we have a statistical, disciplined and scientific approach to investing, that doesn’t mean that as a human you don’t watch your returns going down in periods of poorer performance and experience all the negative emotions that losses entail,” says Ewan Kirk, chief investment officer of UK-based hedge fund manager Cantab.
But the managers, who go as far as sending researchers to the British National Archives to extract grain prices from the Domesday Book to construct trend following models, remained convinced the strategy would recover.
“When people doubted trend following, it reminded me of people giving up on value investing before the technology bubble burst, at exactly the wrong time,” says Sandy Rattray, chief executive of Man Group’s AHL, one of the largest and oldest of this type of hedge fund. “Studies have shown that momentum has worked well over long periods. It was a brave person who said that momentum was permanently broken, but many did at the beginning of 2014.”
Having begun the year as the most hated hedge fund strategy, many of these trend following funds have emerged as the best performing funds of 2014, outpacing their stock picking rivals who rely on mere human intuition to make money.
Helped by large moves in commodities, energy prices and interest rates, as well as the ongoing devaluation of the Japanese yen, funds like AHL, as well as rivals such as Cantab, and Isam, have all reported double digit returns for their investors this year. In contrast, many well known funds following other strategies, most notably global macro traders, have lost money this year.
Their managers argue it was their ability to withstand the short-term pressure of radically overhauling their core principles that meant they were ready to profit when the right market conditions returned.
“Have we changed things on the basis of what happened? The answer is no. We did not lose the faith. We are always grounded in research, and coming up with new ideas,” says Mr Kirk of Cantab, which has $3.2bn under management. “If a model is losing money, but is within the statistical expectation, you can’t just chop and change everything because you have a period of poorer performance.”
Investors in these funds, who were beginning to lose patience, now appear to be back on side. “They really needed this,” says an executive from a multibillion-dollar hedge fund investor. “If they had suffered another year of bad performance it was possible some of the smaller ones could have gone out of business entirely.”
Part of the problem for trend following funds has been their perceived complexity, with terms such as “black box” frequently used to describe an investment strategy that many hedge fund investors find difficult to analyse compared with more traditional stock picking techniques.
Mr Rattray argues that in fact the machines, which are constantly monitored by humans to check for abnormal market moves, are far more transparent than traditional fund managers.
“If you tell me what Japanese government bonds will do tomorrow I can tell you exactly what we will do in response,” he says.
He believes people will gradually get more comfortable with computers making decisions about investing their money.
“Sometimes people can be suspicious of the idea of using models or computers to make decisions. It reminds me of Nissan at first finding people didn’t want to buy the cars they built using robots in factories. It took time for consumers to trust cars that were not put together by humans on an assembly line”.
Posted by Bud Fox at 12:29 PM
Tuesday, October 28, 2014
Thursday, October 23, 2014
We’ve done testing going back 100 years or so (so has AQR in their paper ) and I was delighted to see a new book out by the crew at ISAM (up a whopping 28% this year) that has a 800 year backtest! Looking forward to reading it.
If you want some background reading on Trendfollowing search the archives, lots and lots in there including some of the below:
Podcast interviews that are excellent
Bhansali paper on Trendfollowing through the Rate Cycle
On the Nature and Origins of Trendfollowing – Stig Ostgaard
Dual Momentum Investing – Antonacci
Following the Trend – Clenow
Trendfollowing Bible – Abraham
Global Investment Returns Yearbook – Dimson, Marsh, Staunton
Appendix in Smarter Investing in Any Economy – Michael Carr
Trendfollowing – Michael Covel
The Capitalism Distribution – LondBoardFunds
Posted by Bud Fox at 7:47 AM
Wednesday, October 08, 2014
Tuesday, October 07, 2014
Posted by Bud Fox at 9:55 AM
A lot has been made of the track records of Bill Gross and Dan Ivascyn managed funds since the sudden departure of Gross from PIMCO. Mainstream media has covered the aftermath in great detail, but explanations of the performance have gone relatively untouched. Was the performance of Bill Gross really that awful? Was it entirely attributable to a poor call on US Treasuries? Is the Ivascyn magic touch now about to change all of PIMCO’s bond funds? Let’s sort through the facts and establish some pragmatic views on the subjects.
1. Ivascyn knocked it out of the park
Make no mistake about it, the management of Dan Ivascyn’s funds the since the crisis has been nothing short of superb. The PIMCO Income Fund (PIMIX) is up an average of 12.8% over 5 years versus the category average of 7.2%, ranking it better than 99% of peers according to Morningstar. Fund assets grew from $300mil in 2008 to $6.5bil at the end of 2011, and now $38.6bil at the end of September 2014.
Ivascyn and co-PM Alfred Murata targeted beat up credit assets that would benefit from a reflating of the financial markets. As central banks moved interest rates to zero and removed government bonds from the system, investors were forced to incrementally move out the credit curve.
An example of something that PIMIX has owned and done extremely well on is Spanish Covered Bonds. This is one the larger holdings in PIMIX. As shown, in three years, the price has risen from ~50 cents on the dollar to ~120 as the Euro debt crisis calmed.
Arguably the largest source of returns for the PIMCO Income Fund has been from non-agency MBS. There’s been arguably no better place for outsized returns in fixed income than non-agency MBS since 2009. Ivascyn and team made shrewd bets that these assets would recover and they did.
All in all, Ivascyn’s bets have been credit related and have centered around risk premium compression in the junkiest areas of credit. He has not been without misses - as his PIMCO funds held large amounts of Brazilian entrepreneur Eike Batista’s bankrupt OGX, as well Mexican homebuilder Homex. The point is not that he got a few wrong, but that he bet big on a recovery in the weakest areas of the credit markets and has largely been correct. Gross himself recognized & apparently liked this opportunity set as he is the largest owner of the Ivascyn managed PIMCO Dynamic Income fund (I consider it a leveraged version of PIMIX) with over 1.6mil shares held.
2. Gross’ Total Return Fund was not comparable to Ivascyn’s Income Fund
The objective of the PIMCO Total Return Fund is to "maximize total return, consistent with preservation of capital and prudent investment management. The fund invests at least 65% of its assets in investment grade fixed income".
The objective of the PIMCO Income Fund is to "maximize current income and to seek for long-term capital appreciation…"
These objectives are not anything similar to each other. The Gross managed Total Return Fund by mandate must seek preservation capital and may only hold a maximum of 35% in non investment grade bonds. In contrast, the Income fund is seeking to maximize current income and long term capital appreciation. Gross was forced to hold a substantially larger amount of government bonds and lower yielding IG credit.
3. Even if he wanted to, the Total Return Fund was too large to buy the bonds that Ivascyn bought
Peaking at $293billion, the Total Return Fund is an absolute behemoth. Bottom line is that the types of bonds which had the most outsized returns (such as non-agency MBS) were not able to be purchased in great enough size to move the needle.
The size of the entire non-agency universe has fallen to under $750billion. After accounting for legacy holders, hedge funds, and banks, the universe to buy is very small. As an example, the large Maiden Lane auctions where the Government sold off amounts of non-agency MBS were only around $7bil if I recall correctly. If the Total Return Fund bought that whole thing it still would’ve been a very small allocation to the fund.
4. The performance of the Total Return Fund was largely based on duration calls
With a fund so large as Gross managed, the relatively performance of it came down to his call on duration. It’s been well documented that he was wrong about US rates a few years ago and that lack of duration hurt his relative performance. Regardless of QE or “the new normal”, his views on how much duration to take was the big determinant. He bet that rates would rise and inflation would as well (Gross funds were heavily long TIPS).
Yes, Gross and team made some mistakes but comparison to Ivascyn’s funds are misleading. They were playing in very different areas of the bond market and the size of Gross’ Total Return Fund were a big headwind. Astute readers will note that Ivascyn isn’t on the PM team for the Total Return fund & that’s probably a smart choice. Ironically, as Gundlach mentioned yesterday, the biggest mistake that Gross made might have been letting his flagship fund get too large.
Posted by Bud Fox at 6:19 AM