We explain the key terminology in relation to our investment approach.
Absolute return
"Absolute return" is the gain or loss of an investment and measured as a percentage of the invested capital. Absolute return may involve trading both long as well as short positions. This is in contrast to "relative return" which relates to trading long positions only and the performance is measured against a benchmark. The hedge fund industry is often referred to as an absolute return industry.
Liquid markets
"Liquid markets" are markets with many buyers and sellers, deep order books, and tight spreads. It is easy to execute a trade and short-term changes in demand and supply have little impact on the price and the bid-offer spread. Examples for liquid markets include the major G10 currency pairs, government bonds from OECD countries, short-term interest rates, or main steam commodities. Liquid markets are presumed not to "dry up" or become "thin" in times of general market turmoil and distress, but to remain tradable.
The total notional outstanding of derivatives was $444 trillion in 2016 (Bank of International Settlement).
The total notional outstanding of derivatives was $444 trillion in 2016 (Bank of International Settlement).
Investment strategy
An "investment strategy" is a set of principals and protocols put ion place to achieve specific investment objective. In executing an investment strategy, ich the portfolio manager, or trader, is entering long and/or short positions in markets with the objective to generate long-term positive gains. Investment strategies in general generate returns from exploiting broadly three categories of return drivers: momentum, carry, and value. Each category contains a number of sub-categories and permutations. All investment strategies have in common that they make money by selling an asset at a higher price than buying it. Trading strategies can be systematic or discretionary in nature or a mix of both.
Systematic vs. discretionary
A "systematic" investment strategy is characterized by a formulaic and repeatable investment process without discretionary intervention. It is developed using scientific methods and backtested over long periods of historical data to verify the investment hypothesis and create confidence in the hypothetical results before going live.
A "discretionary" trading strategy is the opposite. It often relies on the trade decision of one individual or small team of individuals where the decision process may vary based on circumstances and is not necessarily repeatable in the future.
A "discretionary" trading strategy is the opposite. It often relies on the trade decision of one individual or small team of individuals where the decision process may vary based on circumstances and is not necessarily repeatable in the future.
Momentum
"Momentum" is a measure for the change of price of an underlying market over a certain period of time. In trading momentum, it is presumed that price momentum persists for some time before subsiding or reverting. Prices in a market with positive momentum are expected to raise further where as prices in a market with negative momentum are expected to fall further. There are many statistical methods to measure momentum and to determine the direction of a trade. Trend-following is one such methodology.
Carry
"Carry" is the return from holding one asset by selling another asset. For example in currency carry trades, the trader borrows in a low interest rate currency and invests the proceeds in a high interest rate currency and profits from the interest rate differential. In commodities and fixed income, term structure arbitrage is a common carry trade where the trader holds the longer-term higher yielding asset and sells the short-term lower yielding asset. Sometimes carry trades are also referred to as asset arbitrage trades or time arbitrage trades.
Value
"Value" refers to trades driven by fundamental factors such as demand and supply or macro economic themes and imbalances. Examples include the state of inventory of commodities, purchasing power parity between countries, monetary policies or other fundamental drivers.
Equal weighted asset allocation
"Equal weighted" asset allocation refers to assigning equal weights or 1/N to each asset N. For example with $100, one holds $50 of asset A and $50 of asset B.
Risk weighted asset allocation
"Risk weighted" asset allocation is also often called "risk parity" or "equal volatility weighted" asset allocation. Here, one allocates more money to the less volatile and less money to the more volatile markets. The weight is calculated proportional to the inverse of the volatility. For example, if asset A has a volatility of 20% and asset B a volatility of 10%, the asset A receives a weight of 33.3% and asset B of 66.7%. This gives each market an equal opportunity to contribute in equal amounts to the overall portfolio returns. It creates a balanced portfolio.
Risk control
"Risk control" is the process of managing the overall market exposure of the portfolio. One popular risk control method is the target volatility mechanism to achieve a consistent long-term volatility profile of the portfolio returns. This is achieved by adjusting the portfolio leverage proportional to realized versus target volatility. The leverage is reduced in more volatile markets, and increased in less volatile markets. Other risk control mechanisms may include rules to close out certain assets at certain times or to reduce overall exposure.
Rebalancing
"Rebalancing" describes the process of redistributing assets in a portfolio to new or predefined target weights at a specific point in time. It is sometimes referred to as "selling the winners and buying the losers" and rebalancing therefore has a mean reversion effect on the portfolio returns. For example in an equal notional weighted portfolio, if one starts with $50 in asset A and $50 in asset B and at rebalancing, and at the end of the period one A is worth $40 and B is worth $80, one would sell $20 in asset B to buy another $20 in asset A so that both assets start with $60 allocation each into the new period two.
UCITS, AIF, Hedge Fund
The Undertaking for Collective Investments in Transferable Securities (UCITS) Directive was originally introduced in 1985 to create a single market in the EU for fund offerings to the public. While UCITS Funds are open to retail investors, Hedge Funds in Europe may not be offered to retail investors but only to professional, qualifying, or institutional investors. Often, Hedge Funds are referred to as "off-shore" or "unregulated" funds as they may be domiciled in for example Cayman Islands, British Virgin Islands, Bermuda, or also Luxembourg, Lichtenstein, Malta, or Ireland and do not follow UCITS investment guidelines. With the introduction of the Alternative Investment Fund Management Directive (AIFMD) in 2011, the EU regulator requires Hedge Funds that are offered in Europe to obtain authorization as Alternative Investment Funds (AIF). The formerly unregulated hedge fund market in the EU became regulated.
CTA and Managed Futures
In the United States, trading future contracts dates back to the 1850s. The Commodity Futures Trading Commission (CFTC) first recognized the “Commodity Trading Advisor” (CTA) in 1974. The CTA and managed futures industry managed about $350 billion (11.3%) of the $3.0 trillion hedge fund industry in 2016 (BarclayHedge).
Historically, CTAs show profitability over an entire business cycle while the return stream can be lumpy. The long-term value proposition of CTAs include portfolio insurance, portfolio diversification, and capital appreciation.
Historically, CTAs show profitability over an entire business cycle while the return stream can be lumpy. The long-term value proposition of CTAs include portfolio insurance, portfolio diversification, and capital appreciation.