- The below article is deemed too important to allow it to get lost in our usual series "Press Snips".
- Though this article has been published in the widely read periodical "Hedge Fund Insight" it does describe the reasons for our strong returns last year and our view on commodities, currencies and equities for 2014.
- Our previous article was in the top 5 of most read articles of 2013: (http://www.hedgefundinsight.org/top-hedge-fund-stories-of-2013/).
- The least one can take out of the below article and others about us in Hedge Fund Insight is that the trading process is research intensive and requires input from various disciplines from economics and statistics to politics and psychology. Finding the trade ('Trade Entry'), 'Risk Management' and 'Portfolio Construction' are the most important factors to consider in making investment decisions.
- Remember: It really is all about being the Casino, not the Gambler!
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Gold, the Yen, Upside in Equities and Petroleum Week With
Archbridge Capital
on
In this article Simon Kerr, Publisher
of Hedge Fund Insight, has a Q&A session with global macro manager Hakan
Kocayusufpasaoglu, CIO of Archbridge Capital.
Hedge
Fund Insight: You
had a good year in 2013, with your macro fund up over 19%. In which asset
classes did you make the most money, and how much leverage did you have to
carry to get those returns?
Hakan
Kocayusufpasaoglu: Even though our instruments are leveraged since they are
exchange traded futures etc., we do not utilise leverage for our portfolio, and
we manage our risk very carefully. In fact risk management is the most
important part of trading for us and this culture is imprinted into all
Archbridge Capital personnel. In terms of asset classes we tend to have
differing strategies: Macro trades in one camp and Relative Value trades in the
other. Last year 70% of our profits came from Macro trades, like short
Treasuries or short the yen vs. different currencies (as discussed in this previous article), including the US$. But
in other years Relative Value trades dominate. The mix of both allows us to
have a higher return for a given risk level and has helped to keep our Sharpe
ratio above 2.3. In terms of asset classes, we have seen last year a
proportional allocation between bonds, FX and commodities and equities. By a
tiny margin FX and commodities contributed most to our p&l last year.
Hedge
Fund Insight: Many macro managers made little from commodities last year.
Did you have one dominant view or trade? Which commodities did you make money
in?
Hakan
Kocayusufpasaoglu: We did have a few prevalent views about commodities last year.
The first had to do with gold: Most people look at gold as an inflation or
recession hedge but the main driver of gold according to our research of the
gold price over last 100 years is real interest rate levels. When real rates
turn negative and are expected to remain there for long periods of time it
usually creates a gold rally, while the opposite causes the gold price to fall.
As we have stated in the media, we believed that QE reduction is in effect a
reduction of negative real interest rates and that the gold price would be
falling from the highly elevated prices of US$1900/oz. This materialised as we
got closer and closer to the Fed’s tapering efforts.
Additional
to the gold trade argument was also that tail risks in the world were being
priced out which supported downward pressure on gold. We also generated
revenues from relative value trades in commodities, like the WTI-Brent trade,
where a similar quality crude was trading substantially below the other
European crude. The price differential was substantially higher than
transportation costs and was caused by logistical issues which over time should
be alleviated. The rule is that all logistical issues typically get solved when
a large profit potential is involved and so it was with this trade.
Hedge
Fund Insight: China is key to world growth yet official GDP data does not
tell you much except the level central government would like it to be. How do
you assess what the underlying growth or real growth rate is in China?
Hakan
Kocayusufpasaoglu: Statistics in China, as you say are not always the best indicator
of Chinese economic growth, one has to go a little deeper in order to get the
full story for China. We pay attention to things like electricity usage, port
activity and lumber usage. Overall we have been of the view that China’s shift
from being a foreign investment driven economy to a consumption economy will
slow down their overall growth performance and that view seems to bear fruit
via the overall statistics and the other proxy indicators for Chinese economic
growth going forward.
Hedge
Fund Insight: We have just had the Chinese GDP for 4Q 2013. Officially it
was at 7.7% y-o-y. What do your measures tell you underlying growth was?
Hakan
Kocayusufpasaoglu: Our measures tell us that GDP will be slowing down over the
next quarters due to a clear disorientation from investment driven to a
consumption driven economy. Our research also informs us that the credit
limitations put into place are having an effect on the housing market, which I
see finally slowing without a collapse, which so many had feared.
Hedge
Fund Insight: There is a debate going on about whether emerging markets are
going to return to generating the growth and equity performance that they
used to. What are you going to look for to get involved in emerging markets
equities in the short or medium term?
Hakan Kocayusufpasaoglu:We have analysed the
probabilities of EMs entering a crisis, ie the contagion risk. There
are two major issues at work. At first glance when one compares the situation
of EMs to those in the previous EM crisis of ’99 for instance, we see that EMs
are in a much better position than they were then. They are larger, more
powerful and have a stronger underlying economy. EMs are now around 40% of
world GDP and will exceed 50% in a few decades. Their GDP per capita is
rising steadily and so is their standard of living.However, there is a second
worrying issue that is at play this time that is different than in the past. A
huge number of US$ has entered into EMs from the developed countries since
the 2008/09 crisis, around 4 trillion US$. This money has entered into the
EMs taking their credit risk and currency risk. In the past foreign funds
entered EMs only taking credit risk, as they invested in $s or hedged
their FX risk; whereas now they have entered into the EMs in their local
currency making them more sensitive to FX movements in EMS than ever
before. Local currency government bonds went from around 600bn$ in
2008 to 2.5tr$ of foreign funds in 2013. The key danger is that foreign
investors have big EM FX risk and may run to the exit doors at the same time,
finding that the door is too small.
Evaluating
both the above points one positive, one negative we have reached the
conclusion that some EMs will suffer, but that an overall crisis will probably
be avoided this year. That is that EM central banks will realize (some already
have) that they have to raise rates more and by doing so have to keep
their FX stable at higher levels, so that any depreciation of their
currency happens in an orderly fashion. The EMs experiencing strain and
difficulty are to our calculations around 10% of world GDP and hence
probably too small to affect the path of developed markets in any grave
way this year.
Despite
our relatively benign outlook we are, however, making investments which
should be successful in either scenario. For instance we are bullish the
US$ especially when we get closer to short term interest rates rising in
the USA at the start or middle of 2015. Any EM crisis will assist this
view as the US$ is the main safe haven currency of the world. We also
believe that Eurodollar contracts (3-month interest rate contracts in the
US) are pricing in rate rises when none will happen. Again an EM crisis will
assist this trade.
Hedge Fund Insight:Is there more money to be
made being short the Yen this year? Which currency would you take for the long
side, and why? If there is money to be made short the Yen, what do you want to
see from the markets as a set-up?
Hakan
Kocayusufpasaoglu: Please see above for the long US$. The yen will weaken to the
120-125 levels over the next years, but it is the EM contagion risk that is
keeping the yen anchored at the moment. If as we believe that gets priced out
in the next few months, then the yen will enter another weakening leg. We are
still waiting for that moment and watching the yen carefully.
Hedge Fund Insight: Gold seems to be in the
process of bottoming. What is your view, and if it is can you make any money
from an instrument bottoming rather than going up in price?
Hakan
Kocayusufpasaoglu: Gold, like the yen will strengthen if the EM risk talked
above materialises, but we are being prudent in limiting ourselves to trades in
both macro and relative value that are not binomially dependent on these two
scenarios (as described two questions above).
Hedge
Fund Insight: In which case, what trades have you got on that will benefit
from scenarios other than the ones described above. These trades must be
diversifiers relative to the long $/short Yen trade described above. How do you
size them in an absolute sense, or relative to the existing positions in your
portfolio?
Hakan
Kocayusufpasaoglu: We have a number of RV positions that are insulated from the
scenarios described. In fact the scenarios above and the resulting trades fall
into the Macro trade category. We have for instance some gasoline spread
postions and some spread positions in crude (Brent-WTI). These RV
trades benefit from very different outcomes and are for the most part
insulated from the above mentioned macro scenarios. For instant in gasoline we
have seen the US winter gasoline spread widen. Since winter gasoline is
easier to produce and can be imported easily, and since we are not seeing
very strong demand improvements and refinery utilization is nowhere close
to maximum, we expect these winter gasoline spreads to come back into line.
Since they are only one or two months apart their volatility is limited
and the trade is nicely insulated from other macro events like the ones
discussed above.
Hedge
Fund Insight: Some developed equity markets may be running into overhead
supply. Do you see them that way?
Hakan Kocayusufpasaoglu: We still see upside
in the equities markets especially in the US. We believe that
on relative valuations, on macro economic projections and on money flow
data that the US equity market is still relatively well positioned for further
upside. Most people are worried that equities will dive since higher interest
rates may mean that equity valuations will be lowered. Though this is
ultimately true it is not so at the start of an interest rate rising
cycle. In fact during the first 6-9months of a rate cycle equities perform
quite well. If we see tapering (i.e. the reduction of easy money by the Fed) as
real interest rises, and we use the Taylor Theorem to translate the 10bn$ per
month of tapering into interest rate rises then we see that the Fed in effect is
raising rates by around 0.7% each month. Tapering can hence be viewed as
the start of an interest rate cycle. In effect at the start of this cycle
we expect US equities to perform quite well. But as we get closer to the
end of the year and tapering is taking its toll on the economy, and people
begin to focus on the Fed funds rate rises on the horizon, then equities
will begin to correct in our view.
Hedge
Fund Insight: You
regularly attend Petroleum Week and indeed went to the last one. What did you
get out of it?
Hakan
Kocayusufpasaoglu: I have been going to the IP week for nearly two decades and
used to go for most of the week and various functions. But these days I go to
one or two functions a year and not the entire week. This year I flew in on the
Wednesday and left on Thursday. There are a number of functions which bring
together a vast array of people from the industry and assist in the exchange of
ideas. Since it occurs only once a year it is probably not much of a
contributor to our trading nor our strategy formation but does assist in
confirming views or raise question marks. Also it assists in seeing old friends,
colleagues and working partners whom you may not have seen in a long
while, since we are all busy people and often nowadays in different countries.
Hedge
Fund Insight: How
much of your portfolio could energy trades be? What is the largest they have
been?
Hakan
Kocayusufpasaoglu: Although we have multiple decades worth of energy trading
experience within the company, the vital point for us is not the size of
exposure we have to an asset class but the correlation it has to other
trades. For instance we may have 3-4 RV trades within energy that are
not dependent on the direction of the market at all and completely uncorrelated
to any other trades we have in our portfolio. In short it is not the asset
class per se, but the correlation of each trade to others that is very
important to us.
Typically we will risk between
1-3% of our AUM on any given trade. In other words if we are risking 3% on one
trade and have another idea about another trade, but it turns out that the two
are correlated quite strongly then we would not take the second trade. All our
trades have to fulfill stringent criteria before we engage and one of them is
that they are uncorrelated to other trading positions within our portfolio.
Hedge
Fund Insight: Can you talk about the Brent-WTI spread trade you have had on?
Hakan
Kocayusufpasaoglu: Both Brent and WTI are similar quality crude oils,
produced in different locations. WTI is deliverable into Cushing,
Oklahoma and is locally produced. Over the last decades WTI used to
trade at a premium to Brent by about the transportation costs that it took to
move crude from Europe to the USA. However, over the last few years we have
seen that due to infrastructure problems the oil stored in Cushing was
not able to move to the Guldf Coast nor to the refineries within the US that
needed the product. Hence there was a logistical bottleneck which made a large
amount of crude oil being accumulated in Cushing and hence drove the price
of WTI below Brent. Substantially below Brent; at times more than 20$ below
Brent. However, such logistical issues tend to be overcome given time,
since a 20$ profit per barrel is an amazingly strong motivator. In fact, oil
was delivered on the back of trucks, trains and any transportation that
could be procured in order to lock in this vast profit potential. We expect WTI
to strengthen towards 4.5$ below Brent, which is roughly the cost of transport
of WTI from Cushing to the Gulf Coast.
Hedge
Fund Insight: Is the
Brent-WTI trade what you would classify as a relative value trade? How do you
think of the portfolio construction in terms of relative positions and
absolute directional positions?
Hakan
Kocayusufpasaoglu: Yes, Brent-WTI would be classified as a relative value trade,
since it is in effect the same product in differing geographic areas and
the trade is to purchase one while selling the other. Other relative value
trades can be across products or across time (time spreads), where one buys one
product and sells the other due to some demand-supply disruption that is
expected to last only for a small period of time.
Hedge
Fund Insight: Thank
you Hakan. I’m beginning to understand how you did so well last year.
Evaluating both the above points one positive, one negative we have reached the conclusion that some EMs will suffer, but that an overall crisis will probably be avoided this year. That is that EM central banks will realize (some already have) that they have to raise rates more and by doing so have to keep their FX stable at higher levels, so that any depreciation of their currency happens in an orderly fashion. The EMs experiencing strain and difficulty are to our calculations around 10% of world GDP and hence probably too small to affect the path of developed markets in any grave way this year.
Despite our relatively benign outlook we are, however, making investments which should be successful in either scenario. For instance we are bullish the US$ especially when we get closer to short term interest rates rising in the USA at the start or middle of 2015. Any EM crisis will assist this view as the US$ is the main safe haven currency of the world. We also believe that Eurodollar contracts (3-month interest rate contracts in the US) are pricing in rate rises when none will happen. Again an EM crisis will assist this trade.
Archbridge Capital AG is based in Zug Switzerland.
To contact Archbridge Capital please email: info@archbridge-capital.com
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