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COMMENTAR Y


these products have is their reliance on a tactical module that uses various macroeconomic variables, allowing their exposure to the various risk premia to vary over time. Both will be managed using average and maximum VaR targets.


Ewan Kirk: There is a mathematical definition of beta and it is the undiversifiable market risk. When it comes to equity index beta, the beta that we have, say, from the S&P, we need to bear in mind that there is only one S&P and only one way of market cap weighting equities, and it’s absolutely free. But in terms of foreign exchange carry, what’s your beta for that? What if you’ve got one and I have got one, and mine is different? 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. Additionally, there are costs associated with dynamic positions so, in a sense, it can’t be beta.


If you have a dynamic trading strategy, it’s not beta, it’s just a dynamic trading strategy. Or to look at it another way, it’s just a systematic trading strategy that happens to have worked in the past. Risk parity happens to have worked in the past. Another way of looking at this is that it is quite close to selling a back test and I feel that some smart beta products are skirting that a little bit too closely. We have a cost-effective trend and value product in the macro space. I am not saying that is beta, but just a cost- effective systematic trading strategy. That’s all it is, but I think many people would call it a beta strategy.


Antoine Haddad: Correct, a lot of people name all these new strategies smart betas, factor-based indexing or risk premia. I agree with Ewan that, ultimately, these are simply systematic trading strategies. We like to categorize or subcategorize these systematic trading strategies under various labels. Some systematic trading strategies can be as simple as adding a risk-parity module to a long-only portfolio, other systematic strategies can rely on filtering the instruments traded with a market capitalization filter, or a geography filter. In our programme, we have chosen to use a well- documented category of systematic strategies – equity and cross-asset risk premia.


Our ultimate goal is to improve the efficiency of our portfolio with a basket of systematic strategies that fulfil the following requirements: they have to have a strong and well-documented economic rationale, be very liquid, and can be easily modified to achieve a “long bias”. Many cross-asset risk premia fit those requirements. 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. The research we investigate is only a first step in the validation that we are looking for; it provides us with a rational fundamental premise


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for a strategy before inclusion in a portfolio. In a risk premium (such as carry, or value, or momentum, for example), investors are “paid” a premium for taking a risk away from other participants not willing to take that risk. The true advantage of this approach derives from the fact 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.


This is the direction we have taken at our firm; we are creating, for example, products that will be replacing some of the “equity beta” clients are searching for with baskets of equity risk premia. We are also creating portfolios of “fixed income beta”, with a tactical basket of fixed income risk premia. If clients are looking for commodity exposure, we will give them the option to participate more efficiently in the upside of commodities via well-known commodities risk premia. The tactical aspect applied to risk premia is critical to the success of our approach. Most of these risk premia may suffer from down periods, should they become “overcrowded”. We look to use our tactical approach to navigate the short-term negative environments that these systematic risk premia will encounter, and take advantage of their well-documented long-term sustainability.


Ewan Kirk: I may be wrong, but I do believe there could be a small problem embedded in this approach. Let’s take the size bias as a specific example. This is a well-known factor premium. If you can manage the risk and buy small companies rather than buying large companies, over time you outperform the index. The trouble is we can’t all do that, or else eventually every company will have the same market cap. For example, a tiny Norwegian fish canning company would have the same market cap as Apple because if we all invest in small stocks they become big stocks and the premium goes away. So although it has been true in the past, if everyone does it, it goes away by definition.


Oliver Prock: Sure, but not everybody is doing it. I gave up on trying to respond to potential investors “Why is not everybody doing that?” The short answer to this is, “because they don’t”. Of course there is a long answer as well...


Ewan Kirk: Right, but still, not everyone is doing it. So there is a first-mover advantage here and you need to get into small caps before everyone else. We should realize that there is no getting away from market cap weightings for the market; everyone has to be market capital-weighted on average. However, maybe some people are smarter and buy the small cap stocks, value stocks or low-beta stocks, or they buy the high-yielding currencies and sell the low- yielding currencies, but this is not a solution for the industry, it’s only a solution for first movers.


Stuart MacDonald: Smart beta has become a very popular concept, particularly amongst some leading institutional consultants. And smart beta, like any other umbrella term, covers a whole variety of different things. There is smart beta going on in credit, for example. Others position risk parity as smart beta or as we do at Aquila, as smart systematic beta. When I first came across the concepts of smart beta and risk parity, in common with many other people, I felt that you could apply it to almost any mix of anything, but actually you can’t, particularly if liquidity plays a role in what you’re doing.


Ewan Kirk: The aspect that is often overlooked in risk parity strategies or indeed any systematic strategy is the role of execution costs. To go back to cap- weighted equity indexes, this is free because you don’t have to trade. However, if it just costs you one basis point a day to rebalance your position, which is not an awful lot of money, but that one basis point a day is 2.5% per annum. That is a lot of money and you are already paying that into the market just to get to your risk parity position. The cost of trading dwarfs the cost of management fees – it’s the cost of trading that you really need to worry about. That is why implementation of such strategies matters. We all know certain strategies work, but in the end it’s all about how do you do it.


Stuart Macdonald: You need to look at the execution or general implementation costs, but the hard reality is that the manager has to make sure that they are kept down to a level sufficiently low so as not to make their charges uncompetitive. There are risk parity strategies that are quite stripped down in their substance and therefore appear to be inexpensive. As with traditional hedge funds, the fee levels ought to reflect how much is actually being done over and beyond the basic, but nevertheless it’s in everyone’s interest that the costs are kept down. Something that we may go on to later in the conversation is the role not just of execution and implementation but also matters operational as a whole, which is increasingly being seen almost as a source of alpha.


Akshay Krishnan: We have talked a lot about betas, carry, risk parity and systematic trading in this discussion. However, at Stenham today we have taken a slightly different approach. Within our macro fund of funds today we are purely focused on discretionary trading strategies. This is more a temporary rather than permanent change. Around 12 or 18 months ago, we started to feel a bit uncomfortable regarding the potential impact of the end of QE on CTAs, especially considering the level of leveraged long fixed income positioning. We also noticed systematic strategies had entered new markets to identify sources of carry, such as


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