If we review the first quarter financial performance, the dominant macro theme was the change Fed policy actions. The same could be said about the EU. No increase in rates and no strong trend to normalization. The new macro focus is on the choice of Fed governors.
Is the Fed independent? Should it be independent? Has independence been an important topic in the past? More specifically, should new Fed governors be biased to economic growth, consistent with current fiscal policies over expected inflation, focus on price stability? The current discussion associated with new Fed governors is nothing new. The Fed has always fought for as much independent as possible, yet the Fed is a creature of Congress.
Selected alternative risk premia showed strong performance during the first quarter. There is significant tracking error with the HFR risk premium indices versus individual bank risk premia swaps, but they can provide some suggestive rankings. This strong performance should not be surprising given the large reversal of with equity beta and the strong moves in global bond markets. A couple of major themes emerged for the first quarter centered around positive equity beta risk and falling volatility.
An analysis of the first quarter tells us a lot abut factor investing in the short-run. Foremost, the worst factors last year are the best for this year. Factor risks change with the market environment as shown through the global factor indices from S&P Dow Jones. Factor rotation occurs, but not clear that it is predictable. Factors effects also can be swamped by the impact of large macro events.
Bill Gross has retired and there already has been research to see if he was the Warren Buffet of bonds. His fixed income track record over the long-run cannot be easily be matched, but a careful study of his portfolio suggests that his gains were generated differently than the classic stock-picker. He may have generated alpha but he did it the old fashioned way in fixed income, he took on more sector risk. See “Bill Gross’ Alpha: The King Versus the Oracle” by Richard Dewey and Aaron Brown.
You are so smart. You have a great trade idea and you know it will be a winner, but there is only one small problem. For any trade you make, there has to be someone else on the other side of the trade. For every buyer, there has to be a seller. So for what you are doing right there has to be someone doing something wrong? That may not be exactly true, but any trader should work under the assumption that his smart money is taking advantage of less smart or “challenged” money. What is your advantage when you make a trade? We have looked at this before in “The three ways hedge funds make money”, but I find using the acronym BAIT, developed by Michael Mauboussin in “Who is on the other side?”, is a great way to describe this issue. The acronym BAIT stands for the possible advantages of a manager: Behavioral, Analytical, Informational, and Technical.
As we better understand the return generation process, we are able to dissect any set of money manager or hedge fund returns into its component parts. At a high level, any money manager can be divided into a set of risk factors or premia and alpha or skill. As a general conclusion, researchers have found that as investors get better at identifying risk factors, the size of alpha declines. We are able to attribute more returns to specific risks so the amount that is leftover as skill declines.
At a recent conference, I heard a large money manager say the following, “We do not market time, but we do take market tilts.” Unfortunately, no one was able to ask the manager to clarify the difference between tilts and timing. Aren’t they both forecasts?
An ensemble approach to modeling can be an effective way to get a good idea of the consensus and differences in forecasts on futures moves in the Fed funds. This is an effective alternative to looking at Fed funds futures and options as a market estimate.
Investors may be viewed as trend-follower because they chase performance, only picks recent winners, and sort on performance. However, trend-following professionals often exploit this undisciplined, casual, and unsystematic approach to trends through the investment scaling of chasers. Investor behavior driven by tracking the opinion of peers is a form of trend following and may create price trends; however, it is not the same as a disciplined approach to finding trade opportunities through rules-based behavior.
Any investor needs to know two things: what is the philosophy that drives his decisions; what is the philosophy that is driving the market as a whole. Are you price, fundamental, efficiency or narrative driven? Is the market currently price, fundamental, or narrative driven? Know your expectation mechanics.
I discovered from reading an informative piece on managed futures and CTA’s from HedgeNordic magazine that trend-followers will produce “crisis alpha” but not “correction alpha”. A crisis is defined as a significant and extended downturn while a correction is short-term drawdown. Unfortunately, one man’s correction is another man’s crisis. All crises start and end as corrections.
Many have held the view that central bank FX intervention is ineffective. It can be disruptive and have some temporary impact, but central banks cannot make currency markets do what they don’t want to do. Research using public data, a limited sample and mainly focused on floating exchange rate regimes, shows, at best, mixed value […]