TRADERTALK
our optimal portfolio construction methodology and operates within a real-time computing environment. To most effectively deploy the technology, we trade assets with deep liquidity and maintain a 24-hour-a- day execution desk.
Te Drawdown Control methodology is based on academic research by Dr. Grossman in the early 1990s. Te method solves the problem of maximizing an investor’s lifetime wealth of a portfolio, subject to a maximum loss or drawdown limit. Te solution to the problem outlines both an accelerating schedule for reducing risk as the portfolio approaches its drawdown limit, and a symmetric schedule for ramping up risk as the portfolio appreciates once again. A significant benefit of this approach is our ability to attempt to financially engineer the mitigation of the left tail in our return distribution. And, in fact, our Currency Program has exhibited characteristics of positive skew.
Karlheinz: Our approach to forming expected returns is bottom up and fundamental, implemented through a sophisticated process and methodology that we’ve developed through many years. Tat approach is designed to allow us to move in and out of markets rapidly to capture the changing global opportunity set. Of course, there are times when markets aren’t driven solely by fundamental information. Our drawdown control methodology drives our process to seek to exit losing positions in a fast and expedient way. Te depth and liquidity of futures and FX forwards markets, and option markets on them, typically allow us to do this.
In the past you have talked about countries acting like corporations when it comes to currency trading. How does this impact on your investment thinking?
In currency trading we look at countries like corporations. Te central bank is equivalent to a
company’s treasury department, the dividend is like the short term yield and the currency is like a company’s stock. Many of the factors you would use to analyse a company, we use to analyse a country. We believe that over time money will flow from countries with low marginal productivity of capital to countries with high marginal productivity of capital just as it does with corporations. Sometimes this coincides with GDP growth (slow to high), but not necessarily. Money will flow from countries that are imprudent with their currency management to countries that are prudent with their currency management. You can think of it as exploiting the dispersion of global business and monetary cycles: We “borrow” (sell) from countries where growth prospects are poor, short-term interest rates are low, and monetary policy is or will be loose. At the same time, we “lend” (buy) to countries where growth prospects are good, short-term interest rates are relatively high, and monetary policy is or will be tight. We use deep economic fundamental analysis to make a judgment call about countries and markets we want to be in. All our positions are long/short; long one currency and short another.
QFS takes a systematic approach to investing. How do you apply this to your model development?
Jim: Our model development process tries to accomplish two principal objectives. First, we specialize in understanding the investment opportunities created by macroeconomic, financial and policy events. So we start with a fundamental hypothesis. Elaborating investment hypotheses as measurable, falsifiable statistical equations is the next step, and coding and statistical testing of the idea completes the process. We reject the large majority of the ideas we test, but for those that hold up, we implement them as expected return equations.
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