The BNP Paribas THEAM Quant – Cross Asset High Focus fund (managed by BNP Paribas Asset Management) has received The Hedge Fund Journal’s UCITS Hedge 2023 award in two categories for calendar year 2022: Best New Launch and Best Multi-Strategy Fund (AUM > $300m), based on risk-adjusted returns.
Many systematic macro strategies apply multiple models such as carry, trend and relative value to multiple asset classes, and some apply most or all models to most or all asset classes. For instance, THEAM Quant – Multi Asset Diversified, a previous award winner, trades trends across several asset classes.
THEAM Quant – Cross Asset High Focus (TQCAHF) is more selective about which of its proprietary factor models are applied to which asset classes. Carry is applied to equity volatility and commodities; trend momentum models are traded in commodities and short-term interest rates, while relative value models extract alpha from currencies and equity volatility. There is no direct equity exposure beyond volatility.
If there are too many strategies the risk can be spread too thinly. It is a more compelling alternative to focus on selecting and combining fewer strategies.
Vincent Berard, Head of BNP Paribas Global Markets’ Product Strategy for THEAM Quant fund range
This addresses investor demands for diversification versus equities and bonds down 20% in 2022. TQCAHF anchor investor DWS’s Multi Asset Total Return team is seeking liquid alternatives with low long-term correlation to risky assets combined with positive long-term return expectations. And with risk free cash paying 4% or more, investors need a reasonably high volatility target to obtain a meaningful diversification benefit from a complex liquid alternatives product. The clients who collaboratively helped to develop and seed TQCAFH are comfortable with a volatility target of 15% and return potential of 10-20% per year. Henning Potstada, Co-Head of Multi Asset & Solutions EMEA at DWS, summarises: “We are very satisfied with the results and our investments into this product. It is the perfect combination of BNP Paribas’ strong quant investment capabilities and DWS’ Total Return philosophy”.
Head of BNP Paribas Global Markets’ Product Strategy for THEAM Quant fund range, Vincent Berard, argues that the objective requires a higher focus, high conviction basket of strategies: “If there are too many strategies the risk can be spread too thinly. It is a more compelling alternative to focus on selecting and combining fewer strategies and having a good chance that one or two of them will do really well in any year”. Thomas Graby, risk and portfolio manager in the Multi Asset Total Return team at DWS, cites 5 key objectives the team is looking for within the liquid alternatives space: positive and stable return expectation; ability to perform across different market regimes/cycles; low long-term correlation to equities and credit, and ideally a negative correlation to both asset classes in crash scenarios; as well as a fundamental idea underpinning the strategies. “All strategies within the TQCAHF toolkit tick most of these boxes,” Graby argues.
TQCAFH strategies were filtered using a quant screen of 65 BNP Paribas quantitative strategies in trend, carry (including term structure) and relative value (including long short), that are developed by the corporate and institutional banking (CIB) global markets side of BNP Paribas. Together with BNP Paribas Asset Management some of these strategies are selected using large teams of structurers, researchers and traders, experts in product engineering and synthetic replication, and are structured into funds including UCITS funds (mainly under the name “THEAM Quant”), swaps and managed accounts.
The quant criteria included lower drawdowns and truncating left tail risks, relative to annualized returns. “Therefore, a pure short volatility strategy would not fit, though there is a VIX trading strategy with long and short volatility exposures. The shortlist also excluded strategies with a structurally long equity exposure,” says Berard.
The process initially selected the best two quantitative strategies for each of the broad three strategy buckets, subject to overrides on asset class concentration. Commodities monopolize the top carry strategies, but diversification constraints led to equity volatility carry being selected. Currency carry was rejected because it has more drawdown risk and higher correlation with risky assets due to emerging markets exposure.
Some strategies that ranked highly on a pure quant screen, such as BNP Paribas Asset Management “quantamental” equity long/short and equity market neutral strategies, which have been profiled in The Hedge Fund Journal could not be selected given the specific profile of the portfolio. BNP Paribas Asset Management’s expertise and innovation in ESG and sustainability strategies is less relevant to a macro strategy such as TQCAHF, which does not own single corporate securities and reports under SFDR Article 6. The usual THEAM Quant ’s derivative overlays to optimize risk return in conventional asset classes were also not germane, because TQCAHF’s aims to generate an attractive risk reward profile without overlays.
The BNP Paribas THEAM Quant – Cross Asset High Focus fund received The Hedge Fund Journal’s UCITS Hedge 2023 award for Best Multi-Strategy Fund (AUM > $300m).
The six strategies in TQCAHF have partial but not full overlaps with various other THEAM Quant products but have been engineered for the TQCAHF objectives. “For instance, the short-term rates momentum model is also one half of the THEAM Quant – Fixed Income Diversifier fund (its other half, long/short government bonds, was not selected). Dynamic Risk Mitigation is one building block within the Dynamic Volatility Carry strategy. Commodity Carry and Trend have some overlap with the THEAM Quant – Alpha Commodity fund, though the strategies are not implemented in the same way,” explains Berard.
The strategies were not only picked for their standalone qualities, but also for how the combination interacts at portfolio level. The highest pairwise correlation amongst the six strategies is about 0.5 and most of them range between -0.1 and +0.2. This reduces volatility and also means that leverage or gross exposure of around 5 times is needed to maintain through the cycle average volatility of 15% over the medium to long term. Between launch and April 2023, volatility has averaged 15.8%. Realised volatility will fluctuate and is only constrained by the UCITS one month 99% Value at Risk ceiling of 20%.
The historical Sharpe of 1.38 of the six strategies taken together is very high, though it has been sustained out of sample in the first 18 months of the launch, with total returns of 30%1 and volatility near 16%. Realistically, Berard acknowledges that, “a long run Sharpe above 0.7 would be adequate for this sort of strategy”.
The selection process did give some consideration to back testing, in that a higher margin of uncertainty was applied to more recent strategy launches versus those with longer track records.
Additionally, the rationale for persistency of alpha through cycles is not only extrapolating past performance but is also based on a mix of behavioural and structural inefficiencies, exploited through a disciplined and systematic approach to avoid typical behavioural biases seen in human investors and traders.
The money market trend strategy trades trends in interbank deposit futures contracts in USD (CME SOFR futures) and EUR (ICE Euribor Futures). It is based on behavioural trend anomalies. “It has profited from forward markets consistently under-pricing central bank rate hikes. The steady upwards revisions to market expectations have created powerful trends,” explains Berard. The other trend strategy on commodities, takes long and short positions in energy, precious and base metal contracts, based on moving averages.
The commodity and money market trend models are relatively simple; the distinctive feature is rather the decision to apply trend to only these two asset classes.
“Carry in contrast is a more structural than a behavioural anomaly,” says Berard. The equity volatility carry strategy aims to “square the circle” of generating both positive or neutral carry, and a payoff from volatility spikes. This dynamic risk mitigation strategy is a relative value volatility strategy that to some extent harvests the premium of implied volatility over realized volatility, and uses it to pay for long volatility exposure. “It has one leg long volatility to replicate the delta of buying options on the VIX, and also a short leg selling puts on the S&P to help finance the long exposure,” explains Berard.
Some other volatility strategies use calendar spreads to try and mitigate the costs of long volatility exposure, whereas BNP Paribas trades the calendar spreads as a relative value profit centre. It trades long and short contracts on the VIX futures curve to optimise roll yields from the term structure slope. It will be net short the VIX under contango and net long the VIX under backwardation.
Term structure premia also provide the investment thesis for the commodity carry component, which trades energy and metals on a market neutral basis versus the conventional BCOM index.
BNP Paribas views its commodity strategies as potential hedges for both deflationary and inflationary tail risks. The manager expects that commodity carry could be quite defensive and generate outsized returns from a demand shock while commodity trend could do so from a supply shock.
The second relative value model, the FX value strategy, is essentially a valuation mean reversion strategy, owning undervalued and shorting overvalued currencies to wager on reconvergence. But its definition of currency valuation goes beyond a generic value approach based on baskets of goods and is very different and much more tactical than a pure PPP (purchasing power parity) approach that often works only over multi-year periods. The strategy is instead designed to profit over shorter time periods. “We use a five-factor market and macro model including equities, interest rates and commodities. The strategy holding periods can range from days to months and it often does better in a more volatile climate,” explains Berard.
It is important to understand the volatility-to-return behaviour of all strategies bundled together.
Thomas Graby, risk and portfolio manager in the Multi Asset Total Return team at DWS
With no direct equity strategies in the portfolio, there is no explicit reason for equity correlation and the historical return profile showed low or negative correlations to equities.
The short-term rates strategy can however have a significant long or short interest rate duration, though it is dynamically varied. “This strategy has been as much as 900% leveraged in Q1 2022, at maturities between one and two years, which equates to significant ten-year Treasury equivalents. However, as rates have risen the leverage has come down to nearer 400%. Consequently, the strategy incurred only limited losses from the 8-11 standard deviation event in March 2023 that saw the sharpest rate drops since the 1987 crash. There was no need for any top-level deleveraging because the strategy itself had already automatically deleveraged,” explains Berard.
As of April 2023, the short-term rates strategy has flat carry though it had been running negative carry at times in 2022. In broad brush terms, the expectation for TQCAHF overall is somewhat positive carry. Net short bonds exposure in the short-term rates strategy, and/or longs in lower yielding currencies in the FX value strategy, could contribute some degree of negative carry, but either or both of these could be outweighed by the positive carry from the commodity carry and VIX strategies or both. Realised carry from the two term structure strategies can differ from forecast carry, but it could be substantial: “Predicting the quantum of carry for either equity volatility or commodities is not straightforward as any static estimate would need to assume constant curve shape. But in approximate terms, ceteris paribus, commodity carry might make 10% at the sub-strategy level,” Berard estimates.
Trend and carry are complementary in several asset classes. “In 2022 persistent rate rises helped the money market trend strategy, while the associated strengthening of the US dollar hurt the FX value strategy, which was short the dollar. Yet FX value only lost 0.75% against a 30% gain for money market trend,” explains Berard. Carry also diversifies trend within commodities: “The carry strategy is short the front end when commodities are in contango, which can profit from a commodity crash that is steeper at the short end. In 2023 commodity trend has suffered a reversal which has been balanced out by commodity carry,” says Berard.
There is usually one really big winner and sometimes two in any calendar year, and given the weightings, they move the needle of performance. The calendar year attribution based on past performance simulations since 2008 shows a very positive skew; losing strategies never lost more than a single digit percentage and often less than one percent, while winning strategies made many times more. Dynamic risk mitigation contributed 41.72% in 2020, money market trend was 30.20% in 2021, commodity carry 18.15% in 2008.
Research explored various weighting methods including variants of risk parity before deciding to use relatively simple fixed weights reset monthly. Graby explains, “It is important to understand the volatility-to-return behaviour of all strategies bundled together. If all strategies show high returns, when their volatility is high, a fixed weighting scheme works better compared to a risk parity approach, where one would cut strategies when they tend to perform best. In contrast, if all strategies tend to post negative returns when their volatility is high (like equities do), risk parity works better. It is important to understand the volatility-to-return matrix of all strategies. Ideally, all selected strategies should demonstrate similar behaviour; if not, different weighting schemes can be used for different strategy buckets, based on their return-to-volatility behaviour”. Weightings are preset, partly based on Calmar ratios that were also used for the quant screens, with some over-rides to reduce equity volatility and increase bond exposure. Resetting monthly leaves some headroom for strategies to outperform and grow intra-month, before reverting to fixed weights for the next month.
In common with other systematic THEAM Quant products there is no performance fee and ongoing charges range between 0.25% and 0.76% depending on share class.