Mark: The models which drive the JB Quantitative Currency fund have formed a key part of our foreign exchange overlay strategy for funds such as the JB Absolute Return products for several years now. In 2008, we decided to launch the JB Quantitative Currency hedge fund as a stand alone product. It was launched in March 2008.
How does the fund compare to other quantitative/systematic funds?
Mark: We feel our fund is a little different to many of the other systematic FX funds currently out there. We have taken both of our years of experience in discretionary foreign exchange trading as well as input from other colleagues at Augustus to create several models which are driven by fundamental macro-economic and financial variables. The models systematize the way a discretionary trader might approach foreign exchange markets and as a result are very intuitive.
Unlike many systematic funds, we do not employ trend-following or ‘break-out’ models which are based on the price of the security being traded. The range of models we use also means we do not rely solely on one methodology or one trading timeframe.
What is your investment/trading philosophy?
Mark: We believe that over time currency markets are driven by macro-economic and financial variables. These variables are quantifiable and can be systematized allowing profitable trading models to be created.
However, for certain periods of time, economic fundamentals are less of a driving force (or are even ignored completely) and other factors such as risk appetite or market sentiment dominate the market. We have shown that if the models can correctly identify such market environments, they will produce stronger and more consistent returns. Finally, we operate a rigorous stop-loss policy for the fund. Each model has its own monthly hard stop-loss limit.
Can you tell me more about the various models in the fund?
Mark: There are four models in the fund – two of which have two sub-strategies – giving six trading machines in all. The models are as follows. Fundamental Momentum tracks changes in one currency’s fundamentals relative to another currency and goes long or short accordingly as long as the economic/financial environment is viewed as appropriate. The appropriateness of the environment is measured in two ways (hence the two sub-strategies) – through a credit conditions index and through a volatility index.
The second model is Environmental Carry which, as the name suggests, goes long ‘FX carry’ only when the backdrop is conducive to strong carry performance. This model also has two sub-strategies – each using a different environmental filter to determine if the backdrop is appropriate for carry.
The third model buys/sells a currency when there is a significant positive/negative change in sentiment towards it over a very short period of time. The model typically closes its position relatively quickly, giving this model the shortest holding period in the fund. The final model buys or sells the ‘core’ FX markets (which we define as US$, , CHF, and ) versus the peripheral G10 FX markets based on a signal which is provided by a combination of the risk backdrop and the trend of the core FX markets relative to the periphery itself. This is the only component of our models which uses the trend of the instrument itself as part of its signal.
You mentioned you had a rigorous stop-loss policy. Can you describe it in more detail?
Tom: Sure. As we mentioned earlier, each model (or sub-strategy within a model) has its own monthly stop-loss limit of 3%. If this stop is triggered, that model is stopped out for the rest of the month and the following month. Even if all models are stopped out and experience poor slippage on those stops, it is extremely unlikely that the fund will ever lose more than 5% in any given month which is very important for our clients and for us as fund managers. In our backtest period (going back almost 10 years), there has been no month when more than four of the six models/sub-strategies have been stopped out. Even four models/sub-strategies stopping out is a very rare occurrence.
When a monthly stop is triggered, why does the model remain stopped out for the following month?
Tom: We have found that the performance of each model exhibits a reasonable degree of serial correlation. This makes sense to us on an intuitive level as it seems each model’s style of trading can fall out of favour temporarily (say two to three months) as the market shifts its focus from one set of drivers to another.
Conversely, if a model is profitable in a given month, its leverage is given a one-off increase until that model has a down month. We view this money management strategy as akin to a bank or hedge fund re-allocating its risk budget from loss-making to profitable traders. This money management strategy gives stronger and more consistent returns over time.
Given that the models all employ fundamental economic and financial variables, how correlated are they?
Mark: We believe one of the fund’s strengths is the limited (and at times negative) correlation between the models. An example of this is last September and October when the Fundamental Momentum model had two of its best ever months (in large part from being short the Australian dollar) whilst Environmental Carry lost money and wasstopped out. The blend of the four models and two sub-strategies has far superior risk/reward characteristics than any individual model itself.
Your firm has two currency hedge funds – one quantitative and one discretionary. Why not combine the two skill sets?
Tom: Both currency hedge funds have been profitable since launch but the correlation between the two funds is not especially high. We view the two funds as complementary but prefer to leave the decision as to which one to invest in up to the client. In our view, they should invest in both!
Mark Dragten has been with the Julius Baer Group since 1999. In January 2005 he joined Augustus as a currency portfolio manager. He currently manages the JB Currency Hedge Fund Quantitative Segregated Portfolio. Prior to this he built systematic trading strategies to trade both proprietarily as well as to successfully market foreign exchange to institutional and private clients. Mark has a First Class Honours Business Studies degree from Stirling University.
Tom O’Shea has been employed in financial markets since 1993 as an economist at Yamaichi (1993-1995) and as a fixed income strategist at Comerzbank (1995-1997). Tom joined the Julius Baer group in 1998 as a portfolio manager. Since 2007, he has contributed to the Absolute Return Fund and has been part of the JB Currency Hedge Fund Quantitative team. Tom has a BSc in International Business and Modern Languages from Aston University.