Q: What is the history of the fund?
The Credit Suisse Managed Futures Strategy fund was launched in September 2012 and is based on in-house research that began in 2007-2008. Historically, our group had been focused on systematic trading strategies that employed various types of alternative risk factors.
With this fund, we wanted to build a broad, multi-asset portfolio to systematically offer investors access to trends across major markets, while remaining liquid, transparent and low cost.
In the trend space, accessing managed futures has been challenging for investors, primarily because the performance among active managers tends to be quite erratic. Often one year’s best performers become the next year’s worst performers. We believe our strategy is more reliable, less expensive, and more transparent.
Assets under management for the strategy are roughly $500 million, and the fund manages approximately $150 million.
Q: How would you describe your investment philosophy?
Our philosophy centers on representing the trend factors in major asset classes, rather than looking for the highest return in a back-test or simulation.
Being systematic is also central to our thinking. To facilitate this, we developed a robust methodology which included testing, and consulting with leading academics as well as active allocators within the space.
We do not tinker with our methodology, or react to marketplace vagaries, unlike active managers, whose portfolios reflect their views. Instead, we let the system work and implement the strategy as it was created. This helps eliminate behavioral biases.
Remaining transparent is key. We believe the fund should behave in ways people understand, so it employs a rules-based approach, making it possible to see what drives changes in the portfolio’s composition.
Q: What is your investment strategy and process?
The idea that trend following is profitable and part of market dynamics is longstanding – it dates back centuries – and is supported by significant empirical and academic research.
The conviction that a trend has value in a portfolio began to build in the early 1980s. In 1983, John Lintner, Professor of Economics and Business Administration at Harvard University, suggested in a now well-known paper that trend following could complement a traditional 60/40 portfolio.
However, the belief that trends exist in the marketplace runs contrary to the notion of market efficiency. Some behavioral economists suggest trends exist because investors initially underreact to market information.
An example is the reaction of risk managers who, as trades move against them, are forced to exit, perpetuating those price movements. Another is confirmation bias which can lead to investors chasing performance thus establishing a trend.
Our strategy seeks to take advantage of these trends and provides exposure across major markets and asset classes. We look at equities, fixed income, currencies, and commodities, examining price behavior across a range of instruments and time horizons. How trends develop over different time horizons across a variety of contracts dictates the portfolio’s exposures.
Having various time horizons associated with each instrument we track gives us exposure to both longer- and shorter-term trends. However, we have to remain considerate of the tradeoffs when making allocations.
Too much weight on shorter-term movements may increase trading costs to the point we may not benefit from some longer-term trends. Likewise, if totally geared toward longer-term trends, we may not be nimble enough to capture shorter and medium-term movements. So we aim to create diversification across asset classes and trends, but remain aware of the nuances of price movements and transaction costs.
Regardless of asset class, we seek out highly liquid instruments. They provide the strategy with the ability and capacity to trade efficiently, and liquidity is also key to the fund’s investors.
Specifically, the portfolio expresses long or short views on bellwether instruments in particular asset-class pockets. For example, within equity indexes, these include the S&P 500, the Hang Seng, the Nikkei 225, the EURO STOXX 50, and the FTSE 100. Within fixed income space, they include U.S. rates, U.K., Euro, and Japanese government bonds. Within currencies, we look at the Australian dollar, the pound, the Canadian dollar, the euro, and the yen. Within commodities, we scan subgroups including agricultural, precious metals, industrial metals, and energy.
The markets and economic factors represented through this set of instruments are ones most investors’ portfolios have sensitivities to. As a result, the fund can serve as a valuable diversifier in a portfolio, potentially counterbalancing losses elsewhere. Often it sees outsized returns in periods of high volatility, to both the upside or the downside.
Q: What is your research process and how do you look for opportunities?
Recognizing trend patterns is at the heart of everything we do, and our research helps us understand what is and is not an established trend.
Much of our research occurs in advance of any strategy going live, as opposed to active equity managers who do ongoing research about companies and earnings. Before creating the strategy, we spoke with scholars and industry practitioners to gain an academic understanding of it. Then we looked at data and analyzed the strategy across many time periods.
Ongoing work is based on a constant desire to validate the assumptions used in building our system. We want them to be robust through time, and our process focuses on making sure that changes in the market or the instruments have relevance. For example, if the long-term impact of the UK referendum is the erosion of the viability of the euro, we would have to consider the relevance of the euro as a currency exposure in the portfolio.
We also want our results and exposures to meet the system’s expectations and we continually look at how altering certain elements might improve the program. To date, we have not identified anything with sufficient value to change it.
Q: How do you construct your portfolio?
A key component of trend investing is the determination of appropriate entry/exit points. For each instrument within the portfolio, we use a range of independent lookbacks to detect trends across various time horizons, ranging from shorter-term to longer-term. A salient feature of our process is it is not dependent on just one lookback – a variety are utilized to identify robust trends and also to react in a timely fashion during daily rebalancing.
Our process is inherently nimble. We compute signals daily, and based on how they change, can react daily. This allows us to capture quick market-moving events using different lookbacks and our ability to trade on any given day.
One of our most important decisions is how to allocate risk within the program. Some might argue that risk ought to be allocated proportionally to the strength of a given signal. Our approach is more stable, and attempts to systematically allocate risk equally across signals.
Each signal within each underlying contract thus exerts the same amount of influence on our holdings. In practice, we consider the time horizons that influence whether we are long or short in an instrument. If half are telling us to be short, and half are telling us to be long, they effectively offset one another.
When the system does not see significant trends, instead of trying to force itself to take risk, it in effect de-risks itself. We think this is an elegant way to deal with one of the biggest risks in this strategy: being overly invested in markets which are not in any sort of a trend, and being chopped up as the signals fluctuate between desiring to be long or short. Our method ensures significant exposure when we have agreement across our signals through time – but when there is less of a clear trend, exposure is lower.
To help ensure the strategy performs as expected, we follow a number of metrics: monitoring transaction costs, analyzing the attribution of returns across the instruments that are traded, and understanding how much of the return is driven from short-, medium-, or longer-term signals.
Q: How do you define and manage risk?
Managing risk is inherent in the strategy. At the top, two mechanisms are employed. One is target volatility, which measures the volatility of the portfolio’s assets. The second is a risk-mitigation tactic which imposes a maximum limit to the target volatility risk of the portfolio; when it is reached, automatic de-leveraging trades are triggered, ensuring we do not deviate too far on the upside relative to our portfolio target.
Looking at overall diversification is important in terms of concentration in the portfolio. We are already going across two dimensions of diversification, which are lookbacks and the number of contracts. When considering new contracts or markets that could potentially be added, we continue to keep an eye on concentration to understand whether the portfolio needs further diversification.
Philosophically, there are different types of risk we care about. The first is whether the product is capturing trends; if it is not, we are not delivering what our investors want.
The second focuses on drawdowns. When we think about risk, it is the minute-to-minute, day-by-day drawdown losses we are most concerned about, especially in trendless or choppy markets which pose the greatest risk to our type of strategy. Though we believe drawdown risks ought to be contained within the product, there also must be some willingness to take risk in order to make money. This may result in periodic drawdowns – so that trade-off certainly exists.
Including short-term lookbacks offers us another way to manage risk. They can work as stop-losses in certain environments, and because they are more dynamic and move faster, they also help mitigate drawdowns.
The fund both benefits from and acknowledges that the instruments it is trading are liquid. There is a body of work to support the notion that the distribution of returns in the space is skewed to the positive. As a result, we have fewer scenarios where a disproportionately large amount of money is lost, and tend to have several episodes where larger amounts are made.
Overall, the way we manage risk is a combination of the strategy’s design and the ongoing research we do. Together, they ensure the fund reflects developments in the marketplace and provides exposure to the major markets that people care about with respect to trends.
