Good backdrop for trends – economic, political and geopolitical instability

Greenig argues that investors should, “Own the tails and not be owned by the tails,” as he sees a more unstable economic, political and geopolitical climate. “My first job in finance was an internship at Commodities Corporation in the 1980s. So, I’ve seen a lot over the decades, and I’ve never seen a more unstable macro backdrop. It’s not one thing, but the convergence of many things.”

He continues: “Since WW2, the world has been shaped by a few key factors:  American economic and military dominance, cheap and plentiful energy from fossil fuels, global supply chains and so forth. Now, almost everything is in flux. China has emerged as an economic superpower, and already the GDP of the BRICS is larger than that of the G7, once purchasing power is considered. Then you have huge issues around energy and climate. Folks should read Vaclav Smil to understand the magnitude of the challenges here. Cheap fossil fuels made modernity possible, in Smil’s view, and now climate change compels us to try to re-engineer how we power our societies. It will cost trillions. Of course, many countries are already in precarious financial shape at a dangerous intersection of high debt loads and tightening monetary conditions. Politics are another source of risk, as polarization and populism have become major problems that impede constructive actions on a range of issues”.

Market dislocations and regime shifts are where trend followers tend to earn their money, by trying to exploit investors’ enduring behavioural biases. “The world is unstable and non-stationary, and convex strategies, including trend following, zero in on some robust, hard-wired behavioural patterns. These biases are hard for people to transcend even when they know about them. Anchoring bias, for example, is inevitable in a bewildering, changing world. Likewise, herding behaviour emerges from the social construction of narratives. Trends continue to happen for good reasons,” says Greenig. He finds that Minsky provides one framework for understanding these behavioural patterns, as does Irving Fisher’s work on deleveraging.

Traditional and alternative trend following 

Greenig thinks this backdrop is generally constructive for all sorts of trend following strategies, which include CTAs, as well as other strategies that exploit regime shifts and tectonic macro changes. 

Florin Court has had a correlation of around 0.6 to traditional trend followers but has generated better absolute and risk-adjusted returns than most of them. Higher absolute returns have come from stronger trends, and a higher Sharpe has come from the internal diversification. Alternative markets have outperformed dramatically from 2009 through 2021. This strong history for alt markets trend was well known to Greenig and the other co-founders of Florin Court, Deputy CIO Dr David Denison and COO Anthony Vinitsky, who had previously worked together at Man/AHL, manager of one of the first alt market CTA funds.

A potential nuance: “As a trend follower, we expect to do well in crises. Since we trade so much in emerging markets, we should excel when crises occur there. On the other hand, our higher diversification means that we might be a step or two behind a traditional CTA in a developed market dislocation. In any event, we would still expect to deliver good results, as we did in 2022 when we made about 20%.”

A growing investment universe

Florin Court trades a wide mix of commodities, some of which are listed in emerging markets including China, Brazil and South Africa. Indian commodity exposure awaits a more open and tax friendly regime. Florin Court trades in a wide range of electricity markets in the US and Europe and plans to add more of them as and when liquidity improves. 

The manager now trades over 500 macro markets in commodities, power, fixed income outside G3, inflation swaps, credit, currencies and equity indices, as well as about 2000 single name equities, mainly in emerging markets, where Greenig expects to have a greater edge than in developed markets traded by more specialist equity hedge funds. Emerging market equities are traded using sector trends and market neutral factor trends, amongst other signals.

Some of the largest contributions have come from European electricity, Latin American interest rates, and Asian currencies. Turkey has been “the gift that keeps giving”, and trading there illustrates a perspective on how liquidity can become asymmetric as a dislocation occurs. “Before a crisis, there is usually a period of deterioration, a gradual bleed down. Trend systems should be getting short. Then some catalyst may trigger the breakdown, and things begin to really move lower. The bottom falls out. There won’t be strong two-way liquidity, with so many people trying to sell, but those short ahead of the full breakdown actually benefit. As liquidity for sellers dries up, the trend can over-extend. On the other side of the market, it is actually easy to buy and cover the short during such a crisis,” says Greenig.

On average Florin Court has onboarded 50 new markets per year, net of some (such as Australian electricity) discontinued for liquidity optimization reasons. Each new market needs to add something different, have acceptable transaction costs and liquidity, be traded by multiple counterparties, and be operationally feasible to trade.

The pace of adding new markets might at some stage slow down, but Greenig is confident about adding dozens of new markets over the coming years and Florin Court is often amongst the first systematic traders to enter a new market. He sees subsequent adoption by others as helpful up to a point: “In new markets, inflows from trend followers can improve trends, but beyond a certain point they become overcrowded, which can add some chaos to the dynamics”.

Why systematic investing?

Discretionary managers also trade these markets, and Greenig’s earlier career included running proprietary trading macro and fixed income desks; these included both discretionary and systematic traders at Greenwich Capital and Goldman Sachs: “This taught me about correlation breakdowns, leverage dangers, kurtosis, and above all about humility. Markets can be difficult and strange”. During 30 years of watching and trading markets, as well as supervising risk takers, Greenig became attracted to systematic trading due to: “The ability to scale models and apply principles to multiple markets simultaneously and consistently. I also like the mental clarity of systematizing ideas and think it is then easier to stay objective”. 

Tweaking trend following

Florin Court is predominantly a trend follower, with some modest tweaks. “David Denison and I, together with our research team, have a lot of quantitative experience and knowledge, but we resist the temptation to tinker excessively, partly for fear of overfitting,” says Greenig. Philosophically, Greenig, “Does not want to sacrifice the positively skewed tail qualities of trend for the sake of a marginally higher Sharpe ratio”. More specifically, he is wary of adding carry exposures that can backfire in a risk-off climate. “We have some gentle carry tilts in fixed income but no explicit currency carry,” he says.

Models are to some degree tailored to the dynamics of asset classes and sectors: “Credit spreads tend to blow out fast but compress slowly, for example,” says Greenig. Currency markets are traded faster than others and have shown a strong diversification benefit despite lower absolute returns.

Markets are relatively equally weighted in the long-run, but more risk is devoted to better trends at any point in time. Continuous models mean there is nearly always some exposure to all markets traded.

Non-trend signals

Greenig admits that, “We could run the strategy purely on trend, without the non-trend models though they have made an additive and non-negligible contribution to returns”. Non-trend models, which average 15% of inputs per market, can include fundamental or cross-market signals such as cash-CDS basis. (A carve out of the non-trend systematic macro models is now in a standalone fund, with assets of USD 150 million).

Nimble models

Greenig argues that assets of USD 1-3 billion are a sweet spot that allows for market access and meaningful position sizes but also maintains room for manoeuvre for more nimble trading. He finds that the inherent positive skew of trend following can be accentuated through faster and shorter-term models and breakout signals. Greenig expects to be somewhat nimbler than some other trend followers and uses rapid volatility scaling techniques: “Models expand positions in earlier stages of trends and start cutting them when volatility expands. When markets go parabolic, the models will start cutting fast, and once they reverse the trend signals soon switch sign”. 

This is partly informed by Minsky’s bubble and crash framework, which can also apply to regular market behaviour: “Strengthening narratives drive trends, but they eventually become fully priced or overpriced, and volatility can spike up when narratives and trends begin to change. Minsky called this ‘Distress’,” says Greenig.

Steady and consistent volatility

Some trend followers argue that constant volatility would be a straitjacket, suffocating some of the most violent trend moves, but Greenig is of the opinion that a systematic manager should deliver its stated target volatility over time. Florin Court targets long-term volatility of 10%, and has consistently delivered volatility within a few points of this target. This is made easier by the lowly-correlated alternative markets universe. Fundamental and structural differences across the markets provide an a priori reason for decorrelation, which is borne out by statistical patterns: Florin Court’s markets have several times more independent bets than a traditional CTA universe, according to the firm’s analysis. “Therefore, any rare correlation spikes tend to be localized into markets such as regional electricity or industrial Chinese commodities. The portfolio is much less likely to find itself under or over-geared due to correlation pattern changes,” says Greenig.

Nonetheless, Florin Court does have additional safety valves to control volatility. “We use a dynamic gearing approach that monitors volatility and correlation spikes in branches and twigs of the allocation tree, and automatically adjusts positions accordingly,” says Greenig. Moreover, the manager sets a conservative floor under its market-level volatility forecasts, even when realized volatility has been low.

“Black Swan” surprises can still come from fat tails, and Greenig seeks to truncate kurtosis through maximum diversification into markets such as Spanish electricity, Chinese stainless steel, and Chilean interest rates. “The program’s return profile is relatively non-kurtotic,” Greenig confirms.

Onboarding new markets

Indeed, notwithstanding these guardrails, Greenig is confident in the models and expects to, “Add more value from the “operational grunge” of bringing in new markets – and potentially onboarding them faster than some more bureaucratic organizations”. Florin Court do thorough operational homework before starting small positions in new markets, which can grow to full size within a few months.

Florin Court’s COO, who was Head of Investment Operations at Man Group, helped pioneer the offshore swap structure that is widely used to access Chinese futures markets, facing counterparties outside China who may have subsidiaries inside China. Over time swap costs have come down and Greenig judges that, “Savings from direct trading are not sufficient to cover disclosure and regulatory risks”.

Execution and instruments

The manager uses futures, ETFs, and swaps, generally choosing the most liquid instrument to access exposure. The split is roughly 40% exchange listed, 40% OTC and 20% hybrid, such as centrally cleared OTC markets. OTC commodities, where the physical market dwarfs the derivative, can sometimes be larger and more liquid markets than futures. Florin Court will not, however, take or provide physical delivery of commodities. 

Counterparty risk is carefully assessed. Florin Court initiated some exchange-listed cryptocurrency exposure in 2017, but this remains small; expanding it awaits more confidence over counterparties. There was no FTX exposure.

Trading is automated as far as possible, though there are also three full-time traders who can handle markets requiring a high touch. 

Firm culture

Florin Court’s first office is in London. Its second office, in Abu Dhabi, straddles European time zones and liquid Asian markets, and houses additional research, operational and technology activities. It sits in the Abu Dhabi Global Market (ADGM), which is an ‘offshore’ jurisdiction within Abu Dhabi, like the DIFC in Dubai. “The regulatory framework there is very similar and familiar to UK financial businesses, and their compliance regime, via FSRA, is relatively seamless with our UK FCA oversight,” points out Greenig.

Greenig takes pride in having had a very low turnover of both staff and investors. “We have an outstanding team. My partners David Denison and Anthony Vinitsky are amazing, and right across the firm, we have outstanding people. Folks are highly motivated and work hard, and the environment is constructive and supportive. We spend more time with one another than with our families, so I want people to enjoy their work. We hire with great care and really support each team member in their role. There is no contradiction between our focus on performance and our positive work environment – they go together.”

Investors are institutional and cover many types and geographies. About 30% of Florin Court’s assets come from seeder Brummer, the largest hedge fund manager in Sweden and Scandinavia. 

ESG

Florin Court benefits from Brummer’s dedicated Responsible Investment Team and Brummer’s active participation in the SBAI and UN PRI. For instance, thermal coal, carbon intensive utilities and controversial weapons are excluded from Florin Court’s investment universe and at the management company level office carbon emissions are offset.