After generating -12.17% performance in 2013 and starting out 2014 with -4.78% in January, Aref Karim, chief executive officer and chief investment officer at Quality Capital Management (QCM), laments the lack of opportunity as his Global Diversified program is experiencing among its worst drawdowns in its nearly 18 year history.

Contending with “new” market environment since 2008

“Systematic Macros and CTAs alike have had to contend with a ‘new’ environment ever since the global crisis of 2008,” Karim wrote in an investor letter reviewed by ValueWalk. “With reduced asset volatility and a regime shift in correlations over such a protracted period, market opportunities except in equities, all but disappeared.”

Market Trend

QCM’s Global Diversified program relies on a market environment of price persistence to properly function, an issue of late.  “As the Fed continued to expand its balance sheet through 2013 while hinting of a start to tapering, market nervousness ensued,” the letter said, setting up the primary problem market environment that occurred in 2013 for a trend follower. “That uncertainty took its toll with resultant whipsaw moves in the markets and sporadic sell-offs in June and again in December.”

Difficult market environment for trend followers

QCM is 80% trend following with a 20% counter-trend program in the mix, and has had difficulty with markets that lack momentum. “The air cleared somewhat in December with the action of the Fed’s first $10 billion cut,” the letter noted, then pointed at one reason being cited for a lack of clear market trends.  “The artificially induced liquidity that started in 2008, following the housing and credit bubble, did avert the risk of global disaster that all feared. The benchmark rate targeted by Fed towards zero, and a second round, hitting on long term rates through purchase of bonds all brought some stability but with plenty of nervousness and speculation on the Fed’s exit policy.”

Alterations to formula not taken lightly

A major topic of discussion among algorithmically driven traders, who rely on mathematical formulas and computers to generate buy and sell signals, is how frequently that algorithm should be adjusted.  Some funds, such as Winton Capital Management, are known to adjust their strategy and incorporate a wide variety of strategies based on market environments not only based on price persistence.  Other strategies prefer to remain true to the original trend following strategy which had worked well during periods of time when markets freely moved through different environments.

QCM is in the middle of this debate.  “As part of the QCM philosophy we avoid making frequent changes to the core model or to alter parameters,” the letter said. “Enhancements, when made, tend to be the output of an evolutionary exercise, rather than a reaction to events. This is why we do not ‘time’ their implementation and instead put these in when ready. By not ‘fitting’ inputs into the model, we minimize the risk of systems-decay. Top-down logic and market phenomena always.” That said, the strategy did make three primary adjustments to their formula in September:  Removal of the final directional indicator; Risk Parity adjustment in Commodities & Currencies and Enhanced Hedges to efficiently go to cash.

“The enhanced strategy is considerably better in tackling shrinking volatility and the resultant whipsaws in markets,” the letter noted. “It also has greater awareness and brings hedges in more actively to go to cash when asset correlations lose their natural patterns due to forces outside the norm. And what is more, the enhancements do not compromise the return generating power through normal economic cycles. In other words an investor faces no risk of substitution of one set of opportunities for another during a change in market environment, but simply an uplift in efficiency in the way it deals with both.”