Global macro has attractive opportunities in 2015 following on from 2014. In April 2015 some macro funds had their best ever month, having shorted German bonds on negative yields in what Bill Gross dubbed “the trade of the century”. This comes hot on the heels of the oil price crash in late 2014, which was the steepest plunge since the 2008 financial crisis, and bestowed billion-dollar profits on some macro managers. What makes macro most opportune is that markets are no longer all marching to the same “risk off/risk on” tune – witness coffee and cocoa both in strong bull markets last year.
Currency markets, which turn over trillions of dollars each day, are also throwing up the divergences that macro traders thrive on. The US dollar is in the ascendant on expectations that the Federal Reserve may finally raise interest rates, while the euro and yen have been weighed down as the European Central Bank (ECB) and Central Bank of Japan are pursuing aggressive quantitative easing policies. But accommodative monetary policy does not automatically weaken currencies: China’s central bank is also easing, having cut interest rates three times over the past six months, yet the renminbi currency continues to advance. Indeed, macro is always full of surprises – the Russian rouble currency was in freefall in 2014, but has turned out to be one of the top performers in 2015, and it is discretionary macro traders who are well placed to profit from these idiosyncratic moves.
In developed equity markets, leadership has shifted from the US to Europe, with equities seemingly moving inversely with currencies. Mainland Chinese equities are also exuberant, having doubled from their lows in October 2014, whilst other large emerging markets, such as Brazil, have been in the doldrums. After many years when emerging market bonds were perceived as super-safe, default risk is now stalking selected markets. Argentina defaulted in 2014, and there are fears that others may follow suit. Venezuela is viewed as vulnerable, while the election of Syriza in Greece has raised fears of a Greek default and possibly even a “Grexit” or Greece exiting the euro – something ranked as an acute “Black Swan” risk by some macro traders.
TFG Systems’ macro fund clients, including Thiel Macro, run by Paypal and Palantir co-founder Peter Thiel, are animated by the apparent normalisation of financial markets which had arguably been suppressed by Federal Reserve policies that dampened volatility for years post-crisis. Renewed policy uncertainty and divergent central bank policies are re-igniting the macro stage. TFG chief technology officer, Martin Toyer reflects, “For eight years central banks did nothing on interest rates but now they are doing something – and inflation expectations are also changing.” This is germane to TFG clients, such as Prologue Capital, that trade inflation-linked securities. Down in Latin America the inflationary genie has forced some central banks, such as Brazil’s, to raise interest rates, while Europe is haunted by the spectre of deflation and bond yields have touched the lowest levels on record, even reaching negative territory in some cases. Indeed, a handful of large companies have also issued debt at negative yields, and TFG Systems CEO Barry Fenwick opines that “credit spreads are the tightest ever, and equities are getting toppy after seven years.” He thinks a macro approach that can trade long and short across all asset classes makes sense.
An expanding macro investment universe
For instance, fixed income macro fund Prologue, TFG’s first client after TFG’s spin out from the NYLON macro fund in 2008, trades a wide spectrum of markets, and Prologue COO Duncan Tiplady says, “Prologue has found TFG can easily accommodate the core instruments that the Prologue strategy trades, including Treasury Inflation Protected Securities (TIPS), interest rate swaps, swaptions, and overnight index swaps (OIS).”
Clearly TFG, which is winning new clients in the US and Asia, has the versatility to handle the complexity of what sophisticated macro and fixed income hedge funds actually do in 2015 – and this extends well beyond exchange-traded futures. “The complexity of a macro hedge fund is infinitely higher than an equity hedge fund,” says Fenwick, who, like several of the team, spent some years supporting proprietary traders at Barclays Capital. Toyer, who was responsible for risk and market-making technology at Barclays Capital, elaborates how macro funds are trading on multiple platforms and also still do many trades on an over-the-counter (OTC) basis – the regulators have mandated that only some products must be traded on a trading platform, and there is often a desire to structure a trade with a bespoke pay-off profile.
Additionally, macro funds are trading a growing spectrum of asset classes. On top of the traditional mix of currencies, commodities, bonds, and equities, macro funds are taking active views on interest rate swaps, inflation-linked securities, corporate credit, mortgage-backed securities, variance swaps, VIX futures, and all manner of both plain vanilla and exotic derivatives of the aforementioned markets. This presents challenges for some risk systems that have gaps in asset coverage or in configurability – but not for TFG, whose DNA is clearly in macro trading, as the system was conceived inside the NYLON macro fund founded by renowned Barclays Capital trader, Alan Burnell. Explains Toyer, “An interest rate swap and a bond future have a similar risk profile, so you need a consistent approach to measuring their exposures, even though the valuation calculations for the two positions are very different.” This consistent view of assets from the ground up is the hallmark of how TFG has developed its systems, which have expanded over the years as TFG client assets have grown enormously.
German Bund plunge and Swiss franc surge
Even in the largest and most liquid asset classes, including G7 government bonds, the German Bund contract has in May 2015 displayed the greatest volatility in 24 years – placing a premium on real-time systems. Witness Ben Pugh, COO of fixed income manager Ovington Capital Management LLP, which has used TFG since inception: “We use TFG throughout the trading day to see where exposure and risk are, and where we are making and losing money. Real-time updates have been crucial in May, with some instruments experiencing large price swings in a matter of minutes due to volatility”.
The most violent market event in the first half of 2015 was, arguably, the Swiss franc de-pegging, which caused the demise of some macro funds. How did TFG gauge the risk of this currency? Clients can decide what look-back periods to use, including the pre-peg period, and the system is flexible enough to incorporate a wide range of historical and hypothetical stress and sensitivity tests, going well beyond simple Value at Risk. But a 20 or more standard deviation move such as the Swiss franc float – which saw the currency appreciate by 30% against the euro at one juncture in the morning – throws into sharp relief the difference between real-time and end-of-day risk systems. TFG’s real-time risk calculation capability is critical for some funds, particularly those that promise their investors compliance with risk parameters on an intraday basis, and not merely in time for daily, weekly or monthly reporting. The de-pegging took plenty of funds by surprise, and TFG’s real-time recalibration meant they were instantly alerted to the heightened risk environment.
The sharpest intraday market moves in decades are being blamed on the liquidity crunch in bond and credit markets, which is in turn ascribed to banks and brokers retreating from market-making and holding less inventory. Understanding how much of your risk can be immediately hedged with liquid instruments is a key feature of TFG. Does this real-time calculation have a voracious appetite for computing power? Perhaps surprisingly, it does not. Toyer argues that TFG’s real-time risk framework is more efficient because TFG only calculates the things that have changed; it is hugely wasteful to recalculate everything. Still TFG seems far more powerful than some legacy systems, as it was always engineered for the dynamism of the trading floor. Fenwick recalls how his former company, using another vendor’s system, did 40,000 interest rate derivative calculations in 10-15 minutes, using 400-500 machines. Now TFG can do 10,000 calculations in a quarter of a second on one machine – and this is partly because TFG was always designed for the purpose.
Time is money for macro hedge funds. On the front office side, Prologue’s Tiplady recalls how he was impressed by TFG’s “real-time risk, profit and loss, user interfaces and live VAR”. States Fenwick, “TFG is the only vendor risk system that is truly real-time while markets are open.” He acknowledges that some risk systems can do real-time risk for one asset class in isolation, but asserts that “none of them can do real-time for all asset classes together.”
Prologue was also attracted by user-friendly reporting. TFG outputs allow users to define how they want to slice and dice real-time reporting, which can be by currency, country, sector or many other axes. Complimentary client testimonials abound: “TFG is flexible, nimble and knowledgeable.” Another user observes how “Large service providers tie you in so you are stuck,” whereas TFG is not seeking to lock clients into long-dated contracts with notorious notice periods that could exceed the life of some new hedge funds! A further customer sums it up by saying, “You don’t want a large tech team; you want a cost you can manage.” TFG is thus viewed as a shared resource, and can appeal to early-stage as well as established funds.
Bespoke and global client service
In essence TFG was written by hedge fund managers, for hedge fund managers, and so was a buy-side system from the start.
TFG takes pride in its flexible responsiveness to clients, with updates to the system released every two months. TFG is able to add components with very swift on-boarding times, and has recently been rolling out customised modules such as specific risk reports and blotters for a new client in Hong Kong. This illustrates how TFG’s “Software as a Service” (SaaS) business model rewards long-term relationships: it’s a service, not a system. The up-front cost, including installation, is minimal, with nearly all of the overhead for funds being ongoing – and external. Clients do not need to have or build internal development capabilities, as the framework allows for rapid building of integration points, and can be hosted externally on TFG servers – or on the client’s own ones.
US and Asian offices now allow for even swifter response times. The acquisition of Risk Technology Solutions (RTS) in October 2014 provides an on-the-ground presence in the US, with RTS’s Barry Fenwick becoming CEO of TFG. The Indian office helps to provide platform support, customer service and testing in Asian time zones, and is staffed by seasoned programmers who have spent around 15 years in London or New York before returning to India.
Front to back to basics
TFG’s market coverage and adaptability are of clear value to front-office portfolio managers, but the system does not overlook the more routine, bread and butter needs of the back and middle offices, where attention to detail is a constant need. In 21st century finance, Straight-Through Processing (STP) matters just as much as Just In Time (JIT) does for modern manufacturing.
Says Prologue’s Tiplady, “TFG covers many aspects very well, whereas many other systems grew out of narrow areas. It makes sense that other systems have strengths in areas where they were originally conceived, such as risk reporting, order management or accounting, but can be less competent in their non-core functions. TFG is strong in all areas.”
TFG offers a front-to-back solution, starting with trade capture and going on to profit and loss accounting, risk, valuation, reconciliation and reporting. TFG touches every role in the C-suite, from CIO, to CRO, CEO, and COO – though not all clients need their own CTO given the support TFG offers. TFG is a buzzing hub, with spokes integrated into all of the leading prime broker systems (including Barclays, BAML, Citigroup, Credit Suisse, Deutsche Bank, J.P. Morgan, Morgan Stanley, Northern Trust, Societe Generale Prime Services and UBS) making it simple to capture trades, which are matched up with post-trade processing systems such as MarkitWire.
TFG can grab trades from myriad sources, which is particularly important for macro funds that trade on a wide range of venues and via different mediums. FIX Protocol may be very much standard, but TFG also captures trade data from non-FIX trade blotters, and in fact TFG can handle any API (application programme interface). Reconciliations with prime broker, custodian, depositary and administrator records are standard practice nowadays, and TFG Systems immediately flags up any exceptions that can then be investigated and resolved. Shadow administrators are becoming fashionable but can also be costly, so TFG allows for shadow accounting and most clients also calculate a shadow NAV as part of the reconciliation process. In this regard Prologue’s Tiplady finds TFG invaluable as he manages a lean operational team. Prologue does full shadow accounting in-house, using TFG for cash and trade reconciliations and calculating daily NAVs from the system, including expense, performance fee and management fee accruals, for various share classes and series.
One area where TFG does not need to innovate is valuation models. Toyer in general thinks that “valuation models are well understood, and are not really evolving, so we use the industry-standard models and focus on implementing them well rather than devising new models.” However, TFG is at the forefront of risk modelling and aggregation – something that was recognised when TFG won The Hedge Fund Journal’s “Real-Time Risk and Portfolio Management Award”.
Are negative interest rates, seen in Japan, the Eurozone and Switzerland in 2015, a spanner in the works of valuation models? “Standard models have been able to handle negative rates for years,” says mathematician Toyer, “simply by using a normal instead of a lognormal model, and TFG clients can choose their preferred model.”
Clearly valuation is one area where discretionary input might be necessary, as valuation sources nowadays can be drawn from multiple places: broker-dealer quotes, Markit pricing, or CDS reference data from Bloomberg – or, indeed, models. TFG is flexible enough to allow users to define their own data inputs such as choice of interest rate curves, for valuing level 3 or “mark to model” instruments – and on this topic Toyer has authored a white paper, entitled, “Collateral-Based Discounting”, which can be downloaded from TFG’s website. Here valuation subjectivity goes with the territory, and the values that TFG models generate can be compared with other third-party valuations to gauge dispersion.
The advent of CCPs (Centralised Clearing Counterparties) and Swap Execution Facilities (SEFs) does not, of course, resolve the differences of opinion around valuation of some instruments. To the contrary, some clients find that these new behemoths are creating an extra level of complexity, because valuations from the CCP or SEF can be quite different. A recent instance saw a client’s fund directors asked to sign off on a TFG valuation, which differed from the CCP valuation as the CCP’s value did not match any executable price. So TFG is not just used for shadow accounting – its valuations do feed into official and final net asset values for funds, typically at month end, but the system can also cope with daily valuations on liquid alternative such as UCITS or ’40 Act funds.
As with valuation, regulatory reporting and risk aggregation benefit from a holistic platform that keeps the data in one place. TFG provides all of the underlying data that is needed for regulatory reporting and then the managers decide how they interpret and aggregate the data. TFG clients are submitting returns for the SEC’s Form PF, the CFTC’s Form CPO-PQR, and ESMA’s AIFMD-related Annex IV, as well as Open Protocol reporting and commercial risk aggregation approaches.
Global macro hedge funds have always been TFG’s predominant client base, but thinking laterally hedge funds are not the only people who trade global macro. In-house treasury departments of corporates, insurance companies and pension funds are all doing some macro trading, as are sell-side desks. Right now many macro markets are in uncharted territory, while the number and complexity of tradable instruments seems to grow every year. In this environment, TFG is ideally positioned to cater for the most sophisticated macro hedge funds.