Friday, 24 March 2017
Last updated 20 hours ago
Jun 22 2010 | 10:57am ET
Aref Karim is the CEO and CIO of UK-based Quality Capital Management (QCM), a hedge fund manager specializing in managed futures. During 2008, a year which saw many hedge funds flounder, QCM's flagship Global Diversified Programme (GDP) returned 59%.
QCM trades in financial and commodities assets in 115 instruments worldwide, its positions constantly adjusted by means of a proprietary trading system, the Advanced Resource Allocator (ARA). Karim trained as a chartered accountant and worked for some years with the Abu Dhabi Investment Authority (ADIA). FINalternatives senior reporter Mary Campbell caught up with him recently in London.
Your Global Diversified Programme returned 59% in 2008 but struggled in 2009, losing 12%, how do you explain the downturn?
The managed futures industry as a whole has performed poorly in 2009, and the way I look at it is 2008 and 2009 are one continuum in the market. It just so happens that December 2008 separated the two years. And at end December or very early in January 2009 we were at a high – pretty much most CTAs reached a peak around that time. In early 2009 there was immense concern expressed in the bond market about supply issues. With the stimulus packages that had been put together globally…there was much liquidity injected into the market, so that from the beginning of the year virtually...bond yields started to rise, as bond prices declined on concerns of over-supply and long-run inflation.
Our systems did very well in the last quarter of 2008 on the back of fixed income and the dollar, the safe haven play if you like…but when debt instruments unexpectedly started to come off, our long legacy positions from end 2008 carried forward to 2009 hurt us. Most of the losses of 2009 came in the first four months of the year.
Our investment process is largely driven by dynamic asset allocation through the proprietary ARA (Advanced Resource Allocator) model. This tends to try and shift risk away from positions not working in our favor; but of course, in order to do that, you need other markets where we are more favorably disposed to spread that risk to. And that is one area where the system struggled, because pretty much nothing else was going on in the other markets and the systems will only go into cash reluctantly.
In March of ‘09 equity markets hit a low. By April-May we were already starting to initiate long positions. But generally volatility was subdued in most markets. Our strategies tend to perform better when there is a rise of volatility in the market – particularly directional volatility, strong trends – and because we tend to trade off more from longer-term trends, those trends were relatively weak in 2009.
But in the greater scheme of things, there will be inevitably periods when any system or strategy is going to be a little out of sync…however it is important to stay invested. There is a path-dependency element that is crucial in investing and particularly for skew-focused strategies such as ours. Under-performance and timing errors are caused in a portfolio when an investor gives up and thinks ‘Oh, things are just not happening here’ and closes the investment. Often times, that’s when opportunities come about.
In managed futures, returns come at unpredictable times and with equally unpredictable magnitude in a clustered fashion. And you just don’t want to miss out on it. We do our bit and try and risk manage through difficult periods and with patience. When you put 2008 and 2009 together we still end up with about 40 % for the two years combined. The way I look at it is, over the 14 years we’ve compounded wealth of about 600% and what’s the worst that we’ve done, peak to valley? Well, it’s about 22% – which is not a bad ratio at all.
How are things looking now, as of June 2010?
The difficulties have continued into 2010 so far. Just when things started to look better and the world economy appeared to be somewhat on the mend a major credit crisis developed in Europe. And the contagion risk of this European debt crisis means, yet again, there is much concerted government and outside intervention to try and deal with this. Our long global equity index positions that had been doing well gave back much of the gains as markets reversed. And so did some of the commodities such as energies as the dollar firmed and the euro sank in May.
Numerous external factors, including governmental ones, have come into play. Authorities are trying to manage both the volatility and the direction of the markets at this point in time. A serious situation as this with all the intervention means the natural flows of the markets are not in operation. The question in the investor mind is with the new austerity measures imposed, will slower growth in much of Europe drag financial and commodity markets into a lull where we shy away from risk assets for a long period?
The China situation with credit curbs to prevent asset bubbles also puts some risk into the global economic recovery. So, if this situation were to persist for an extended period of time, for our type of strategies, and indeed for most directional managers, it would be difficult to make large returns. However, we also know from experience that even in uncertain periods these strategies can often extract enough returns from some of the periodic volatility in the market and so it pays to be patient. ..Something has got to give obviously when you’ve got so many variables thrown in – so many government interventions and policy decisions that are in play… a few here and there will suddenly cause the markets to move. And that is what’s good for us.
You’ve said that you are a “believer in commodities.” Why?
The distinction between financial assets – paper assets or IOUs – and real assets – as in commodities, the tangible, ‘touch and feel’ assets – has been acknowledged by most for a long time. We can print paper and take away paper. We can create or destroy purchasing power of financial assets in this manner. Real assets, on the other hand, are limited in supply. If you look at oil, there is a finite supply of oil in the ground. There is a finite supply of metals… and even in agriculture, you can see the impact of global warming, there’s only x-amount of land on earth…So, you know, these two assets [financial and commodities] have different behaviors. Some of these commodities form the input to manufactured products … so you need the raw materials that go into cars and planes and whatever.
The correlation in the long run of financial assets and commodities has been low or negative. And this is quite evident, for example, during inflationary times when you can see commodity prices rise and real value of financial instruments fall or bond yields rise. The recognition of [commodities] as an asset class has become more evident in the last 20 years or so when institutions – and I’m talking about pension funds and other large financial institutions, including sovereign wealth funds – have realized [their] portfolio properties are different from traditional asset classes of equities and fixed income. For a long time, institutions have shied away from having commodities in their portfolios and have not recognized them to be a separate asset class. Such investors today recognize that this form of investment actually does add considerable value in terms of their overall portfolio allocations.
In my early years with a sovereign wealth fund –the Abu Dhabi Investment Authority –we expressed our desire to hold real assets principally through a large gold holding. We ran a commodity portfolio but largely in the form of gold and …that was to serve as a hedge against the financial assets the institution held. Most central banks typically have some of their monetary reserves in gold – the US Federal Reserve still holds something like 270 million ounces of gold and this does not move, it’s been there for years. And there is a purpose for it. It is to act as a backstop to the fiat currency, the paper money of no intrinsic value that we can print easily. That has now extended into not just gold as a commodity …but commodities as a whole, through baskets. So the SPGSCI [Standard & Poor’s Goldman Sachs Commodities Index], Dow Jones UBS etc, you’ve got all these swap products and indexes that have been created to replicate a whole basket of commodities… and investors have been buying into them. It’s a great diversifier for a portfolio. I do believe that commodities are an essential part [of a portfolio] – their portfolio behavior is different, so therefore it makes [them] a separate asset class, and the diversification/correlation story is a good one. …Real assets are finite in supply whereas, paper, you can pretty much print at whim. At QCM we trade commodities and we have two products dedicated to this asset class.
You've recently introduced a UCITS III-compliant version of the GDP, is that your response to EU plans to regulate hedge funds?
What we didn’t have in the past was an onshore, European investing vehicle. We have now partnered with Deutsche Bank on this product launch. And what the UCITS fund has done is to open that avenue for us. It is also a product where, potentially, retail investors can come in. We’re not offering this to retail investors initially, but down the road it is possible that we will do this.
Retail investors, when taken, will be able to invest theoretically with a minimum of only $100 although for practical purposes we will probably have to raise that threshold. They can invest in a fully diversified portfolio of asset classes – equities, fixed-income, currencies to commodities, pretty much everything – so they have in one shot, through a futures portfolio, an exposure to all the asset classes but with a small but affordable amount of money [invested]. They have benefit of correlation, an investment that gives them portfolio insurance when equity markets get badly hit, and expect absolute returns in the long run. And what is more the product it replicates, the QCM Global Diversified Programme, has a long performance history in excess of 14 years.
The additional comfort, of regulation, as you mentioned…is a very important factor. We like the idea that this is going to be available to investors in a completely regulated framework with attractive terms. It offers daily liquidity – futures are highly liquid and transparent anyway, but nonetheless this product offers daily liquidity. It is fully collateralized so that investors will be fully protected from credit risk. It also deals with the problem of UCITS products in the extent to which you can trade commodities. A futures instrument where you can take physical delivery results in a problem with UCITS III. Deutsche Bank [has] created a swap structure and that allows us to offer investors exactly our Global Diversified Programme but conforming to the UCITS rules…It’s a great solution from our point of view.