The imperative to diversify is viewed with increasing urgency by investors, including Aspect Capital CEO Anthony Todd. He does not expect that the past decade of historically very high returns from equities and bonds is likely to be repeated in the coming years.
Higher correlations between and within markets and asset classes, post-crisis, have also forced investors and managers to widen and deepen their search for new sources of diversification. Applying trend-following models to new markets is one research avenue that has yielded rewards for a number of systematic managers. Trend-following in alternative markets exhibits the hallmark CTA quality of low and asymmetric correlations to traditional long only assets – meaning that traditional ‘crisis alpha’ remains intact. It also provides another layer of diversification because momentum strategies in alternative markets have only a moderate correlation – of around 0.6 – to those in traditional liquid futures markets.
Aspect, which has grown assets to $7 billion on the back of inflows and performance, has been broadening the scope and breadth of markets traded for many years, and just over half of the 160 markets traded in Aspect Alternative Markets Fund (‘AAMF’) – namely emerging market currencies, including non-deliverable forwards (‘NDFs’), and interest rate swaps – are already traded in other Aspect strategies, such as the 20-year old flagship Aspect Diversified, and the recently launched Aspect Systematic Global Macro.
AAMF also introduces less easily accessible markets that are not traded in other Aspect programmes. These include Treasury Inflation-Protected Securities (TIPS), credit indices, commodities such as South African maize and Italian electricity, and equity sector indices. AAMF has initial capacity of $1 billion and this does not need to accommodate any sub-allocations from other Aspect strategies. Going forward, Aspect is steadily expanding its investment universe; it expects to add seven or eight more markets to AAMF by the end of 2017, and might get to 200 by the end of 2018.
The only free lunch?
If diversification is “the only free lunch” in investing, AAMF isdesigned to exploit this. In terms of factor exposures, AAMF has some overlap with existing Aspect programmes but certain markets – such as European electricity, some sector indices (based on standard definitions), and particular emerging market interest rates that lack liquid futures – are driven by different factors. Post-crisis, the new markets (whether viewed individually or as a group) happen to have generated stronger risk-adjusted returns from trend-following than have the traditional markets. However, Aspect back-tests strategies over long look-backs, in a process overseen by Chief Risk Officer, Anna Hull, who featured in The Hedge Fund Journal’s 2017 ‘50 Leading Women in Hedge Funds’ survey in association with EY. And Aspect does not see any inherent or structural reason as to why these markets should show stronger trends through cycles and over longer time periods. “Statistically, we do not have confidence that they trend better. Their propensity to trend is not statistically worse or better. And we don’t see any illiquidity premium for deploying trend models in more obscure places. Nor is it easier to identify trend signals in these markets. We do not have statistical confidence that the recent outperformance of non-traditional markets will persist over time,” says Director of Investment Solutions, Christopher Reeve.
It is instead lower pairwise correlations within the AAMF investment universe that Aspect perceives as a persistent advantage of the strategy. These correlations vary over time, and do spike up in crises, but over the past decade correlations amongst the non-traditional markets – of between 0.25 and 0.30 – have been consistently lower than those in the traditional markets – of between 0.35 and 0.40, according to Aspect.
Barriers to entry
A significant number of the systematic hedge fund managers that The Hedge Fund Journal talks to are not currently trading many of these markets. (The only other managers who have mentioned the benefits of alternative markets when we interviewed them over the past few years were Man AHL Evolution, Transtrend, Systematica and Cantab Capital (part of GAM Systematic)).
The alternative markets vary in terms of liquidity. They are not necessarily less liquid than traditional futures, but can be harder to access. “The strategy is easy to explain and is not super complicated in terms of using multiple models, but the devil is in the detail in terms of how the markets need to be accessed to do it well. It is very easy to do this badly” says Reeve.
The obstacles include operational, legal and execution mechanics. Managers need to be able to trade swaps, forwards and ETFs as well as futures. “Some of these instruments – such as ETFs, sector swaps and FX – are in fact traded using Aspect’s existing, scalable processes, where most execution on traditional markets is already automated,” says Reeve. Others are more labour intensive and require varying degrees of manual involvement, which can entail Bloomberg chat or telephone calls. A manual Request for Quote (RFQ) process rather than a transparent order book visible to all can be the modus operandi. In some cases, new legal documents need to be drawn up with existing counterparties. For other markets, relationships need to be forged with specialist brokers to source good liquidity in these markets. This is an important nuance: “even where electronic and automated trading options exist, there may be little or no liquidity on the screen, so better liquidity may be found through other channels,” explains Reeve. Some markets trade only over the counter (OTC) while others require a broker that can access more obscure exchanges. He reckons “at least four brokers, two central clearing counterparties, and one backup clearing broker, are needed to trade some alternative markets.”
Trend following and other models
AAMF diversifies by markets but not models. Whereas Aspect Diversified employs 80% trend-following models and 20% modulating factors, AAMF only uses the trend-following models from Aspect Diversified. “This is a great out of sample test for our trend following models. There are no customisations, adjustments, tweaks or fitting from a signal generation process or perspective,” says Reeve. (“Minimal refinements are made for efficient execution, to take account of the costs and mechanics of markets” he admits).
Elsewhere, Aspect is also innovating in terms of models. Some of Aspect’s other strategies stick with trend following while others have introduced new models, as discussed in our profile “Aspect Introduces Six New Systematic Strategies” in Issue 121 of The Hedge Fund Journal. In common with AAMF, Aspect Core Diversified focuses on pure trend following, but in traditional markets while Aspect China Programme applies trend following to Chinese futures markets (and is currently only investible by mainland Chinese entities).
Four other strategies use different models including a high proportion of non-trend models. Aspect Absolute Return Programme (AARP) seeks to harvest alternative risk premia. Aspect Tactical Opportunities Programme (ATOP) trades a range of shorter-term strategies. Aspect Systematic Global Macro (ASGM) and Aspect Dynamic Currency Hedging Programme trade their eponymous strategies. Some of these strategies were initially seeded with proprietary capital, as was AAMF. ATOP and ASGM both already have external investments.
Aspect offers offshore funds, and onshore funds including UCITS. Aspect also provides separately managed accounts. AAMF is a Cayman vehicle, and Aspect does not contemplate setting up a UCITS for the AAMF strategy.