institutional insights - bainbridge partners€¦ · institutional insights december 2014 exists...

Eurex Group December 2014

InstitutionalInsights

Is trend back on trend?

It seems to be part of our human natureto constantly discuss and make statementson what is ‘on trend’ – be it fashion, art,music etc… and the financial markets areno exception. The one main differentialhere though is that trends are made ona quantitative basis and on statistics ratherthan simply qualitative measures. This atleast removes (for the main part) one ofthe largest issues, which is ‘who decideswhat is on trend’. In the financial industrythere is no single influential voice but the market itself.

In this edition we look at this very topic in our guest article provided by our regular contributor Katy Kaminski – ‘The return of the trend: It’s all about correlation’, which is based on her recentbook jointly written with Alex Greyserman, “Trend Following with Managed Futures –The Search for Crisis Alpha”.

The CTA space is heavily focused aroundtrends and has been strongly criticized forthe lacklustre performance over recentyears, with claims that the CTA market isdead in the water. Katy looks at the his-torical performance and trends in trendfollowing strategies and identifies corre-lation as a major influence on portfolioreturns. Correlations appear to have returned to normal levels in 2014, andthis is in parallel to the performance inthe trend following space.

EditorialCatherine Alexander

Mariusz NowakUniversity Warsaw

Antoine HaddadFounder and CIO,Bainbridge Partners

Kathryn M. Kaminski, PhDDeputy ManagingDirector, Institutefor Financial Research (SIFR),Affiliated Faculty,Stockholm Schoolof Economics

Renaud HuckHead of Buy SideRelations, Eurex Group

Catherine Alexander Vice President,Buy Side Relations, Eurex Group

What is inside(click to get there)

Editorial 1

Thought leadership 3

The return of the trend: It’s all about correlation

In conversation 6

Renaud Huck andAntoine Haddad aboutthe health of the managedfutures industry

Trading insight 11

Academic insight 14

Institutional Insights December 2014

www.eurexgroup.com 2

In recent months, CTAs have returned totheir days of former glory, outperformingmost other strategies, showing impressivesigns of recovery heading back towardsthe top of the pack in 2014. Volatility hasbeen a key driver of this – for most of2014 (and post-crisis) markets were veryflat and this had a knock-on effect ontothe managed futures industry. Marketswere crying out for some volatility andthen finally in October it arrived, injectingsome life into the CTA space.

For our interview in this issue I am delighted to welcome Antoine Haddad,Founder and CIO of Bainbridge Partners,a London-based wealth managementcompany, and Renaud Huck, Head of BuySide Relations at Eurex Group.

Antoine gives some insight into the struc-ture of the portfolios he runs at Bain-bridge, discussing their activities in 2014and plans for the company in 2015, as well as providing commentary on the health of the managed futures industry,on which he takes an optimistic viewpoint.

It seems impossible to escape the wordregulation when having any conversationwith a fund manager and this interview isno exception. Antoine discusses the impli-cations that EMIR will have on BainbridgePartners and the industry as a whole.Another key phrase that continues to appear when speaking on this topic isthe ‘futurization of the industry’, wherebyfutures contracts are developed as an alternative to capital intensive OTCproducts. This of course creates oppor-tunities for exchanges like us.

This leads onto the focus for this issue’s“Trading Insights”, where Renaud Hucklooks at one of the new products atEurex Exchange – EUR Secured FundingFutures – launched on 12 November2014. This contract is based on short-term repo transactions traded on EurexRepo’s regulated and active GC PoolingMarket and is the first pan-Europeancontract that references interest rates oncollateralized funding. This product com-plements our money market segmentand our EUR-denominated fixed incomefutures, extending our fixed income offering at the exchange.

Moving now onto another core productoffering at Eurex Exchange – equity indexes and specifically MSCI – we com-missioned a research paper by WarsawUniversity to explore how trading MSCIindexes futures can create a very attrac-tive strategy that generates less volatileand more stable portfolio results com-pared to the MSCI World benchmarkthrough Generalised Momentum AssetAllocation (GMAA). A summary of the paper and findings has been includedin this edition.

I hope you enjoy this edition of Institu-tional Insights. As always, I welcome any questions or comments you mayhave regarding the content of the maga-zine so please do get in touch with any thoughts: [email protected]

Catherine, on behalf of the team

Catherine Alexander

Vice President,Buy Side Relations, Eurex Group



Thought leadershipKathryn Kaminski

Kathryn M. Kaminski, PhD

Deputy Managing Director,Institute for Financial Research (SIFR),Affiliated Faculty, Stockholm School of Economics

1 See “In Search of Crisis Alpha: A Short Guide to Investing in Managed Futures” Kaminski, 2011.

the attention of both academics and investment managers to this classic andoften debated investment strategy. In the wake of financial disaster, trendfollowing strategies seemed to be one of the only hedge fund strategies able to capture the coveted crisis alpha.1

Following their exemplary performancein 2008, the years of post-crisis recoveryhave provided lack-luster but not terribleperformance for systematic managers.Figure 1 presents the yearly performanceof the Newedge CTA Index since 2000.From this figure, it is clear that the per-formance post 2008 has been somewhatdisappointing in relative terms while yearto date 2014 looks promising.

Across the managed futures industry, fingers have been pointed in various directions. The first and most obvious,yet ambiguous, culprit has been the recent low yield macro environment in-cluding quantitative easing, governmentintervention, and the global focus onmonetary and fiscal policy. Regardless of the type of crisis, in recent work by

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The return of the trend: it’s all about correlation

Trend following is one of the classic investment styles. “Find a trend and follow it” is a common adage that hasbeen passed on throughout the centuries.When there is a trend, follow it; whenthings move against you or when thetrend isn’t really there cut your losses.Despite the simplicity of the concept the strategy has roused substantial criti-cism from neoclassical economists. For decades, trend following has beenshunned as the black sheep or more ap-propriately the “black boxes” of invest-ment styles. The 2008 financial debacle,a year where many trend followers earned double-digit returns, roused

The main goal of a trend following system is to take divergent risks. A divergent risk taking strategy cuts losses and follows winners.


2 See “Is this Time Different? Trend Following and Financial Crises,” SSRN working paper, Hutchinson and O’Brien, 2014.

3 For a further discussion of the convergent divergent framework for risk taking, see Eurex Institutional Insights recent discussion in “Blending Convergence with Divergence” Kaminski (2013) or visit TEDx talk by Kathryn Kaminski available on youtube.com.

4 See “Trend Following with Managed Futures”: Chapter 5 Divergence and Tradability of the Trend, Greysermanand Kaminski, 2014.

5 MIT Professor Andrew Lo developed the concept of the Adaptive Market Hypothesis. The AMH explains that the concepts in evolutionary biology can provide the framework for understanding market dynamics over time.See Lo, 2004 and 2006.


The typical trend following system maytrade between 50 to 200 different markets. The size of these positions aretypically a function of the measuredstrength of a trend using some simplequantitative measures. Positions are alsovolatility adjusted so that positions in less volatile markets have an equal shareof the risk in a portfolio. The main goalof a trend following system is to take divergent risks. A divergent risk takingstrategy cuts losses and follows winners.This strategy is the mirror opposite of a convergent risk taking strategy whichdoubles up on losers and takes profits.3

A divergent strategy has positive fat tailsand positive skewness while convergentstrategies have negative fat tails and negative skewness. Consistent with the term divergent risk taking, a trendfollowing strategy profits from divergencein market prices. The financial interpre-tation of divergence is the process bywhich market participants or groups ofmarket species evolve and adapt to newmarket conditions.4 At odds with classicaltheories of efficient markets, in the worldof adaptive markets, market ecologiesare not perfect and from time to timeprices diverge and create profitabletrends.5 The goal of a trend followingsystem is not to necessarily predict a trend, the goal is to be ready to follow

Hutchinson and O’Brien (2014), they demonstrate that post crisis trend follow-ing strategies tend to suffer from poorerperformance than average.2 In theirwork, they go back 100 years and showthat this is true for many crisis periods inhistory, for example the Great Depressionor World War II. Put in simple terms, similar to how households and sovereignsare suffering to grow in the shadows ofpost crisis debt overhang, trend followingseems to lag in the aftermath of a finan-cial crisis as well. What causes this difficultperiod of performance? The answer towhy trend following has suffered fromdifficulty during the last few years maybe much simpler… It’s all about correla-tion. First, a look at what trend followingstrategies do and then an explanationwhy correlation really matters.

Trend following strategies systematicallyallocate risk across a large range of futurescontracts. Whether it is lean hogs, gold,or German bunds, each position is poisedand waiting for the next big trend.

http://www.eurexchange.com/exchange-en/about-us/news/thought-leadership-kaminsky-blending-convergence-with-divergence/739998



exists and there are many different tradesin the market. When correlation is high,the world becomes polarized and thereare only a few trades across markets. For a trend following system, when correlation is high, this is not good for diversification and it means that thereare only a few possible trends to capture.In a highly correlated world, an oppor-tunistic strategy such as trend followingfinds few opportunities and may under-allocate capital to the few that do exist.Figure 2 plots the inter market correlationsacross futures contracts. At a first glance,correlation in markets seems to exhibit a step function. Correlations skyrocketedin 2007 to 2008 and plateaued at ex-tremely high levels until they began todecline again in 2013. Correlations seemto have returned to normal in 2014, andin parallel performance has returned tothe trend following space. CTA strategieshave moved from the bottom of the packin the hedge fund space towards the topof the pack in 2014.

A short discussion of portfolio construc-tion brings us back to one of the core tenets of finance: diversification. Duringthe same period of high correlation acrossmarkets and difficulty for systematic strategies, equity markets have soared tonew highs. In fact from 2009 to 2013,the 5-year return for the S&P 500 Index is in its 98 percentile of all 5-year returnssince its inception in 1928. Few periodsin history have seen such tremendousbull markets. Yet, if history does happento repeat itself, when the long S&P 500

a trend when it occurs. As a result, thecore focus is on portfolio constructionand risk allocation across a diverse rangeof markets.

In portfolio construction, there are threeinputs: return, volatility, and correlation.We can consider how each of these threemay have impacted recent performancebeginning with returns. Throughout his-tory, there are always trends or at least a trend in some futures markets. The re-turn of trends seems unlikely to have impacted the overall performance of a trend following system. When we turnto the potential role of volatility, manyhedge fund managers find low volatilityenvironments difficult. Although thismay also be the case for trend following,futures markets are some of the deepestand most liquid markets globally – if posi-tions are volatility adjusted the level ofvolatility should be marginal. Third, we canfinally consider correlation. Correlation is a measure of relationship between different asset classes or contracts. Whenthis relationship is weak, diversification

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trade reverts, the losses for this one tradecan be devastating – this is when diversi-fication really matters. Systematic trendfollowing strategies are diversified acrossall asset classes poised to profit any typeof divergence in market prices. Regard-less of whether we see a bull market in

the near future, rages across currencypairs, or big moves in commodities, inter-market correlations are down and per-formance in systematic strategies seemsto have regained speed. Perhaps we are seeing the long awaited return of the trend.

In this issue Renaud Huck talks to Antoine Haddad, Founder and CIO ofBainbridge Partners, about the health of the managed futures industry, the implications of EMIR as well as currentindustry topics such as “futurization”.

Huck: Could you please tell us a bit about yourself and your role at Bainbridge Partners?

Haddad:My name is Antoine Haddad. I am the Founder and CIO of BainbridgePartners, a wealth management companybased in London. The firm was estab-lished in New York in 2001, and relocatedto London in 2008. We currently manageclose to USD 850m in assets, and have a total of 15 professionals on our staff.

I earned Degree in Electrical Engineeringfrom the University of Virginia in 1989,followed by aMasters Degree in ElectricalEngineering from the University of Michigan in 1990. I then worked as a commodity trader for Louis Dreyfus in the early ’90s trading Grains fromtheir main office in the Midwest of

the United States. From 1993 to 2001 I worked for Millburn, a CTA and quan-titative trading firm based in New York.

Huck: Could you please describe whatBainbridge Partners is?

Haddad: Bainbridge Partners is a wealthmanagement company focused on helping institutional and large privateclients manage both the alpha and betaaspects of their financial portfolios.

Bainbridge’s activities fall under thosetwo categories: pure alpha generationand dynamic beta participation. We havethus created two lines of products, onefor each of these two categories.

On the alpha front, we run a series ofsystematic proprietary trading strategiesin house, and a pure-alpha fund ofhedge funds.

In conversationRenaud Huck and Antoine Haddad

Renaud Huck

Head of Buy Side Relations,Eurex Group

Antoine Haddad

Founder and CIO,Bainbridge Partners

On the beta front, we focus on creating“dynamic beta” portfolios; these are effectively systematic, single-asset classand cross-asset class portfolios, builtusing diversified baskets of risk premia. –That is a departure from most beta portfolios that use geography and marketcapitalization as their main diversi-fication tool.

Our firm’s goal is to give large institu-tional and private clients access to a very “modern” portfolio constructionapproach.

Huck: What has been the main focus of Bainbridge Partners this year?

Haddad: The main focus of BainbridgePartners this year has been within the two separate activities that we have –the “beta” portfolio construction on one side and the “alpha” generation onthe other.

On the beta front, we have been workingclosely with CBP Quilvest, a Luxembourgbased private bank to launch two UCITfunds – the “Sequent GTAA – Cross AssetRisk Premia” and the “Sequent TAA –Equity Risk Premia” trading programs.

Both programs will be long-biased, butwill rely on risk premia building blocksto diversify their exposure to the variousasset classes they are exposed to. CBP-Quilvest chose to work with us as theypro-actively look for innovative solutionsfor their clients.

While various banks have successfullycreated “passive baskets” of “dynamicindexes”, our products will be better de-scribed as “active baskets” of “dynamicindexes”. What we are really saying isthat while most premia tend to have an attractive long-term return profile,they very often go through down-cyclesthat our tactical approach will try to capitalize on. Our products will focus on combining the various known riskpremia such as value, carry, momentum,etc. for each asset class, while using a tactical component to adjust the weightof each risk premium over time, accordingto the various environmental inputs wemonitor. To control exposure, the cross-asset product and the equity only productwill both be managed using an averageand a maximum VaR targets.

From an academic point of view, riskpremia such as value, momentum, carry(and many other premia that are welldocumented in academic research) pro-vide very efficient portfolio buildingblocks, simply because the correlations



“Bainbridge’s activities fall under those two categories: pure alpha generation and dynamicbeta participation.”

“Our firm’s goal is to give large institutional and private clients access to a very “modern” portfolio construction approach.”

among risk premia is generally low andrelatively stable. Their use in portfolioconstruction can help achieve more efficient returns than those achievableusing the traditional geography or marketcap building blocks that are commonlyused in many portfolios today.

Our two new products – the Cross Assetportfolio and the Equity Only portfolio,will use risk premia as their diversification

engine. The differentiating aspect these products have is their reliance on a tactical module that uses various macroeconomic variables, allowing theirexposure to the various risk premia tovary over time.

In addition to CBP-Quilvest’s client base,we believe our risk premia products will appeal greatly to Nordic and U.S.pension funds. They have already addedsome risk premia based products in the form of passive baskets, and are certainly ready to consider a tactical allocation to such risk-premia baskets.

Our focus on the “alpha side” is to inter-nalize some of the alpha strategies thatwe used to access via allocations to thirdparty funds. Instead of allocating the assets of our pure-alpha “Aperio MasterAlphaStrategy” product to external

managers, we are hiring portfolio man-agers to run those strategies in-house.This is helping us improve the trans-parency and risk monitoring clients arerequiring from their advisors.

This change is significant and shows our commitment and constant effort to innovate on the multi-manager side. It is our constant attention to risk thathas helped us post positive returns during the 2008 financial crisis.

Huck: The managed futures industry has been struggling during the past few years to generate alpha. What isyour reading of the situation?

Haddad: The managed futures industryrelies primarily on market trend and mo-mentum for its returns. I say “primarily”because there are some managed futuresprograms that have clearly expandedbeyond these factors and have managedto do better throughout this recent period.But the majority of managed futuresplayers have indeed been struggling dueto the recent low volatility environmentin most asset classes – and here we aretalking about ten to 15 year lows in foreign exchange or equity volatility.

Huck: How do you see the situationevolving? How do you see trend following evolving?

Haddad: Looking forward, I cannot imagine volatility in equity markets orforeign exchange markets, for example,



“ It is our constant attention to risk that has helped us post positive returns during the 2008 financial crisis.”

remaining near their 15 year lows at 12 percent and 5.5 percent respectively.The coming expansion in volatility willhelp two things: first it will help improvethe return profile of most momentum andtrend based managed futures programs,and second, it will increase the appetiteof long-biased investors for strategiesthat are more defensive and neutral.Both improved returns, and increasedappetite will be supportive for the come-back of trend following.

Huck: The current regulatory landscapein Europe is changing – with soon the implementation of EMIR. How doyou see your business growing in thesenew conditions?

Haddad: As most of your readers know,EMIR, which stands for “European MarketInfrastructure Regulation” is the EuropeanUnion regulation on derivatives, centralcounterparties and trade repositories. Its aim is to introduce new requirementsto improve transparency and reduce the risks associated with the derivativesmarket.

EMIR’s reporting requirements includepositions, collateral and valuation re-porting.While the ultimate responsibilityfor the accuracy of this reporting remainswith us as the investment manager, wehave delegated the day to day reportingresponsibility to our prime brokers. Ourprime brokers will report our positions,collateral and valuations to the trade

repositories on a daily basis while we, as the investment manager, performreconciliations between what is reportedby the prime brokers and what is repre-sented at the trade repositories.

We are fortunate in that our prime brokersare currently providing this service freeof charge. This is however not the casewith all service providers and is likelynot to be the case indefinitely with allprime brokers. We also need to considerthe time and cost incurred by us as the investment manager in agreeing the terms of this reporting with the primebrokers and setting up internal recon-ciliations. This process has not been facilitated by the fact that certain traderepositories have been overwhelmedand under-prepared for the amount ofdata being reported to them, which hasled to a back-log in the accessibility ofthe data on their portals. These back-logs give credence to the questioning ofhow useful this information will be forthe regulators, if it cannot be aggregatedefficiently and in a timely fashion.

It is yet another addition in a growinglist of regulatory burdens which are adding to the compliance and regulatorycosts to existing managers while also increasing the barrier to entry for newinvestment managers or the barrier to launch for new products of existinginvestment managers.



“Both improved returns, and increased appetite will be supportive for the comeback of trend following.”

On the positive side, however, EMIR isalso an opportunity to harmonize the waywe do derivatives. We hope its ultimateimpact will be to reduce counterpartyrisk and to create a level of transparencyin the exposure and open trading posi-tions that institutional clients will readwith a higher degree of clarity.

Huck: One of the major topics of the financial markets is the futurizationof the industry. How do you see Bainbridge Partners benefiting from it?

Haddad: When given a choice, Bainbridge, and more particularly theBainbridge’s Sequent product line ofquantitative trading strategies, has always preferred trading in futures ratherthan in the OTC markets. Bainbridge,and most hedge funds that look for liquid markets that have a standardizedtrading format will certainly benefitfrom what you call the “futurization” of the industry. It will enlarge the poolof potential markets they can trade, thus helping them create more efficientportfolios.

Huck: Finally, how do you see investors’needs evolving in the near future? Andhow will Bainbridge Partners help themto meet their investment needs?

Haddad: Institutional investors, in thecurrent risk compliance climate, will require a strong risk framework, im-proved liquidity, and full transparency.

As an exchange, you are trying to helpthem achieve this goal by bringing to yourexchange platform products previouslyonly available on the OTC market. Youare thus improving the counterparty riskmonitoring and liquidity of new products.

As a wealth manager, we are trying toanswer those same needs by buildingproducts that have those same character-istics: strong risk framework, improvedliquidity and fully transparent.

In our systematic programs, for example,we use very robust modelling techniquesto create products whose risk is managedvery tightly, and whose portfolio con-struction relies on mixing a series ofsimple market factor models with strongeconomic or behavioral rationale behindthem. We apply this methodology on allliquid asset classes.

In our multi-manager programs, we alsomonitor each external allocation for itscompliance with our main requirements,and we are evolving our allocations toinclude more strategies in the form ofmanaged accounts, where we have anintra-day access to risk parameters andpositions for the strategy that we employ.



“On the positive side, however, EMIR is also an opportunity to harmonize the way we do derivatives.”

What is the background to this product & market? • EMIR, Dodd–Frank, CRD4 & Basel III,but also IOSCO’s proposal for unclearedswaps have lead and will lead to a sig-nificant increase in the demand for cashand non-cash collateral and collateraloptimization by banks and non-banks.• Liquidity is generally expensive to ob-tain and even more difficult to securedue to balance sheet costs and concernswith regards to collateral, particular inmoments of market stress.• The traditional instruments used tohedge a repo’s interest rate risk, EONIAswaps, have exhibited a significantbasis relative to repo rates over the lasttwo years as unsecured financing andhence EONIA itself has become less relevant for bank treasuries as well asnon-banks.• On the other hand, the STOXX® GCPooling Deferred EUR Funding Rate isbased on more than EUR 40 billion ofdaily anonymously traded, centrallycleared OverNight, TomNext & Spot-Next GC Pooling repos for a broadrange of ECB eligible collateral.• Therefore, Eurex offers to its ClearingMembers and their customers a set ofsimple, standardized, Eurex-listed, cash-settled futures around the ECB reserve


Trading insightRenaud Huck


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GC Pooling Market: development of outstanding volumes

Renaud Huck

Head of Buy Side Relations,Eurex Group

Eurex Exchange’s EUR Secured FundingFutures are based on short-term repotransactions traded on Eurex Repo’s regulated and active GC Pooling Market.They are the first pan-European contractsthat reference interest rates on collater-alized funding.

EUR Secured Funding Futures comple-ment our money market segment as wellas our EUR-denominated fixed incomefutures. With this introduction Eurex Exchange offers trading opportunitiesalong the complete secured and unse-cured EUR interest rate curve. Users not only benefit from a wide range of efficient hedging instruments but alsotheir portfolios are eligible for significant margin efficiencies.

http://www.eurexchange.com/exchange-en/products/int/mon/eur-secured-funding


euro lending transactions, it benefitsthe market with an independent, trans-parent and rule-based interbank fundingindex.• The index establishes the volume-weighted average repo rate based onopen order book EUR OverNight, TomNext and SpotNext transactions in the GC Pooling ECB basket and ECB Extended basket with the samevalue date.• Today the STOXX® GC Pooling EURDeferred Funding Rate is the firstchoice in the pan-European interbankrepo market. The liquidity is twice the volume of EONIA and demonstratesthe shift from the unsecured towardsthe secured money market followingthe financial crisis.• The significant deviation between the repo rate and EONIA during 2012clearly shows the importance of the STOXX® GC Pooling EUR DeferredFunding Rate as the benchmark for interbank secured financing.

EUR Secured Funding Futures –key benefits & opportunities: • The first available instrument for trea-surers, repo desks, fund managers andcollateral managers to hedge againstfluctuations in euro secured financing(repo) rates and to permit to lock inrepo rates up to eight months.



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EONIA vs. EUR Deferred Funding Rate

maintenance periods which allows totrade or to risk manage the - CCP cleared collateralized fundingrate (interest rate risk), and - secured-unsecured financing/invest-ment spread (basis risk)for a first time, based on Eurex Repo’ssuccessful 114 member strong GC Pooling repo market with approximatelyEUR 180 billion of notional outstanding.• As short-dated cash settled futures, the initial margin requirements shouldbe low and the contract tradable by all of Eurex’s clients. Additionally, the futures should be eligible for cross-margining with other Eurex moneymarket futures.

The contract’s basis – transparent & secure:• The STOXX® GC Pooling EUR DeferredFunding Rate was designed as an alter-native to and to complement the un-secured interbank lending benchmarkEONIA. Representing the actual secured



• Allows users to hedge the basis riskbetween GC repo and EONIA/EURIBORinterest rates.• Is an efficient hedging or trading instru-ment for changes in the ECB’s monetarypolicy, since the contract is linked tothe ECB reserve maintenance window.• Enables spread trading against existingEONIA/EURIBOR futures and centrallycleared EONIA swaps as well as to bene-fit from portfolio margining throughEurex Clearing Prisma.• Best execution, price transparency andindiscriminate access to EONIA interestrate swap (IRS).• Features reduced capital costs and miti-gated risk as a result of Eurex Clearingas central counterparty.• Market-Making program available fromlaunch date.• Expanded functionality and minimal latency on our leading T7 trading architecture.

Now easy to manage: cash flow require-ments of cleared IRS positions In the new world of mandatory OTCclearing, daily mark-to-market valuationsof cleared IRS positions create fundingcash flow requirements.

The owner of an in-the-money IRS position will receive a cash amount fromthe clearing house and vice versa for the owner of an out-the-money position.In addition, the receiver of the cash variation margin (VM) is required to paydaily price alignment interest (PAI), i.e. EONIA for euro swaps, on the totalof the mark-to-market of his position.

Hence, the owner of the in-the-moneyIRS position will find it necessary to investthe VM received in order to finance the PAI. Given strict investment guide-lines and the inherent daily variability ofthe VM position, it is common to investthe funds in short-term repos. Unfor-tunately, the achievable repo rates are almost always different to the chargedPAI (EONIA) rates.

For more information on Eurex EUR Secured Funding Futures watch our video.

Generally, the in-the-money IRS holder is short the EONIA vs. repo interest ratespread and vice versa for an out-the-money position. Historically, we have observed that the spread has reacheddouble digits and stayed at elevated levels for a long time e.g. around +10bpsfor all of 2012.

Since 12 November 2014, the new EurexEUR Secured Funding Futures contractfor the first time provides the possibilityto hedge costs/investment rates of VMsand PAIs.

http://www.eurexgroup.com/group-en/newsroom/media/EUR-Secured-Funding-Futures.-Hedge-secured-interest-rate-risk./1128606





Academic insightMariusz Nowak

Generalized Momentum Asset Allocation using MSCI indexes licensed byEurex Exchange

Abstract The below presented research showsthat by using MSCI indexes and the Generalized Momentum Asset Allocationmodel one can create a very attractivelong-short strategy that generates lessvolatile and more stable portfolio resultscompared to the MSCI World bench-mark. The GMAA model allows the utili-zation of additional factors to capturemomentum and trend reversal to predictthe mid-term market conditions.

IntroductionAsset allocation is a portfolio constructiontechnique in which assets are selected to maximize the “risk to return” ratio according to the investor’s risk tolerance,objectives and investment time horizon.

Recently many asset allocation modelshave been considered such as momentum(trend following) or so called minimumor mean-variance models. Simple momen-tum strategy can be created by rankingassets based on last m period returns and then holding them for n periods. The performance of this kind of strategyis well documented by academics andconfirmed to be far superior to passive

methods (Faber 2007, Fama 2010, andmost recently Clare et al. 2014). A moreadvanced approach can be found in Butler (2012) who introduces the conceptof the Adaptive Asset Allocation Model(AAAM) integrating three factors: momentum, volatility and correlation.The most recent application of a gener-alized momentum model can be found in Keller, Putten (2013). The authors extend the momentum model towards a generalized momentum model, calledFlexible Asset Allocation (FAA), by addingnew momentum factors.

We propose the Generalized MomentumAsset Allocation Model (GMAA), whichcaptures two market phenomena: momentum and trend reversal. It is basedon the first four moments of weekly returns distribution described by mean,variance (standard deviation), skewnessand kurtosis.

The goal of our research was to find outwhether these factors can be used as predictors to construct a profitable investment strategy.

Mariusz Nowak

University Warsaw

AuthorsMembers of Quantitative Finance Research Group at the University of Warsaw:

Piotr Arendarski, Paweł Misiewicz, Mariusz Nowak, Tomasz Skoczylas, Robert Wojciechowski



MethodologyThe model is defined by linear function,which combines ranks of all the factors.Each rank has its own weight that waschosen in optimization phase (based onan in-sample period). Below is a briefmodel description:

1) For each time t in {0,..,T} all assets are ranked in descending order withrespect to four factors (weekly returnsmean, variance, skewness and kurtosis)and for each asset j a score Sjt is com-puted in a following way:

Sjt = w1R1 jt + w2R2 jt + w3R3 jt + w4R4 jt

2) For each time t in {0,..,T} all assets areranked in descending order with re-spect to scores Sjt ,

3) k assets with the highest and k assetswith the lowest score value form re-spectively: a long and a short positionin the portfolio in time t. Each asset is given an equal share in the portfoliocapital (1/2k),

4) Weights described in step 1 are chosenso as to maximize the informationratio of the portfolio over a certain period (called optimization window orin-sample period).

5) Chosen weights are used to obtainscores for t+1 period Sjt+1 to construct an optimum portfolio (in the mannerdescribed in step 3) for out of sampleperiod.

6) Steps 1 to 5 are repeated for the wholedata (T time windows) and final results are taken from all out of sample periods.

In order to find optimal weights duringthe in-sample period, we chose a grid search optimization technique, becauseobjective function (information ratio) isnot differentiable regarding wi and mayeven be discontinuous in some regions.

Overall, there are five parameters thatare not subject of optimization, and allexcept the fourth were analyzed in termsof the sensitivity of the model. They were:

1) Optimization step: 0.1 (default); 0.05;0.5; 1

2) Number of weekly returns observationsto calculate factors: 26 weeks (default),13, 52

3) Optimization window: 52 weeks(default), 26, 78

4) Rebalancing period: 13 weeks5) Number of chosen assets: 6 long and6 short (default), 3 long and 3 short, 9 long and 9 short



proxy real market conditions, transactioncosts on the level of 0.1 percent of in-vested capital are included in the results.

Performance metrics for the model (de-fault strategy) comparing to the bench-mark are presented in Table 1. Cumulativereturns of both strategies are similar butdefault strategy is less risky – annualizedstandard deviation is significantly lowerand has a higher information ratio.

Figure 1 shows the equity line for thedefault strategy and the benchmark. It is obvious that the default strategy’sperformance is very stable across thewhole period, while the benchmark’sperformance is more volatile. Figure 2 indicates that while the benchmark strategy experienced large drawdownduring the financial crisis in 2008/2009,the default strategy saw much lowerdrawdown during the entire period.

Table 1. Performance metrics for default strategy

Default model performance

Default strategyBenchmark

Annualized return

0.0360.046

Annualizedstandarddeviation

0.0550.183

Informationratio

0.650.254

Maximumdrawdown

0.0860.511

Length ofmaximumdrawdown

726

Net informationratio

0.5660.254

1,8

1,6

1,4

1,2

1,0

0,8

0,6

0,4

0,2

Default strategy Benchmark

Jun 04 Jun 05 Jun 06 Jun 07 Jun 08 Jun 09 Jun 10 Jun 11 Jun 12 Jun 13

Cumulative returns

Figure 1. Equity line for the default strategy versus buy and hold strategy

Results Bearing in mind that MSCI index futuresare still relatively new financial instrumentsand long-term historical time series arenot available, we decided to use MSCIindexes data. This choice allowed us touse a dataset containing 10 years ofweekly closing prices – from 1 January2004 till 28 February 2014. A buy andhold strategy on the MSCI World Indexwas used as a benchmark. In order to



0.7

0.6

0.5

0.4

0.3

0.2

0.1


0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 0.16 0.18 0.20

Annualized returnAnnualized risk

Figure 3. The risk to annualized return relation between the default strategy and the benchmark

0.0

-0.1

-0.2

-0.3

-0.4

-0.5

-0.6


Jun 04 Jun 05 Jun 06 Jun 07 Jun 08 Jun 09 Jun 10 Jun 11 Jun 12 Jun 13

Drawdown

Figure 2. Maximum drawdowns for the default strategy versus buy and hold strategy

Figure 3 shows that the default strategy’sreturn to risk ratio is more attractive thanthe benchmark’s. At a similar level as annualized return, default strategy hassignificantly lower annualized risk.

The results indicate that the default strategy outperforms the benchmark in terms of net information ratio which is 0.56 (0.25 in the case of the bench-mark). It is worth noting, that the maxi-mum drawdown of the default strategyis as low as 8.6 percent compared to51 percent in the case of the benchmark.This performance can be especially impor-tant for mutual funds managers whoseclients may withdraw the capital in caseof dramatic loss of funds.

Conclusion In this research project, we studied differ-ent variants of the Generalized Momen-tum Asset Allocation model. Perhaps the greatest benefit of long-short tacticalasset allocation is the reduction in vola-tility that accrues to this approach bybeing neutral to the market systematicrisk. This in turn leads to substantialreductions in the maximum drawdownwhich an investor may experience. However, the concern of a long-shortstrategy is still relative in performance to a benchmark. Results show that thedefault strategy produces much lowerdrawdowns and higher information ratiothan the comparable buy and hold strat-egy (MSCI World Index). Importantly,presented results include an approxima-tion of transaction costs that an investor

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may incur in the real market. This impliesthat the obtained investment performanceof the Generalized Momentum Asset Allocation Model for MSCI indexes isalso applicable to trading MSCI indexesfutures.

Bibliography1. Butler A. (2012) Adaptive Asset Allocation: a Primer, working paper,Macquarie Private Wealth

2. Clare A., Seaton J., Smith P., ThomasS. (2014) The Trend is Our Friend:Risk Parity, Momentum and Trend Following in Global Asset Allocation,Version: September 11th, 2014

3. Faber M. (2007) A Quantitative Approach to Tactical Asset Allocation,Journal of Investing, vol. 16, 69–79

4. Fama E. (2010) Size, Value, and Momentum in International Stock Returns, Journal of Financial Econo-mics 105 p. 457–472

5. Keller W., Putten H. (2010) GeneralizedMomentum and Flexible Asset Alloca-tion (FAA), Working Paper

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