COMMENTAR Y
Looking Under the Hood, Part 1 Smart betas, factor-based indexing, and risk premia THE OPALESQUE UK ROUNDTABLE
T
he Opalesque 2014 UK Roundtable was sponsored by Salus Alpha and Eurex and took place on 3 September 2014 at the London
offices of Eurex with:
1. Oliver Prock, CEO, Salus Alpha Group and CIO of Salus Alpha Capital;
2. Ewan Kirk, CIO and co-founder, Cantab Capital Partners;
3. Antoine Haddad, founder and CIO, Bainbridge Partners;
4. Stuart MacDonald, managing director, Aquila Capital;
5. Nacho Morais, CFA, FRM, CAIA, Pragma Wealth Management;
6. Akshay Krishnan, head of macro strategies, Stenham Advisors;
7. Renaud Huck, senior vice president, Eurex Group.
Matthias Knab: Some of you have already mentioned a number of new products that you have launched successfully. Let’s look at those and other new launches in greater detail. Please share with us what products you are working on at the moment.
Oliver Prock: At Salus Alpha we are currently working on some new arbitrage models to add to our commodity arbitrage strategy. Besides that we constantly try to improve execution technology for all our models. We achieved fully automated execution with straight-through processing capabilities that is able to add positive alpha and eliminate slippage entirely. I think the execution engine we developed is unique and gives us a significant competitive advantage.
Renaud Huck: For us as an exchange 2014 was a very interesting year. As you will be well aware the past few years have been fairly busy in terms of regulation. The Dodd-Frank Act was introduced in the States, while European regulators decided to launch the EMIR regulation, and as a European clearing house we had to go through a process of being reauthorized by ESMA in order to become a qualified CCP.
When we did our preparations ahead of EMIR, we realized that a lot of the buy-side and sell-side players in the industry who were extremely active in the OTC space would as a consequence of regulation see the scope of activities drastically diminished or constrained. Some would even have to potentially exit the OTC space and move their business model towards a more exchange-listed and exchange-cleared model.
Consequently, we thought long and hard about what new products and services would be needed. Obviously our clearing house (Eurex Clearing) has been offering OTC IRS clearing for more than two
56 Editorial note
The academic literature of the last 30 years is filled with papers and research that support the existence of certain premia in various asset classes. Risk premia products are no longer a novelty; most bulge-bracket banks have successfully rolled out their suites of “risk premia” and “smart beta” indices, which has been of great interest to Nordic and US pension funds.
Risk premia such as value, momentum, carry, etc., provide very efficient portfolio building blocks, simply because the correlations among risk premia are generally low and relatively stable. Their use in portfolio construction can help achieve more efficient returns than those using the traditional geography or market cap building blocks that are commonly used in many portfolios.
Today, these new strategies are also called smart beta, smart systematic beta, factor-based indexing or systematic risk premia. But when the quintessential mechanical engineers and astrophysics PhDs start kicking the tires and looking under the hood, deeper questions open up...
Is it just a back test?
Obviously, risk parity seems to have worked in the past, so how different are the new products from, say, selling a back test? Moreover, when it comes to equity index beta, the beta that we have from, say, the S&P comes with a clear and uniform definition, and it’s absolutely free. But, looking at other betas like, say, FX carry, what’s the beta for that?
“What if you’ve got one and I have got one, and mine is different?” asks Ewan Kirk. “It’s not really a beta then. Maybe my beta is more beta than your beta. Maybe your beta has got more alpha in it than my beta.” On top of that, there are costs associated with dynamic positions so, in a sense, it can’t be beta. So maybe a dynamic trading strategy can’t be beta, maybe it’s just a dynamic trading strategy. However, it is undisputed that risk premia can provide portfolio managers with a greater number of low-correlation portfolio building blocks than the more typical geography and market cap building blocks.
It’s not about your model – it’s about your execution.
Today, it’s not a challenge any more to write down a nice, simple trend model, which in gross terms looks great and appears statistically indistinguishable from the best CTAs in the world. However, that will be in gross terms. Owning a cap-weighted equity index is free because you don’t have to trade. On the other hand, if the rebalancing cost of a portfolio is only 1 basis point a day, that will be 2.5% per annum, dwarfing the cost of management fees. Therefore, huge efforts go into saving tiny fractions of a basis point and executing at “lag 0”. Still, some offered risk parity strategies are quite stripped down in their substance and therefore appear to be inexpensive.
Matthias Knab
Knab@Opalesque.com
years and, in terms of products, we recognized that in the fixed income space there would be a need for a swap futures and a repo futures product. We are delighted to be able to offer a complete suite of fixed incomes futures, covering the whole range of short and long-term money and bond markets with listed and OTC products.
As of 1 September 2014 Eurex launched swap futures and in mid-November we will launch repo futures.
Earlier in July we launched FX futures, which for us was a whole new asset class that had not been targeted or offered before. Subsequently, we are currently very busy promoting these products, but also engaging with the buy side and sell side in a broader approach; looking at how the new regulatory landscape will influence business in the future, the new rules of engagement for market participants and, taking all this into account, we offer them dual avenues to suit their needs –
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