The Epsilon Diversified strategy resumed trading commodities in October 2021 for a large US OCIO (outsourced Chief Investment Officer) mandate. This started as a separately managed account but is now being migrated to an offshore open-ended fund, which opens up the strategy to other investors.

Metori runs dedicated Chinese futures strategies, China Trend Opportunities, and has also added selected Chinese commodity futures exposure to the offshore fund.

A time varying opportunity set

Metori tentatively estimate a potential Sharpe ratio increase of 20-30% from commodities, a large part of which could come from Chinese commodities.

Additional diversification does not of course guarantee better returns every year. “Commodities have enhanced the back-tested Sharpe ratio, but it was very time varying. Commodities were particularly helpful since Covid, but over other periods they may have been flat and even detracted from returns in some periods such as 2015-2019,” reflects CEO and co-CIO, Nicolas Gaussel.

Similarly, Chinese futures have been additive in some periods and detracted in others. According to Metori’s China trend index, in 2015-2016 Chinese futures generated markedly better trends whereas between 2021 and 2023 global trends beat those in China. “We do not judge that this recent underperformance represents alpha decay in Chinese futures, because the opportunity set fluctuates. The lack of synchronization between Chinese and global futures increases the diversification benefits,” says Gaussel.

Epsilon Diversified exposure to commodities also varies with the opportunity set. Of total margin to equity around 20-25%, 20 to 50% could be devoted to commodities.

The Epsilon Diversified risk budget allocation to China has ranged between 0% and 25% of the total allocation. There is no cap on China exposure per se, but a margin to equity cap per contract indirectly limits China exposure.

Access routes for Chinese futures for different vehicles

Though Metori has QFII (Qualified Foreign Institutional Investor) access, the firm is currently using several internationalized futures for Epsilon Diversified. “This is partly to avoid complexity and uncertainty around the Chinese tax treatment of capital gains, which could complicate the monthly NAV calculations since there is only clarity at year end. The Chinese authorities have in fact offered informal assurances that the tax would not be applied, but in the absence of a written guarantee we would rather employ an abundance of caution,” says Gaussel.

The number of internationalized futures has grown to 15 in October 2024. Metori Diversified started with 7 and now trades 9. Metori does not trade all of them because contracts such as gold or copper that have a Western equivalent may be interesting for arbitrageurs but offer limited diversification benefits for directional traders. “The objective is to focus on futures unique to China, such as steel rebar, PTA and polythene. Liquidity is the first criterion and diversification is the second,” says Gaussel. Metori are aware of the general push to open up Chinese markets, and internationalize more futures, but do not want to predict the exact speed or number of futures that will eventually be internationalized.

China appeals in part for the huge size and liquidity of its commodity markets. In aggregate, daily volumes are two thirds of the US level and much larger than in the UK. Of the largest 8 global exchanges with daily turnover above $1 billion, China has 3, in agriculturals, metals and energy, as shown in Metori’s roundtable presentation at the CASAA Family Office Summit. Comparing individual contracts, volumes for the largest Chinese commodity futures are now like those in the US and Europe (see Fig.2).

Beyond commodities, Metori also trades the CNH Offshore Chinese currency contract.

In dedicated local Chinese futures programs, Metori now trades 42 Chinese futures contracts, up from 34 a few years ago, listed in Dalian, Shanghai and Guangzhou. Markets such as apples and eggs are now becoming liquid enough. Unique Chinese futures, such as manganese silicon, eggs, pure terephthalic acid, glass, bar steel and apples are traded by Metori locally.

Metori understands some investors are worried about repatriation and political risk, so will proceed cautiously and gauge investor appetite before contemplating adding the QFII contracts, traded via local brokers and clearers, to offshore funds.

Adapting analytics to Chinese markets

Chinese futures require tailored analytics to allow for time zones and pricing conventions.

The realized distribution of returns used for covariance matrices needs to account for time zone differences to accurately assess quantitative risk. “A naïve correlation matrix can result in the wrong conclusions: some contracts will appear to be more lowly correlated than they really are, and others more highly correlated than is really the case. We have developed methods to systematically address the time differences,” says Gaussel.

Metori has produced a research paper shared with The Hedge Fund Journal showing how the use of synchronous or asynchronous data – and data with different time lags – can change the correlations. The results are quite dramatic: average correlations using one method might be around 0.25 against nearer 0.75 for another method. For some markets and some time periods, one method of calculation can even produce a negative correlation while another shows a positive metric. The size of the differences does vary between markets and methods, and over time, but the gaps show no signs of disappearing since 2012 when the analysis begins.

Additionally, Chinese settlement prices are based on VWAP (volume weighted average price) rather than the last price. “This results in lower volatility than intraday pricing and again we need to make adjustments to compute statistics,” says Gaussel. Metori do not actually trade at the VWAP settlement price, but it is still very relevant as an execution benchmark.

This is one example of the detailed trading rules that Metori has analysed for each of the exchanges they trade on, such as the Dalian Commodities Exchange, Shanghai Futures Exchange and Shanghai International Energy Exchange. The rulebooks are available in English.

‘Alternative markets’

The investment universe has widened from about 70 to 90 contracts. Though Chinese futures can be described as ‘alternative markets’, this very broad and rather subjective umbrella term also includes some contracts, including non-exchange traded OTC underlying markets that Metori avoids. “We stick to liquid listed markets,” says Gaussel.

Metori is monitoring a variety of commodity markets including natural gas, electricity and carbon emissions for potential additions, but do not view the size or composition of their investment universe as the main driver.

Model refinements

Parallel to the widening investment universe there has been some incremental innovation, though the core of the approach has remained consistent. Metori’s distinctive trend following approach has been applied since the latest model was introduced in 2012. It has shown a 70% correlation to trend following indices but has generated better risk-adjusted returns than most CTAs with shallower and shorter drawdowns. The superior risk management has partly arisen from using shorter lookback periods for measuring volatility and correlation, which have alerted Metori to the need for risk reduction and rebalancing in periods such as around Covid in 2020. Turnover can shoot up when the need arises, though the associated transaction costs are carefully optimised. The return profile has repeatedly earned the strategy recognition in The Hedge Fund Journal’s UCITS Hedge awards.

Metori is distinguished by its approach to measuring correlations, and by asset class agnostic allocations. It has an open mind about changing patterns of correlation and can find them within or between asset classes. The models home in on clusters of correlations across multiple markets and arrive at relatively concentrated books subject to some position and factor exposure caps. Perhaps counter-intuitively, Metori contend that their portfolios have truer diversification than strategies holding a larger number of markets: on average three times as many independent bets as a risk budget model.

This philosophy and approach have been only marginally refined since 2012. “The main improvements have been to the methodology for rebalancing between contracts based on the interplay of correlation and strength of trends. We have also introduced improved infrastructure and algorithms for more efficient trading, position taking and execution. We work with brokers to select appropriate algorithms for specific markets,” says Gaussel.

2024 performance divergence

Metori paradoxically maximises diversification yet holds fewer positions, based on correlation patterns. Over shorter periods, the more focused book, with lower correlation also allowing for higher gross exposure, can result in some divergences.

Performance in 2024 has been well ahead of trend following CTA indices despite a somewhat more difficult August. This does not however mean that Metori should be seen as a “high beta” CTA as over longer periods the pattern is different. In some other trend reversal months, such as November 2023, Metori also outperformed. In August 2024, Metori had substantial positions in the Euro, Yen, Nikkei and SOFR. Equity exposure was cut in Japan and Taiwan, but it was maintained in other global equity markets. SOFR and SONIA interest rates saw seven standard deviation moves and the strategy cut and reversed from short to long interest rates in August. Margin to equity was reduced from 20% to 17% over the month. At the time of writing, the Epsilon Diversified program was outperforming the SG Trend Index by 12% while the UCITS fund was outperforming it by 5%.

Investor base

Since January 2024, the offshore Epsilon Diversified fund has led asset raising efforts in North America. The choice of vehicles reflects investor preferences. “Europeans like a regulated UCITS but might want to exclude some or all commodities. They might not be able to get exposure to agriculture for example,” says Gaussel. In Europe, Metori is contemplating launching a UCITS version including commodities.

Other investors may prefer accounts with a higher volatility target to be more cash efficient. Metori has not yet seen interest in variants that are constrained to zero equity beta or zero equity correlation.

In November, Metori’s new subsidiary in the US opened, a venture led in collaboration with a veteran of the CTA industry, Michel Serieyssol. This noteworthy development marks a significant step in its expansion efforts within the US market. A US domiciled vehicle may be launched for qualified investors. Metori would only look at a ‘40 Act structure in partnership with a platform or other provider.

Metori closely monitors the fluctuating opportunity set for trend following, based on its recent Sharpe ratio and diversification within the investment universe. Commodities and Chinese commodities will nearly always improve diversification, and sometimes additionally enhance returns and Sharpe ratios.

Assets of EUR 650 million leave abundant capacity for these highly liquid strategies.