THE ACHILLES HEEL OF VALUE FUNDS, THE TITANS OF VARIABLE INCOME

Size: px

Start display at page:

Download "THE ACHILLES HEEL OF VALUE FUNDS, THE TITANS OF VARIABLE INCOME"

Giles Osborne
5 years ago
Views:

The Quantitative Hedge product range is a new modality of automatic trading systems designed to perform a risk-hedging function, when combined with the purchase of European shares.

1 The Quantitative Hedge product range is a new modality of automatic trading systems designed to perform a risk-hedging function, when combined with the purchase of European shares. For that purpose hedging trading systems used only short positions on the most liquid futures contracts of each respective financial market. The range is designed to cover 90% of the European market. Trading with index futures contract instead of taking short positions on stocks reduces the cost of hedging. It is intended primarily for professional equity managers, who wish to include an alternative mechanism to protect profits from market failures and maintain the profits achieved in the past. But it would also be aimed at small investors interested in self-managing their own capital, with more peace of mind. The development of the system includes optimization processes based on and tested with past historical data, so it is not guaranteed in any case that these results will occur in the future. Past results do not guarantee future results in any case. THE ACHILLES HEEL OF VALUE FUNDS, THE TITANS OF VARIABLE INCOME If you are a professional equity analyst and a loyal follower of the value investing philosophy, in any of its aspects, to see the next chart should not have doubts in identifying who is Mr. Market and who is Mr. Value. Better results than those obtained by market reference index, but with rather volatile movements, and betas above 1, would identify the typical facial features of Mr Value. I have chosen, (as an example for the research process), the analysis of one of the best Spanish value funds, for its style, good results obtained in the pass, and quality in the management team, which I've been following for a long time, that is the Metavalor FI, whose value funds information is published in its web site and CNMV, but it would have been indifferent to choose funds like the Bestinver for the research paper, also. Fuente: 1

How do value investing funds,... when the market falls? As it happens that the weak point of this management style, in the vast majority of value funds, precisely draws the shape of a heel.

2 How do value investing funds,... when the market falls? As it happens that the weak point of this management style, in the vast majority of value funds, precisely draws the shape of a heel... due to Newton's physical principle, everything that rises has to go down, already stronger is the rise, the stronger is the decline, so they tend to fall more than the market before the arrival of downward phases. This is technically expressed by saying that are funds with beta greater than 1, that is, market movements of 1% translate into movements greater than 1% on the value fund. Using the excel simulator available on his web we see that an investor who would have invested 50,000, in the date , loses half of the capital invested if it decides to sell it just two years later. This means technically that it has a drawdown or maximum loss of 50% As value funds are also characterized by a stronger rise to the market or benchmark in upturns, then a significant part of the accumulated profits made during the past disappear when the storm arrives, closing the fork of the profit differential obtained by the managers, with respect to what would have obtained a buy & hold passive management. (Replicate the index buying the shares that compose it). If there are also market conditions of no liquidity, may even cause the collapse or closure of the fund, when trying to withdraw investors their capital in a massive way, this fact almost sank the great Spanish titan Bestinver Value Fund. Therefore, value funds do not usually use hedging strategies, which greatly increases the volatility, and the high risk to be assumed by the investor. This lack of liquidity is mainly due to the fact that value managers tend to have a predilection for companies which go unnoticed to the market, and are not correctly rated, and therefore companies less 2

3 visible are usually undervalued, but have the drawback that they are less liquid. In addition portfolios are very concentrated in few values. 3

4 How has it solved these deficiencies the value industry...?,, Instead of incorporating quantitative managers into their risk departments, that would have been reasonable way, the value industry has chosen to indoctrinate the customer to be patience, to have a longterm investment view, to trust in the management team, and where before the arrival of market earthquakes the best alternative is to have faith, to wait and to remain inside the ship for at least 10 years, because the loss of wealth will recover, and it is only a matter of time.is there any way to minimize the relative risk associated with this management style? That is a good question. after researching on the subject I have decided to launch a range of product that could alleviate to some extent, this chronic pathology that suffers the value industry. The object of the research process has been to develop an specific hedging trading system, which generates only bearish trading signals, with the exclusive purpose of hedging. When the model detects that a bearish swing is taking place in futures market, adopts bearish positions to counter the losses, having a negative correlation with the market, but with positive mathematical expectation, and there lies its complexity. Therefore when it detects a bullish market phase the system withdraws from the game, since it understands that there are others who do it better, humility. The final aim is to try to obtain an optimal combination between equities and hedges that will cushion the market's earthquakes, optimizing the risk-return ratio and reducing the volatility of the fund, but keeping long term profits. What is the theoretical principle on which the range of hedging trading systems models is based? Using statistical simulation techniques, we see that the average result of combining something that has long-term positive hope (as example the market represented by the blue line) with something that has a long-term positive hope but also have negative correlation (example hedging trading system) with the market index, it is something that oscillates rather less (represented by the red line) but which maintains its mathematical expectation with less volatility. That means technically that we increase the Sharpe Ratio. "....Is saying we seek to reduce variance or volatility,.....but we hold hope..." In the example above, the extreme case of a hypothetical market representation with positive drift is shown by the blue line, a trading system with perfect inverse correlation equal to -1 and with positive drift, green line. The red line would be the theoretical result of combining both simulated stochastic processes at 50%. Red line, that is the average between market & sat, have no volatility on the extreme case, but maintain its upward trend. 4

5 Why does the system never take bullish positions? The main reason is that if the system adopts bullish positions it will probably make it worse than a good value manager, so it takes the best possible option and the robotic manager automatically deactivates, leaving the value manager to act. In resume, the philosophy of the system would look like this: "... let the machine act in situations of nervousness, and let the human act in situations of tranquillity" The basic scheme of the algorithm: When the market becomes likely bearish, the system will automatically activate. When the market becomes bullish, it is deactivated. Another fundamental characteristic of the hedging trading system is that it takes special care and is very rigorous at the statistical parameters valuation in generating bearish positions in a context of high volatility, but... Why should we be so rigorous in contexts of extreme volatility when it comes to requiring a trading system to adopt bearish positions...? Because the best profitability opportunities in the value management style arise precisely there, when market volatility is very high and the Price Earning Ratio falls considerably, if incorrect hedging positions are taking in phases of high volatility, we are going to lose the big profits that will arise later and we will probably be late for the party. So we must be especially cautious when demanding to the trading system that activates on a hedge mode, since it could pay very expensive. Performance IBEX QUANTITATIVE HEDGE (COVERAGE) SISTEMA IBEX , , , , ,00 0, ,00 03/01/ /09/ /06/ /03/ /11/ /08/ /05/ /02/ /10/ /07/ /03/ /12/ /09/ /05/ /02/ /10/ /07/ /03/ /12/ /08/ /05/ /01/ /10/ /07/2016 Straight lines are periods of time in which the system is deactivated, due to the lack of optimum conditions required for the system, to be positioned short. It is very important that the deactivation is done in time, since after achieving high levels of volatility and Price Earning Ratio (PER) near to 5 or 6..., the market experiences a spectacular rise later. 5

6 Basic statistics of the back-testing process: Ibex Quantitative Hedge trading systems. Performance summary Ibex Quantitative Hedge Main chart: IBEX minute bars [04/03/ /01/2017] Net P&L ,23 Gross P&L ,00 Profit factor 1,30 Sharpe ratio 0,788 Slippage per side -2,23 Commission per side 5,75 Annual ROI 8,79 % Mathematical expectation 268,46 Session analysis Analyzed sessions 5278 Sessions in market 1329 Winning sessions 691 Winning sessions profit ,28 Winning sessions average 1133,30 Losing sessions 638 Losing sessions profit ,05 Losing sessions average -939,59 Worst drawdown ,00 19/05/2008 Best session ,12 24/06/2016 Worst session ,75 24/01/2008 6

7 Suppose you had invested 50,000 in the Metavalor fund in the year 2000, according to the Excel simulator available on your website, the result would have been the following at the closing date 2016: Product Initial value Final value Initial date Final date Metavalor , , Suppose you invested 50,000 in the Metavalor fund in 2000 but also subscribe to the Ibex Quantitative Hedge Coverage trading system, the simulated result would have been the following as of the end of 2016: Product Initial value Final value Initial date Final date Metavalor + IQC , , IbexQuantHedge , , , , , , , , ,00 0,00 05/01/ /08/ /09/ /09/ /09/ /10/ /10/ /10/ /10/ /10/ /10/ /09/ /09/ /09/ /09/ /08/ /08/2016 As can be seen in the graph above, a significant reduction in risk and volatility levels is done, but keeping profits. 7

8 Other available systems developed to European equities, targeting European professional equity managers: SAT Trading system: CAC Quantitative Hedge. (Coverage) CAC40 + SAT SAT Quantitative Coverage CAC /01/ /07/ /02/ /09/ /04/ /11/ /06/ /01/ /08/ /02/ /09/ /04/ /11/ /06/ /01/ /08/ /02/ /09/ /04/ /11/ /06/ /12/ /07/ /02/ /09/ /04/ /10/ /05/ /12/ /07/ The blue chart shows the evolution of the French market in isolation, the evolution of the CAC Quantitative Hedge system with the pink line in isolation, and the combined evolution of an investor who would have invested in the French market but also using the SAT (trading systems) represented with the green line. A 16 year history (years 2000 to 2016), it is shown. The system has the same fundamental characteristics as the Ibex Quantitative Hedge. 8

9 SAT Trading system: DAX Quantitative Hedge. (Coverage) , , , , ,00 SAT Dax Quantitative Coverage DAX + SAT DAX 0, ,00 03/01/ /08/ /04/ /11/ /07/ /02/ /10/ /06/ /01/ /08/ /04/ /11/ /07/ /03/ /10/ /06/ /01/ /09/ /04/ /12/ /07/ /03/ /10/ /06/ /02/ /09/ /05/ /12/ ,00 The blue chart shows the evolution of the German market in isolation, the evolution of the DAX Quantitative Hedge system with the pink line in isolation, and the combined evolution of an investor who would have invested in the German market but also using the SAT (trading systems) represented with the green line. A 16 year history (years 2000 to 2016), it is shown. The system has the same fundamental characteristics as the Ibex Quantitative Hedge. 9

10 SAT Trading system: FTSE Quantitative Hedge. (Coverage) SAT SAT+FTSE FTSE /01/ /07/ /01/ /07/ /01/ /07/ /01/ /07/ /01/ /07/ /01/ /07/ /01/ /07/ /01/ /07/ /01/ /07/ /01/ /07/ /01/ /07/ /01/ /07/ /12/ /06/ /01/ /07/ /12/ /06/ /12/ /06/ /12/ /06/ /12/ The blue chart shows the evolution of the Italian market in isolation, the evolution of the FTSE Quantitative Hedge system with the pink line in isolation, and the combined evolution of an investor who would have invested in the Italian market but also using the SAT (trading systems) represented with the green line. A 16 year history (years 2000 to 2016), it is shown. The system has the same fundamental characteristics as the Ibex Quantitative Hedge. Product: IBEX Quantitative Hedge Product: DAX Quantitative Hedge Product: CAC Quantitative Hedge Product: FTSE Quantitative Hedge For trading licenses, or any questions you can contact Trading Motion, or directly with the developer. jesusmartinpalacios@gmail.com Developer: Finanzas Cuantitativas ibroker Global Markets SV 10

Quantitative Trading System For The E-mini S&P

AURORA PRO Aurora Pro Automated Trading System Aurora Pro v1.11 For TradeStation 9.1 August 2015 Quantitative Trading System For The E-mini S&P By Capital Evolution LLC Aurora Pro is a quantitative trading