Stockholm (HedgeNordic) – Florin Court launched their CTA-program in August 2015, backed by Swedish hedge fund giant Brummer & Partners. Having initially traded so-called exotic and synthetic markets as part of the portfolio, the program was redesigned last year to exclusively focus on these markets. In an interview with HedgeNordic, Florin Court´s founder and CEO, Douglas Greenig (pictured), explains how he got involved with Brummer, why the shift to an exotics-only program was made, what opportunities and risks he sees trading these markets and why they, contrary to most other CTAs, started trading bitcoin in mid-2017.
“Things really began some time after I left Man AHL, where I had been the Chief Risk Officer. I left in 2014 and, during my gardening leave, I considered what I wanted to do next. One of my first exploratory calls was to Brummer & Partners, whom I had known for nearly 20 years. I was first involved with the Brummer group when I was head of mortgages, as well as the head of a proprietary trading desk, at my previous employer, RBS Greenwich Capital Markets”, Greenig explains when asked about how the firm got involved with Brummer.
Greenig, a PhD in mathematics by background, already in the early discussions with Brummer & Partners found some common ground from where he could start gathering a team and build the product. He describes the relationship with Brummer as “very supportive”, giving them the resources required to get off to a good start in 2015.
“As I began discussions with Brummer & Partners, it turned out they were interested in the idea of a new kind of CTA – approaching new markets as well as using new models. In due course, I began to assemble a team. The team consisted of several people who had left AHL already and who were available at the time. David Denison, Anthony Vinitsky, and I were the three main people involved in creating the firm.”
“As I began discussions with Brummer & Partners it turned out they were interested in the idea of a new kind of CTA – approaching new markets as well as new models.”
“David Denison is a first-class statistician, having taught at Imperial College and written one of the first books on machine learning. Before coming to AHL, where he ran the FX sector, he had also worked for a very good equity statistical arbitrage shop. Tony Vinitsky is our operational guru. He was Head of Investment Operations at AHL. Since AHL had the first exotics CTA program, the operational experience he got and the human capital he developed there proved useful to us given our focus on exotic markets.”
From the point Greenig and his team started to build the program, it took less than a year to launch. Probably a very short take-off run by most standards, but again, the team had a lot of experience to build from given their pedigree.
“It took us the better part of a year to get the program up and running from the point we decided to go for it with commitment from Brummer. We had fantastic support from day one from Brummer, and our experienced team worked very hard to get things in place. The real effort started in early 2015 and we launched in August of that year”, Greenig recalls.
Adding sophistication and new markets
Greenig describes the profile of the program as fairly traditional trend-following using medium- to long-term momentum models at the core. What makes Florin Court stand out is rather the “exotic” markets they trade and how those markets contribute to the program´s diversification. What today is an entirely exotic markets program, was only about half allocated to exotics on day one. Following the shift made in April of last year, the manager continuously looks for new markets to trade as they become available and sufficiently liquid.
“We take tried-and-true trend-following methods that have worked well in traditional, developed markets and apply them to what we refer to as exotic markets.”
“We started with a solid program, but have added a lot of markets and a lot of sophistication since then. I feel now that we are in a very stable place while still making incremental improvements”, Greenig says continuing:
“We take tried-and-true trend-following methods that have worked over the years in traditional, developed markets and then apply them to what we refer to as exotic markets. Exotic markets include things like electricity, emerging market interest rates, credit default swaps, exotic commodities, cryptocurrencies – a variety of non-traditional and OTC instruments. We also trade cash equities whereas most other CTAs merely trade equity index futures.”
According to Greenig, what is essential when trading exotic markets is to have outstanding operational processes, sharp trade execution, control of transaction costs, and strong risk management, including liquidity risk.
“With these exotic markets, one of the hardest things is simply figuring out how to trade them. Many of these markets are over-the-counter where counterparty relationships need to be established, ISDAs* need to be signed, various agreements must be arranged, all these kinds of things. It is much more involved compared to trading futures and FX forwards.”
“We trade about 200 markets at present, not including cash equities. In cash equities we primarily trade Europe and various emerging markets”, Greenig says.
In addition to exotics, the program also trades so-called “synthetic markets,” referring to bespoke exposures that are not available from a single financial instrument. These exposures are created by trading combinations of financial instruments. An example would be trading, as a synthetic asset, the relationship among credit spreads, equity prices and the yield curve.
More diversification and better trends
One important reason for going the exotic markets way is that it adds much greater diversification to a CTA program, according to Greenig.
“If you trade a traditional trend-following strategy using around 50-100 most liquid futures and FX forward markets out there, one reasonable question to ask is how many independent bets you really have on. A lot of times, many of these markets end up being very highly correlated.”
“A statistical analysis of typical CTA portfolios will show that often most of the risk is coming from 4 or 5 themes, or bets. Exotic markets, like South African grains, steel rebar in China and interest rates in Colombia, are much less correlated to each other and more independent as bets, compared against traditional markets.”
“Going from 100 standard CTA markets to 200 exotic markets provides much more diversification. This usually gives you a portfolio of about a dozen themes rather than the traditional 4 or 5. The portfolio is much more diversified, and the potential risk-adjusted return significantly improves. The experience from the few exotic markets CTAs supports this thesis.”
Greenig also believes that the trending properties of exotics market are better, making the case even stronger.
“The second thing that you notice with exotics is that the trending properties of these markets are just better. The average single-market Sharpe ratio for exotic trend-following is about twice as good compared to traditional markets. In other words, the typical exotic market trends about twice as well in Sharpe ratio terms.”
“The average single-market Sharpe ratio for exotic trend-following is about twice as good compared to traditional markets. In other words, the average exotic market trends about twice as well in Sharpe ratio terms.”
Capacity constraints and liquidity
Answering the question on how the lack of liquidity impacts what markets they trade, Greenig says that the Florin Court portfolio is clearly capacity constrained. Some of these exotic markets may not be that deep, but Florin Court have well-defined processes and an experienced team to decide on what markets to go into and how to manage risks well.
“First of all, our program is capacity constrained. You simply cannot trade an exotics CTA portfolio with 15 billion USD in assets under management. However, you can certainly trade 2 billion USD in these markets using a trend-following strategy.”
“You need to closely monitor the flows for every market and what the trading volumes really are. Then you need to make sure that the maximum position you would have in that market is only a moderate fraction of the daily flow. Our entire portfolio can be liquidated in a matter of days without unusual market impact assuming fairly reasonable market circumstances.”
According to Greenig, the fact that the team behind the Florin Court program have been involved in these markets for a decade in previous roles, gives investors a lot of comfort in that they have seen these markets in live action under many different market environments. “We know where many landmines are”.
Not fearing bitcoin
Unlike most other CTAs, Florin Court have already entered into the cryptocurrency market by including bitcoin and ethereum. Greenig sees no particular reason to shy away from this market given its characteristics.
“There are a couple of things we look at when entering a new market. First of all it needs to be sufficiently liquid and we need to be able to track changes in liquidity. Second, we look at some of the statistical properties of the market.”
“The statistical property that tends to be the most troublesome is kurtosis. Kurtosis measures how fat-tailed a market is, after adjusting for its volatility. High kurtosis means that a market is capable of moving many times its normal daily volatility. When you hear about some “10 standard deviation move” in a market, that suggests high kurtosis.”
“The interesting thing about bitcoin is that it does not have a particularly fat tail precisely because bitcoin starts out with such high day-to-day volatility. A 20% move in bitcoin is not that special if you begin with a baseline of 10% daily moves.”
“It is a bit counterintuitive, but the markets that you, as a risk manager, need to be most alert to are the markets that are typically calm and stable, but occasionally go wild. In contrast, the markets that are already known to be volatile will be traded with smaller position sizing. You simply enter with a much smaller positions given the typical volatility of that market.”
“The interesting thing about bitcoin is that it does not have a particularly fat tail precisely because bitcoin starts out with such high day-to-day volatility. A 20% move in bitcoin is not that special if you begin with a baseline of 10% daily moves.”
Onboarding new markets on top of research agenda
Florin Court was designed from the ground up to handle over-the-counter and other non-traditional markets. This clean-sheet design makes it easier and quicker for the manager to add new markets, according to Greenig. The focus on onboarding new markets remain a top priority.
“Adding new markets constitutes 75 percent of our efforts and aligns with our strategy of focusing on market opportunities. Instead of putting most of our work into marginally improving existing models, our energy is mostly spent onboarding new diversifying markets. Adding new markets has higher impact on the overall performance profile of the program.”
“There are a handful of exotic CTA programs at various managers. Florin Court´s difference is our singular focus on exotics. It’s the only thing we do. We’re specialists.”
Recognizing that Florin Court has an early-mover advantage in the exotics space brings the question whether their edge over time will fade as more CTAs enter the space. Greenig views it as an interesting question, but he thinks that the experience and focus they put in these markets will make their edge hold over time.
“There are a handful of exotic CTA programs at various managers. Florin Court´s difference is our singular focus on exotics. It’s the only thing we do. We’re specialists. The entire team is devoted to these markets.”
“We are also pushing the boundaries in that we are early into most markets. I think we were the first to enter the crypto space among CTAs and one of the first involved with Chinese commodities. We aim to keep our edge in going into new markets quickly, but in a disciplined way to maintain the quality and robustness of the program.”
*The ISDA Master Agreement is the most commonly used master service agreement for OTC derivatives transactions internationally.
