Referring to our earlier tweetstorm:
@choffstein asked a great question about whether multi-strat CTAs may have a diluted capacity to provide the "crisis alpha" that probably motivated their purchase.
I offer a few thoughts on this below (0/9)
@choffstein asked a great question about whether multi-strat CTAs may have a diluted capacity to provide the "crisis alpha" that probably motivated their purchase.
I offer a few thoughts on this below (0/9)
1/Prior to 2008 institutions were interested in crisis alpha at an observation frequency measured in quarters, or perhaps months. At this frequency, long-term trend strategies provide strong positive convexity.
2/Modern institutions require position level data from managers at daily frequency, and measure risk in terms of daily VaR. Long-term trend strategies are mostly useless for crisis alpha at this measurement frequency.
3/As a result, institutions have increasingly migrated toward short-term trend strategies over the past several years. These strategies are especially susceptible to crowding and even small decay in their edge because of their high trade frequency.
4/ You gain attractive exposure to long volatility and long gamma, but these qualities have a cost (try sustaining a position in long-vol funds), and overcrowding has destroyed the edge. So simple versions of these strategies now have negative carry.
5/Thus, you need to marry short-term trend, with its conditional exposure to positive gamma, with a balance of positive (longer-term trend, dynamic volatility) and negative (carry, index arb) convexity strategies.
6/The short-term trend strategy can then be engineered to target gamma, without having to produce positive carry. The strategy will trigger infrequent trades on more substantial volatility acceleration, resulting in a smaller cost of carry.
7/The analog is a higher deductible on car insurance. The premium is cheaper because the insurance will not cover fender-benders, but will only kick in to cover major accidents. The other strategies more than cover the premium.
8/Thus thoughtfully constructed multi-strategy CTAs can produce strong protection against major outbreaks of systemic risk, while producing strong positive carry and high Sharpe ratios over the long-term, with low correlation to stocks and bonds.
9/This is a relatively new model for CTAs, but it’s the way we think about our own CTA fund.
