Betting Against the Crowd

Trend Capital’s discretionary, diversified approach pays off

Originally published in the April | May 2016 issue

Trend Capital is not a trend-following investment adviser, and nor will its discretionary trades necessarily follow trends. “We are not contrarian by design but we can be at times” says manager Ashwin Vasan, CIO of Trend Capital Management LP. The potential to bet against the crowd was one quality that attracted Union Bancaire Privee (UBP) to Trend Macro.

UBP, which manages $110 billion, has been investing in hedge funds since 1972 and was familiar with Trend Capital before UBP set up its U- Access Ireland UCITS platform in 2014. “We were already invested in the Trend Macro strategy and had high conviction in the manager from an investor perspective,” says Yves Guntern, Managing Director of UBP Alternative Investments. UBP carries out dedicated research building on its hedge fund DNA to find what it views as the best funds for portfolios and mandates. “We selected Trend Capital for its investment profile and background. We only on-board managers who we have high confidence in and who have gone through our due diligence process,” explains Guntern. Vasan has been in the markets since the early 1990s and investors can have sight of track records from both Tudor, where he spent a decade as a partner, and Shumway, where Vasan developed the macro strategy that is now traded at Trend Capital. Indeed, Shumway co-founder and ‘Tiger Cub’, Chris Shumway, used his family office to seed Trend Capital; Vasan is now dubbed a ‘Tiger Grandcub’.

UBP perceived a gap in the market as Guntern’s opinion was that “few top discretionary macro managers offered UCITS feeders.” This void has now been populated: UBP Trend Macro won The Hedge Fund Journal’s UCITS Performance Award for ‘Best Performing Macro Fund in 2015’. The Trend Macro strategy also outperformed the broader peer group, including non-UCITS funds, as measured bythe HFRI Macro benchmark in 2015.

UBP determined that the Trend Macro strategy was “well suited to a UCITS vehicle because it was liquid and did not have commodity exposure that could cause tracking error,” Guntern adds. Consequently the Trend Macro UCITS aims to run pari passu with the flagship Trend Macro strategy. The UBP UCITS platform (which no longer has a relationship with Guggenheim in the US so Trend Macro UCITS is not now branded as GFS) is fully integrated into UBP and uses service providers including Carne as management company, BNY Mellon as administrator and custodian, and Dillon Eustace as lawyers. They have all been recognised as leading service providers in The Hedge Fund Journal’s annual service provider awards.

UCITS distribution in Europe
UBP’s UCITS structuring infrastructure and know-how was less pivotal than the bank’s European distribution footprint in cementing the deal with Trend Macro, however. Trend Macro is based in Boca Raton, Florida (primarily to indulge in the sporting pursuits of Vasan’s offspring), with an investor relations office in Greenwich, Connecticut. “We only have two people in investor relations so covering the whole globe is difficult. Europe is a unique market where you need a UCITS to access individuals and institutions who only invest via UCITS. And UBP has strong relationships in Europe,” explains Vasan. Adds Guntern: “We are not just a simple service provider enabling managers to launch a UCITS. The key benefit of our platform is giving managers access to our broad distribution capabilities that arise from our sales team’s exposure to a broad investor base including institutions and high net worth individuals.” The Trend Macro UCITS fund has already obtained passports for distribution in 10 European countries and could add more. UBP has as well registered the fund in some Asian markets. Vasan is bolstering UBP’s efforts by visiting Europe to meet potential and existing clients; THFJ managed to catch him in UBP’s London office where he was briefly in transit between Switzerland and Sweden.

Macro as a diversifier
Vasan views diversification benefits relative to conventional asset classes as the core draw of macro investing. “With an asset-rich portfolio of equities, real estate and credit, macro can be an important part of overall asset allocation,” he explains. Indeed, the Trend Macro strategy has been lowly correlated to conventional asset classes and other hedge funds. More importantly, the strategy has performed well in both bull and bear markets for both bonds and equities. Its recent portfolio allocation appears in Fig. 1.

Yet Trend Macro is not merely a purveyor of possible portfolio insurance and has provided a smoother ride than many peers. Trend Capital’s style of management differs from other macro funds that are swinging for the fences with big and bold bets. “It is all about style. Some macro managers view the strategy as having equity-like volatility and can be up 20-30% in one year and down 10-20% in another year,” observes Vasan. By comparison Trend Macro strategy targets single digit volatility and double digit returns.

Inefficiency and volatility
Some of those macro funds with higher volatility targets are pursuing systematic strategies, which Vasan thinks “involve a completely different mindset from discretionary investing.” In former investing roles Vasan has worked alongside both other discretionary, and some systematic traders and pithily summarises his take on the gulf between them. “Systematic managers believe markets are efficient anddo not even try to predict the future. Discretionary managers think markets are inefficient and make an educated guess as to how things will play out.”

One of the most persistent inefficiencies that Vasan identifies is the herd mentality and he illustrates: “There is a general tendency to follow the crowd, especially when markets are down as they were in January and February of 2016 with fears of recession, negative interest rates and China collapse dominating thinking,” as a recent example. But Vasan sees recurring patterns of such overblown panics. Back in 2012 the consensus that Europe was going to fall apart did not happen either. These themes invariably overwhelm the media headlines but old hand Vasan pays homage to the old adage “nobody ever made money trading off the front page of the Wall Street Journal.”

The return of heightened volatility is another market phenomenon that Vasan sees as another inefficiency. He thinks increased market turbulence is partly a consequence of regulations – such as the Volcker Rule and Dodd Frank – reducing market liquidity, by reducing the amount of buffer inventory held by banks and brokers. “Market movements are now two or three times greater than before and we try to take advantage of these inefficiencies,” Vasan states. The strategy’s recent Value at Risk appears in Fig.2, set against VaR for the S&P 500 equity index.

Volatility is also arising from central bank policy surprises, in his view. “They are supposed to be the entities calming the system down but in fact are introducing a lot of volatility into it,” observes Vasan, who reels off how “the Bank of Japan surprised in December; the ECB underwhelmed in December; the Fed made an about face in March; and the ECB surprised in March.” These startling decisions likely contributed to sharp market reversals reverberating well beyond the central banks’ local markets.

Trend Capital could be particularly well positioned to exploit these market gyrations, as the manager is more nimble than some larger funds may be. Trend Capital currently runs $1.2 billion and has committed to hard close its Trend Macro strategy at assets of $2.5 billion across its vehicles (the UCITS fund, other vehicles and separately managed accounts employing the same strategy). The hard close will apply to both existing and new investors. “We will not let this become a moving target as we have been telling people what the strategy’s capacity was since we launched,” confirms Vasan.

Broader investment universe
Vasan wants to maintain room for manoeuvre in emerging markets (EM), arguing “anything in the emerging markets is hard for a $10 billion fund to participate in.” The Trend Macro strategy is not constrained to a small EM bucket and opportunistically allocates between developed markets (DM) and EM. EM has not yet contributed the majority of profits though this is not inconceivable. This flexibility appeals to investors including UBP’s Guntern who stresses: “We very much like the fact that Trend Macro is agnostic over DM versus EM.” Even within DM, Vasan is of the opinion that a $10 billion fund may have difficulty trading meaningful position sizes in smaller currency markets, such as the Scandinavian units (Swedish Krona, Norwegian Krone and Danish Krone).

Accessing these smaller markets helps Trend Capital to build a portfolio of 10 or 20 trade ideas, providing greater diversification than those more concentrated macro funds that emphasise a small handful of themes. Trend Capitals’ asset classes are equity indices, currencies and government bonds, but the last has more variety than might be imagined. ‘Credit’ in this context is not corporate credit but rather emerging market sovereign or quasi-sovereign debt, which could include countries such as Argentina that are “returning to markets for the first time after being shut out for a decade,” Vasan points out. Trend Capital’s strategy can also trade inflation-linked government debt, and could venture into more exotic instruments such as GDP linked warrants. Exotic options are not traded however. Trend Macro only trades plain vanilla options in the strategy because Vasan finds “there is already enough non-linearity in the portfolio,” and around 90% of the plain vanilla options are used for hedging, rather than taking, positions.

Trend Capital’s generic trade types can be divided between thematic and idiosyncratic. The over-arching global macro theme in 2016 is for Vasan “a scarcity of economic growth. China is undergoing a multi-year de-leveraging process; Brazil has a mini-crisis; Russia is under sanctions and behaving more like a Cold War state than a G8 state, leaving India as the only large emerging market country that is performing as it is doing the right thing in reforming.” Harking back to India, he jests that Europe is consigned to ‘the Hindu rate of growth’ meaning the 1.5% rate that India experienced for decades, while Japan is only just above water and the US might manage 2.5%.

Decorrelated trade types
This big picture view could underlie a thematic trade type, such as a view that interest rates, globally, might stay lower for longer, whereas an idiosyncratic trade type could be specific to the interest rate cycle of a particular country. And this underscores the importance of maintaining the flexibility to trade EM. Taking one region as a general example, Vasan observes that “many Latin American countries have rather independent interest rate cycles. Argentina has been hiking due to its devaluation. Brazil has been hiking dramatically but may soon cut and Colombia could also be nearing the end of its interest rate cycle while the US is at the start of its one.” Drilling into Brazil, Vasan argues that “the biggest single fundamental turnaround has been in the balance of payments. The deficit has shrunk from 100 billion to 30 billion and could even move into surplus. Combined with 400 billion of reserves, we have confidence in Brazil’s ability to service its debt.”

Trend Capital generally takes medium to long term views on interest rate cycles and Vasan is not surprised that many discretionary managers have been wrong-footed by trying to call a turning point in Brazil’s rate cycle as “this is a highly political call in terms of how politicians interact with a non-independent central bank” he points out. But the potential to express views on plenty of countries that are disconnected with the US, European or Japanese interest rate cycles can add many dimensions of diversification to a macro portfolio.

Autonomous regional specialists
Perspectives on these multiple, and asynchronous, economic and policy cycles are informed by the four lead analysts, who each cover one region: Asia, Emerging Europe, Latin America, and Developed Markets. All of these analysts have an academic background both in emerging markets, and have obtained advanced degrees in the United States. Vasan has often known his analysts for many years before hiring them, typically as they were on the sell side broking to him, and this familiarity fosters a cohesive team.

Vasan is CIO but analysts are given intellectual freedom. “The team is a meritocracy and I do not overrule anyone as that undercuts and undermines the investment process,” says Vasan. There is instead a structured review process whereby analysts review one another’s work to avoid analyst bias and show that it is vetted. Though analysts have considerable autonomy, they do not run their own books. There is one book comprised of trades unanimously approved by the team.

Bonus formulae follow neither the bottom-up mini-prop desk multi-strat model where analysts only ‘eat what they kill’ nor the top-down approach where they are remunerated only on overall fund or firm profits. At Trend Capital, the formula contains three components: the analyst’s P&L contribution to the fund, aggregate fund profits and their contribution to the whole company.

In forming views, Trend Capital’s analysts find interaction with policymakers and financial industry figures such as bankers, central bank officials, pension funds and finance ministers important to help validate their economic models and strengthen their qualitative assessment. “Sitting in Boca Raton, Florida, it is hard to validate our views, so we have to visit the countries to do proper due diligence. What is most important to us is to understand whether our work is validated by how policymakers look at the world,” says Vasan. This dialogue is much easier in emerging markets that need capital, whereas it can be harder to get access to policy makers – and particularly to central banks – in developed markets. Consequently, consultants are used more in developed markets.

Execution and trading
This fundamental analytical process is expected to drive 80% of returns, but technicals do enter the process when it comes to trade execution. The head trader has worked with Vasan since 1993 when they were at Oppenheimer, while Trend Capital’s other trader worked with Vasan as head of operations at Shumway. The analysts work closely with traders “to work out position sizing, risk management, take profit triggers and stop loss levels,” says Vasan. Trend Capital currently trades mainly Over the Counter (OTC) though futures are used for some equity and bond markets. OTC trading is the key reason why a macro fund costs more to run than “long short equity funds which can outsource everything from back office to trading,” says Vasan. For macro “you need an experienced trading desk, which implies personnel costs, and you also need a suite of ISDAs for counterparty relationships, which implies legal costs,” explains Vasan. To help trade more volatile and sometimes fragmented markets, Trend Capital has this infrastructure in place. Having spent the last five years building a business, a team and a robust track record, Vasan remains confident about the promising opportunity set for Trend Capital’s style of diversified, fundamental macro investing.