“We developed an investment strategy that takes advantage of short-term market trends and volatility,” says Prakash. “We thought this would be a good way to generate uncorrelated returns and pure alpha. We apply this strategy to Asia since Asia has among the most trended and volatile equity markets globally. We also focused on this strategy because it is unique in the marketplace.”
MAPS is a fully systematic managed futures programme focusing on Asia’s most liquid equity indices. It uses price-based, short term models – including pattern recognition, momentum and reversion. It aims to create a long volatility profile to exploit extended trends and high volatility inherent in Asian equity markets.
The programme deploys 12 models across 10 indices (See Fig.1), dynamically adjusting net exposures based on market conditions, producing returns with low or negative correlation to major equity market indices. The programme features controls for system-level drawdowns and correlations to provide a portfolio with attractive risk/reward characteristics.
The strategy has several overriding investment objectives. The overall focus is on generating absolute returns in normal and stressed market conditions as well as producing non-correlated returns to equity markets and other hedge fund strategies, including CTAs. Monsoon is also seeking to maximise the MAR Ratio of annualised return to maximum drawdown. Putting all of these factors together is designed to provide investors with extensive portfolio diversification, strong alpha creation and compelling compounding of returns.
From November 2010 until end-May 2012 the strategy delivered a net annualised return of 13.1% with standard deviation of 11.2% in the 1X version (the strategy is also available in 2X version). The Sharpe ratio came in at 1.15. Gross exposure ranged from 45% to 201% with an average of 118%. Net exposure ran a range from +150% to -150% with an average of +18%, while the average margin-to-equity was 9% (in the 2X version, gross/net exposures and margin-to-equity are doubled). Correlation to the MSCI Asia-Pacific Index was -0.16 with a beta of -0.24 and correlation to the Newedge CTA Index was +0.14.
As an Asian-focused alternative fund manager, Monsoon has designed the strategy with an eye to the region. What’s more, there are relatively few competing systematic strategies operating in Asia, while big managed futures funds will only have a fractional exposure to the Asia equity derivatives market. Nonetheless there are several factors in the Asian market that are well suited to the strategy.
First, the equity derivatives market in Asia including Japan is the biggest in the world with nearly 40% of the market share in listed derivatives, according to data from the Futures Industry Association. North America ranks second at almost 33% with Europe at 20% and other countries a combined 8%. Size means the market is highly liquid with nearly $100 billion notional daily volume just in the 10 contracts that Monsoon trades. What’s more, this figure is growing by a healthy double digit percentage annually. It means Monsoon’s strategy should have plenty of room to attract AUM without pushing up against capacity limits in coming years.
Prakash likes the fact that the Asian equity derivatives market is very much driven by retail investors. He estimates that 40-80% of each different market is retail investor money. For a systematic fund this is ideal since trends are longer and stronger than they would be if institutional money were dominant. In this regard, foreign fund flows also have a noticeable impact as they tend to accelerate both volatility and directional trends.
Finally, the underlying economies, particularly China and India, are generally leading the world in economic growth. Higher volatility accompanies this, making the fund’s risk management and drawdown controls more attractive to investors.
In some respects, this is the second time round for Prakash. Monsoon was managing $1.6 billion in an India long-only small cap fund in early 2008 before the financial crisis saw around 90% of that money move out as investors redeemed. The firm was shaken but left intact. In response, Prakash and the investment team moved to rebuild by focusing on developing an absolute return, lower volatility product to sit alongside the firm’s traditional small cap equity fund. They decided that a systematic approach employing embedded risk parameters could cut drawdowns, while minimising risks related to liquidity, counterparty and operations.
The 32 trading systems are the product of five years of investigation, involving proprietary research, academic journals and working papers with ideas converted into sets of rules, codes and back tested. With 100 models trading the 10 indices, around 1,000 systems were created. The 32 currently utilised are what remained after the elimination of systems that lacked sufficient edge, had highly correlated returns/losses or failed to perform in other liquid markets such as the S&P 500 or Euro Stoxx. Monsoon keeps the process fresh with a semi-annual review that adds or deletes systems based on their stability, correlation and drawdown profile.
Each of the 32 trading systems is rated by correlation and drawdown to the other 31. Each one is allocated from 1% of the risk budget to 8% on the basis of the level of conviction. The strategy has a nine day average holding period for positions, putting it mid-way between a short-term managed futures manager and a medium to long term CTA. With 1,300 round turns per million in the 1X version, the strategy is positioned near the lower end of trade churn for CTAs.
“From a diversification stand point our strategy can make sense for investors,” says Prakash. He notes that the exposure is long volatility and the fund is convex in its returns, offering a good pay off in times of crisis.
“We believe we are one of the only Asia-focused systematic strategies out there – the vast majority of hedge funds in Asia are fundamental long-short and, due to their long bias, tend to generate correlated beta returns whereas we generate uncorrelated alpha returns,” he adds. “In fact, our beta to the MSCI Asia-Pacific Index (which is a good proxy for Asian equity market returns) is negative as is our correlation.”