Systematic Core Macro

What were the major recent events and impacts on your asset class?

So we've seen the US economy remain strong over the summer, which has led to concerns that the Federal Reserve won't be actually reducing rates anytime soon. And at his recent speech at Jackson Hole, Fed Chairman Jerome Powell has restated the FOMC's commitment to a 2% inflation target and the intention to very carefully manage both the economic situation and also labour market progression. Now, one of the consequences of this has been a very sudden sell off in US bonds, with yields spiking to levels not seen since 2007. Now you've also seen a sell off in European bonds, as the European Central Bank (ECB) has also continued to hike rates. Now, this combination of increased interest rates and heightened market volatility has led to a broad strengthening of the US dollar over the quarter. Meanwhile, elsewhere in FX, you've seen a sustained decline in the Japanese yen. And actually, this has been despite the Bank of Japan loosening their yield curve control policy to try to arrest this decline. Elsewhere, you've seen equity markets remain stagnant, with most major global indices broadly down over the quarter.

Other interesting assets over the quarter have been commodities. We've seen a very solid rally across many energies, and this has been prompted by the major Opec+ leaders, which are Russia and Saudi Arabia, offer an extended series of output cuts. And this is despite a backdrop of very, very high global consumption. You've also seen very strong rallies in grains, particularly wheat, as Russia has announced its intention to attack any ships accessing Ukraine through a previously agreed supply corridor in the Black Sea. However, subsequently to these strong rallies, you have seen the price of wheat decline somewhat as Russian wheat production has exceeded expectations. So we're currently living in a very difficult market environment for traditional investments. Investors, when asked, they are showing concern about increasing inflation, increased interest rates and subdued GDP growth figures, essentially asking and wondering where we are in terms of the broader economic cycle.

What can your asset class offer in the current environment?

So there have been a number of challenges put in front of investors in recent months. And these have come from many different sources, and they have caused various changes in expectations throughout the year. So, for example, we started out the year in January with the consensus of an imminent recession, which did not materialise; not yet at least. China was expected to reopen with its economy working at full capacity and that hasn't happened. And that had repercussions on the prices of a lot of underlying assets, commodities in particular. And the more recent slowdown and stress in the property market in China, again, did not help in that regard either. In September, despite inflation figures proving quite sticky, a lot of investors started pricing in potential rate cuts in the US. And that is highly debatable and certainly not in line with what we're seeing from other major economies such as the UK and the EU. And as Chris mentioned earlier, oil prices have rallied in recent months, driven by supply side pressure such as the announced production cuts from Opec+ countries, but also on the back of high levels of consumptions globally.

So, unlike traditional investments, managed futures and CTAs, through their systematic approach are better positioned to capitalise on the moves that we've seen in markets such as commodities, bonds and currencies, hence able to generate positive returns in different market environments or environments, difficult ones like the ones we're living in right now. The fact that these investment strategies also go, let's say they invest through futures markets, means that they have the capability of tapping into hundreds of different markets and puts them in an advantaged position compared to traditional investments in terms of diversification as well. There are other challenges facing traditional investments at the moment, especially given the higher interest rate environment we're in. Cash intensive, fully funded strategies are facing more challenges because of the increased cost of funding, and this is not necessarily the case however, if you look at carry strategies or rate cycle products or alternative market commodities investment through managed futures.

What is your outlook in the near and medium term?

So as systematic investment managers, we don't express views or make predictions about the markets. We are firm believers in the soundness of the investment process and the capability of our strategies and this approach to deliver positive returns under a number of different market environments. Trend following is one of the typical investment approaches in our space, and this is a clear example of a strategy, of an approach, that has benefited from the environment, or higher volatility, or more divergent status of global markets. And this was particularly true last year. Now this year is slightly different; we've had periods of times where trend following strategies have suffered, but conversely, value-based approaches have benefited. And likewise there were markets which proved to be more challenging than others for systematic investors. So now the big takeaway here is that one can never have too much diversification. So whether it's through the deployment of a number of different uncorrelated strategies, or whether we're talking about the breadth of the investable universe of underlying assets, the focus of the systematic investment manager is that in its development research process, is that of maximising the number of orthogonal opportunities.

Is there one chart you’re currently monitoring closely?

As systematic investors, one of the things that we are very focused on is the amount of diversification that's available through the markets that we trade. Now there's different ways in which we can measure this, but one of the ways which we like is to look at the number of interdependent factors that are present in a particular universe of assets. So we're going to show an example of this in the chart on the screen. Now what we've got here is three different asset universes. We've got a universe of the 10 most liquid equity index futures. So this would include markets such as FTSE, Dax and the S&P. We've got a universe of G10 FX markets. And we’ve also got a universe of the top 10 most liquid commodities, which include markets such as WTI crude, aluminium or US corn and wheat. And what we're showing for each of these markets is how many independent factors are present in each universe. Now, what you can see is a number of areas. For example, if we look at equity indices it's typically much lower than it is for commodities. Now in each case, even though we've got 10 assets in the universe, we typically expect to see a number of independent factors which is much lower, in this case somewhere between two and four. And this is expected as many of the assets in a particular universe will have some similarities. For equities, which is generally the most constrained universe that we see, the number of bets is lower. And this is because we have US equities, Asian equities and European equities, which are generally behaving in a fairly similar way. Conversely, in commodities, you often have a much more diverse set of markets across energies, agricultural and metals. And we can see that the number of independent factors in the universe is quite a bit higher.

Now, the other thing that we can see is how it changes over time. And looking at commodities in particular, what you can see is if you go through the Covid epidemic in 2020, you can see a compression in the number of independent factors in the universe coming down really quite substantially. And you can also see a very similar occurrence as we see the onset of the Russian invasion of Ukraine. Again, the number of independent factors in the universe reduces substantially. And only now it's starting to increase, which is something that we want to watch very carefully, where we're considering the amount of diversification that's available across the universes which we trade. Now, from our perspective, we'd obviously like to see a larger number of independent factors, but this is giving us more diversified opportunities for our models to trade. Now, in a realistic portfolio we're going to be trading many more markets. Typically we're trading 100 plus diversifying markets. So we're getting access to many more independent factors than we're showing on the screen. In addition to this, one little known property of many systematic styles of investment is they can actually provide diversification over and above the diversification that's present in the universe itself. And this is something we talk a bit more about in one of our white papers, which is called Diversification in Trend Portfolios.