Kim Bang grew up with his father’s shipping industry in Denmark, and discovered a fascination of the managed futures industry. He went on to work for companies such as Bloomberg and AIG, before founding his current firm with his son. Listen to his story and find out what makes a firm that can compete in the managed futures industry.
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Welcome to Top Traders Unplugged, where my goal is to give you the clarity, confidence and courage you need to invest like or invest with one of the top traders in the world. It is the stories that you never get to hear set out as the most honest and transparent account that I can make of what goes on inside the minds of some of the best investors in the world. Today you're listening to episode 77. If this is your first episode you've heard, you might want to go back and listen to all the earlier conversations. Before we go any further, let's find out who's on today's show.
This is Kim Bang, Founder and Managing Partner of Prolific Capital Markets, and you're listening to Top Traders Unplugged.
Thanks for doing that, Kim. By the way, if you want to read the full transcript of today's episode or any of the earlier episodes, just visit TOPTRADERSUNPLUGGED.COM and sign up by hitting the little button in the top right corner. It's that simple. Now let's get started with part one of my conversation. I hope you will enjoy it.
Kim, thank you so much for being with us today. I really appreciate it.
Thank you, Niels
Now our conversation today is a little bit special as you are the first fellow Dane that I have the opportunity to invite on the podcast. I guess there aren't very many of us in the first place, and hardly any that have been foolish enough to choose the quantitative investment route as their livelihood. But when I look at you background, I notice a lot of familiar names that you, one way or the other, have been associated with. So I'll be interested in learning much more about your journey. But as an emerging CTA you, at least to some degree, compete against the twenty managers within the BTOP50 Index, and who between them have more than 50% of the industry assets. So one of the questions we'll be talking about today, no doubt, is how does an emerging manager compete and break in knowing that 80% or more of the available capital flows will go to the top 20 firms?
The good news is, is that all of these firms at one stage were also an emerging manager. Of the 20 firms in the index, 19 of them actually started with AUM of less than five million dollars. So interestingly each of these firms had their best-annualized returns in the first 3 to 5 years of business, returning on average 20%. Once they grew beyond 500 million dollars, their annualized returns settle around 10-12%, and their correlation converged.
But before we jump into all of those details which I'd love to discuss with you, I just have a simple question that I'd like to ask all of my guests in order to appreciate the many different answers that we get to this question. And it goes something like this: If you were in a group of people that you didn't know, and you were just about to leave, say, a social function and you were standing outside and you just pressed to order your UBER car, and it informed you that it would arrive in 2 minutes, and then suddenly one of these people comes over and asks you, "So tell me Kim, what do you do?" How do you respond to that? How do you explain what you do?
Well Niels, thank you very much for that introduction and indeed it is a real pleasure speaking to a land's man. I think you are probably the first Dane that I have encountered in this industry of ours. So it's a real pleasure. I guess I would describe it sort of very succinctly in that we are money managers. I would say that I would reference our performance, which up to date is - we're running an annualized return around 19%. I would point out that the way that we look to earn money for our clients is in a very non-correlated way. So we emphasize sort of a superior or attractive risk-adjusted return. So I would say that an investor who is a classic investor in stock bonds, maybe real estate - if they're looking for diversification in their portfolio, investing with us is an attractive proposition.
Sure, but we're going to stay with you for a little while longer because I want to get to know your story, how you got into the business in the first place, and also please add as much color to it as you want. You know, how were you as a kid? What were you doing? What were your interests? Because my personal opinion is that investors don't really understand the numbers that a manager produces unless they understand the story behind the manager. So feel free Kim to take us back to your early days and take us through your career.
Thank you Niels. Well, I think I have quite a story as how it pertains to this particular business. I grew up in a family where my dad was a shipping man. As you know, in Denmark the shipping industry is quite a big one, and my dad was very active in the shipping business. He was a pioneer in developing the time charter business in shipping.
As you may know, the shipping industry is a very volatile and cyclical industry. So my dad's business was in chartering ships around the world and coordinating cargo on these various ships. Because of the cyclicality of the markets, he was looking for ways to hedge some of his exposure.
At certain times, he also got into actually dealing in the underlying cargos. He would actually take possession of the cargo, and he would have exposure to the underlying commodities. This is going back into I believe sort of in the mid-'80s, there was a project with the BIFFEX Exchange in London to launch a shipping futures contract. My dad got involved in an advisory capacity to help structure and design this shipping freight index contract. He was one of the early adopters of this contract in a usage for hedging his exposure on the shipping voyages.
He got very interested in this business, and he started… He employed me as a young man to be the data grunt, right? So I would be responsible for putting in data initially for these shipping contracts, but then later on for the commodity markets, in general. You know, I would extract the data from the Wall Street Journal, recording the prices: the high, low, closes, open, the volume on the day, the open interest. All of this data would go into a Lotus 1,2,3 program, right? So you can see we're talking about back in the early 80s. From that, my dad developed a bunch of models. So this was pretty… sort of fairly straightforward models, they were quantitative in nature, they had the moving average components, they had… We studied a lot of the cyclicality of a lot of the underlying commodity markets, and essentially developed I would say sort of the trend following models.
If I could just stop you there Kim, I know that this is about you, but I'm interested now in your dad as well here. How did he know about moving averages and stuff like that? Where was he getting his information from?
Right, so I guess he was getting information for people around the time that were in the business, Welles Wilder, Larry Williams, you know these are some old names in the business that were sort of on the cutting edge of developing technical analysis and quantitative models and so forth. So he had some inspiration from these guys, and as I said, essentially developed some models, and had a fair amount of success. And as I said, initially started in the shipping side of the business but then moved on to the broader commodity markets, and over a period of I would say maybe some 10 years, developed some pretty elaborate markets and then launched a money management business for mostly family and friends and a few sort of business associates. And he ran that business up until I'd say 7, 8 years ago or so. So that was my early introduction into the business, through my dad.
Okay, and tell me a little bit further about how yourself so to speak got involved after your initial introduction to open, high, low, close, and all of that.
Yes, exactly. So I went on a parallel track. My dad was in Europe, and he actually launched this business in Switzerland, and at the same time I went and I finished my studies here in the States, and I went to get a job on Wall Street. I started my career with Drexel, and this was right around the time the Michael Milken, and Ivan Boesky scandals.
So after a couple of years I had to look for new opportunities, and I had a stint with… So my Drexel career was actually in Drexel trading, so that was in the commodity markets, it was in foreign exchange, it was in the financial futures, and I was involved with research and trading, and sales trading. So this was very much my passion after having been introduced to this business. And then I had a stint - I went to Luxembourg at the launch of the financial fixed income futures in Europe. So we're talking about the bonds, the short sterling, and the gilts. I set up a trading desk for Commerzbank, and I ran that for a couple of years.
During that time Drexel trading was bought out by AIG, Maurice Greenburg bought Drexel Trading and launched AIG Trading. Those were my old friends, and they gave me an opportunity to come back to the States and re-join that firm, which I did. So now we're talking about this is in the late '80s. I went back, and I helped them launch a foreign exchange business. I was involved in the market making activity, sales trading, but my passion and sort of real interest was really in developing this business into a money management business, which was an interest of AIG, but only they hadn't really sort of come around to it at that time.
I was working on developing models in my spare time. I was one of the early adopters of a product by Omega Research called System Writer Plus at the time, but today it's called Trade Station. And it is a very neat platform that gives you a lot of historical market data and the ability to develop programs and do backtesting and this kind of thing. I developed some models, and I decided to leave AIG Trading to venture out on my own and to look to raise money. I was very fortunate that I got funded by Tudor Investments. So this was now in the very early '90s, and Tudor Investment at the time was running an experimental program where they would allocate some funding out to emerging managers and talents that they perceived would be talent.
They gave me a very small allocation initially, a few 100 thousand dollars, but within 6 to 9 months, I believe I had about 3 million dollars from them, and I did okay, nothing spectacular. I was focusing on the foreign exchange side of the market, and unfortunately they decided to close the program down after about 18 months.
So I was sort of in business and out of business, but they were very gracious and introduced me to a consultant who had funds from the Virginia Retirement Fund. The Virginia Retirement Fund at the time was a real pioneer into this alternative investment space. They decided essentially to replace the funds that Tudor had initially allocated to me, so I got that three million dollars replaced. I managed money for about another 18 months, so in total about three years, and built a little bit of a track record, which was okay.
Unfortunately, I found that it's very difficult to pay the bills at the time with a family and kids, and sort of 3, 4 million under management, it wasn't really cutting it. Then I had an opportunity to go and join Bloomberg, and I decided that I'd better get a real paying job. My wife suggested that it's probably better that I go and get a real paying job, and so I had to sort of put my passion and dreams on hold at that time.
Sure, sure. So what did you do for Bloomberg?
So at Bloomberg, Mike wanted to build a trading system. So he was looking for somebody with a background in building trading systems. A head hunter came to me and said, "You know, you are somebody who builds trading systems, aren't you? So you should really go and talk to Bloomberg." Now the trading system that Bloomberg had in mind had really nothing to do with the type of trading systems that I had developed.
Mike was interested in building; really an execution platform to compete against Reuters owned Instinet, which was a stock execution, sort of trading platform for institutional clients. At the time that business was very successful for Reuters. It was probably by far Reuters most successful entity. Of course Reuters, being the biggest competitor of Bloomberg, they were… Mike was somewhat concerned about that because they were taking the funds and the profits from Instinet and plowing it into building a Bloomberg competitor. They wanted to build a Reuters analytic to compete against the Bloomberg platform. So the mission was that we had to go and take on the Reuters Instinet and take them out.
Right, nice and simple!
Nice and simple! And it was a very interesting opportunity, and Mike was really interesting in the way he sort of approached it because he said to us, (we were a small team of 3 or 4 people at the time), and he said, "Listen, I have to tell you something. The brokerage business is a terrible business. Commission rates, they only go one way, they go down. Believe me, I was at Solomon Brothers, it's a terrible business. But don't worry yourselves, once you accomplish the mission, you take out those guys, don't worry about it, I'll find you another job somewhere else at Bloomberg!"
So that was sort of how we started off, and the funny thing is, is that the business turned out to be really an incredibly successful business. I ended up running that business for about ten years. We built it up, I think we had more than ten thousand institutional users. This platform was used to get direct market access to equities, futures, options, the foreign exchange markets, we really rode the whole "electronification" of the markets and we participated in that whole period you know, where all the ECN's flourished, Island, Archipelago, New Edge, Bats. And you know, Bloomberg trade-book is still very much around and successful today.
So that was a very, very interesting period. It gave me a lot of exposure to of course to institutional clientele into the microstructures of these various markets - the regulatory environment. We spent a lot of time building execution algorithms that were very nitty gritty in the way that they worked. You really had to understand the microstructure of the markets. You know, the whole idea in that business was to try to improve on the execution quality for our clients. And the clients were big clients who were trading large amounts of stock, or futures, or options, or foreign exchange, and they wanted to minimize their market impact. So we developed a bunch of sort of pretty intricate execution algorithms and order types in order to help our clients to accomplish these kinds of things.
Fascinating! Excellent, and that's pretty much where you ended before? Setting up Prolific?
KimSo now we are into about:
So I was in London for them with responsibility for Europe and Asia PAC for a couple of years as that business was being launched. After that, for me personally, it didn't really work out so well. You know, I wasn't quite as hands-on as I had been with the Bloomberg trade book business, and I was a little bit frustrated with this situation.
So I got an opportunity to run a business that was owned by a private equity firm called Advent International, who had bought a bond business - a bond ECN sort of exchange business that served financial advisors in the United States. So there are a lot of financial advisors that service high net worth individuals in the United States with the big wire houses. And we sat on the desktop of one hundred thousand of these financial advisors, and whenever a client wanted to purchase a municipal bond, a corporate bond, a treasury bond, a CD, any sort of fixed income instrument, they would go onto BondDesk and they would run some analytics and they would search for the type of bond that they were looking for, and they would get access to our liquidity sort of exchange marketplace, and they'd be able to source this product. So it was a very interesting opportunity, and I envisioned that the bond market was the last frontier in the entire sort of "electronification" of the financial markets, right? Because the stocks, they had gone from being driven by human beings, either on the floor of the New York Stock Exchange, or in case of NASDAQ, traders sitting behind the computer screens and manually transacting stocks, right? They've gone from that kind of an environment to an environment that was entirely fully electronic. This is essentially where we are today on all of the equity markets, on all the futures markets, and basically pretty much the options markets, and foreign exchange, right? All of those markets have pretty much been fully "electronified," whereas the fixed income market has really not as yet.
So I thought there was an opportunity to take this platform, a BondDesk, and bring it into the age of sort of a fully "electronified" marketplace, and try to leverage it out and open it up to the broader institutional bi-side community. So I did that for about 18 months or so, and the business was sold to Trade Web. So, today Trade Web is running that business.
So that left me with a situation to figure out, okay, what to do next? And after taking some time off and traveling the world a little bit, and I took my son along with me who was a recent graduate at the time from NYU, and climbed some mountains and did some hiking around and sort of decompressing. So thinking, "Okay, what do I really want to do now?" And it sort of took me back to, I would say, my early passion in the markets and in the space of developing I would say sort of quantitative models and investing in the markets particularly I would say, sort of in the futures commodities markets, financial futures markets.
And it happened to be that my son was also very interested in this, and we'd sort of been developing models together five years prior to this time. While he'd been at NYU, he was developing models and using a trade station platform. My son, he launched a quantitative systems development club while at NYU, called the Torch Capital Management Society, and he got Trade Station to sponsor platforms for the students. So Trade Station provided 20 platforms for students at NYU and NYU Courant Institute. And this club was the most in demand sought after club at NYU. In any given semester, they had more than 200 applicants to join this program for essentially 20 slots.
So it was a very interesting initiative, and my son ran it for a couple of years and had a bunch of the grad students and the Ph.D. students join the club, and he gave them assignments along this spectrum of I would say, the CTA spectrum, and around the classical trend following modalities, and he assigned these guys different objectives, right? Because you know, when we studied the classical trend following programs and systems, we see that they work very well and can even be extrapolated back in history and you can see that the core components behind trend following has a lot of value.
The problem is that it tends to be rather cyclical, rather volatile, and maybe for many investors, a little bit hard to stomach. You know, in particular, certain periods of time. You know if you're looking over a 10, 20, 30 year period, I think you'll see really excellent performance, but the ride can be a rather rough one.
So the objective was: Is it possible to take this core methodology, this core approach, and improve upon it? Is it possible to dampen the volatility somewhat? Is it possible to produce better risk-adjusted returns? So this was the objective of this group or this club. So we gave them assignments such as you know, look at volatility. Can volatility be used to forecast or improve performance? Is there cyclicality components that can be used? Is there role methodology that could be used to enhance performance? Are there more dynamic components that can improve and get better traction and better accuracy in the underlying signals and so forth and so on?, we launched in September of:
Fantastic, great stuff! Now obviously, we're going to dive much deeper into that side of things, but I just want to stay with you as a person a little bit longer, but bringing it a little bit outside the working environment. Because clearly you're busy as managing partner of Prolific, that's a big part of your life no doubt. But what do you do when you're not working? What do you spend your time doing?
If there's any time left I guess!
Yes, of course, of course. I think it's important to have a good balance in your life. I mean I'm certainly not shy of working, and sort of working pretty hard, but I think that it's important to spend time with your family. I have a wonderful wife, and I have four children. I think it's important to spend time with them, and I also enjoy physical exercise and activities, and particularly outdoor activities. So, I enjoy biking, I enjoy hiking a mountain, I'll do some yoga if you get me on the beach, sometimes I like to go down to Aruba and go kite surfing. So, those types of things I really enjoy, and I think taking some time off to sort of clear your mind and do some exercise, I think it's an important thing to do.
Sure, that sounds great. Now in order to succeed in setting up your own business, regardless really I guess, of what industry you're in, you need to be… you could say at the right place at the right time, you need to have the right team. How do you plan this? I mean how do you know if you get those things right so to speak?
Probably more luck than anything else! Certainly in terms of the timing, right? I mean look, I think that in our case, I think we were lucky. The timing was pretty good because I guess that this particular industry, the BTOP50, I think they probably did very well in '08, '09, '10, also not so bad, but then sort of went sideways for a couple of years, right? So, if you'd launched in '12, that would have probably been pretty tough. We launched in sort of the 4th quarter of '13, and that's sort of when volatility came into the markets, and divergence started to become more apparent, and directionality. So there was an opportunity for us to extract a positive and attractive revenue stream.
So I think that a lot of that is circumstantial and chance, right? In terms of the right team of people and the net worth and so forth, that's more about recognizing what do you need to build an organizational structure? If you're not going to hire everybody and build a big team yourself, how do you partner with other people and how do you leverage infrastructures that you may not have yourself? How do you leverage those points in order to build a platform, or business, that you can position at minimum to get off the ground? With a longer view, it has to be somewhat scalable, and it has to, at a minimum, evolve into more of an institutional platform, right? Because at the end of the day if you want to raise some real money, you need to be able to present an institutional platform.
Sure, sure, and I'll be interested in diving into that a little bit more. Now the program that you run today, if I'm not mistaken, it's the Prolific Swiss Program? And I guess maybe that goes back to the days of your father since it has the "Swiss" inside it?
Yes, that's right. My dad, he came up with that name. He's the one who came up with the Prolific, and having named it, exactly what you said, "Prolific Swiss," because he was living in Switzerland at the time, so we sort of carried that through. We haven't quite emphasized so much the Swiss system side of it because we're sitting here in New York, but that is certainly the origins. I would say that the other thing is, is that it's not a singular system anymore. It's really more of a multi-strat program that combines, at the core we would say, directional volatility. Also, we've introduced a number of mean reversion strategies - some partly built into the core model and some really on a stand-alone basis. So it's more of the multi-strat approach today.
Sure. Let's jump to the next topic that I wanted to ask, and I know and realize that you're a small organization. But still, I do want to ask because clearly you have a huge amount of experience in building organizations and running them and so on and so forth. You fully understand what is required in the trading world, so how have you structured your so-called "organization" as it is today with the AUM you have right now? How do you do that and still make it attractive for investors, maybe even institutional investors, to take you seriously?
Right, so it's not easy, I would say, and I think the reality is, is that if you're going to try to make a go of this business, you need to have some money yourself that you can put up. So, I think that you need a few million dollars that you can put into the business yourself. Maybe you can go to a family member or two, and ask for 1 million or 2, and maybe you have a friend or a business associate from your prior life, and maybe they'll put up a couple of million bucks. So, if you can get out of the gate somewhere around 5, and even better around 10, but I think that's the minimum level where you have to start.
I think that you probably can't expect to get any more money from any outside investors for probably the first 18 months. I would think 18 to 24 months is probably the first time, which is around where we are right now. We are getting more inquiries now than ever, and it's from, I would call them, early adopters - but institutional clients. These are probably institutional clients that I would classify as very knowledgeable about this particular industry. So they're very comfortable. They understand the underlying investment strategies, they're very comfortable with the type of trading activity that goes on in these markets, and they understand the risk associated with it and the volatility.
So, they really understand. They actually like to make investments around this time frame. I think the reason, as you mentioned in your opening commentary, is that we've done some research, and it's very easy to do when you look at the BTOP50 firms -there's about 20 of them in there. It's very clear to see, all of them had their best performance in the first say 3 to 5 years in business, and their average performance was around 20%, which is pretty outstanding. And, by the way, these firms, they launched at all different times, right? It's not like they all launched 30 years ago. Some were 30 years ago, some 20, some 10 years ago, right? So they were fairly well dispersed. But in common, they all had their best returns in their first years of business.
Then subsequently they got a lot of money on the management, they're very successful, and they continued to be successful I would say but at a lower level, right? So, their returns are almost half, and the annualized returns are almost half than where they were in the very first years. Perhaps equally important, their behavior, their correlations have converged, right? So, when you are an early adopter looking for an emerging money manager, and you really understand the business and you really know what you're doing, you're in the sweet spot, right?
The opportunity is a sweet spot to make an investment with a good, solid emerging money manager, somebody that you feel comfortable with, that you think has the proper credibility and can run an organization, and you understand their edge and you believe in it, you are really sourcing for a sweet spot. So, I think that's where we are right now. We've been fortunate; our timing for the launch was pretty good. As I mentioned to you, we're annualizing a little over 19% so far, and our sharp is running around 2, which is very high for historical standards in this space. I think the historical sharp of the BTOP50 is closer to .7%.
Indeed, indeed, but, of course, obviously over a much longer period of time. But there's no doubt that you've had a very solid start to your live performance, and of course I've also seen the historical simulations of your systems, and they look very intriguing. Now, before we move into the real nitty-gritty of the system and trading, I just want to pick your brain a little bit because of all your experience in the large organizational structures, but then applying it to a small organization today. What have you kept in house, and what have you outsourced to the partners that you mentioned that you can use when you're small?
Right, so what we're doing in house is clearly we're doing the research. So my son is primarily focused on the research, he's the one who has more of a quant background, so he does a lot of the research and the testing and so forth and so on, of course I participate in that. I am quite focused in sort of overseeing the models and the operational side of it on a day to day basis that it's running properly and so forth and so on. We are looking to… We're in the process of setting up our servers into a co-location site at NY4, and the reason we want to do that is to have a more robust infrastructure I would say, and better redundancy, and closer to the markets and so forth. So we call that sort of a little bit like an outsource instead of running everything internally with the internal computer centers and networks and that kind of thing.
The other thing we've done is we partnered up recently with a firm called Worth Venture Partners. Worth Venture Partners is an emerging hedge fund manager platform - an institutional emerging hedge fund manager platform. So what makes them institutional is that they have a broader staff. They have hundreds of millions under management; they specialize in identifying emerging managers that they think have potential. Currently they have about a handful, so we're just about to be onboard and we're launching in April, So we'll be the sixth manager. And they have some diversified strategies, right? We're one particular strategy, and all the other guys are doing other things. But essentially what they do, is they come in, and they do deep dive due diligence. They do real-time monitoring and operational due diligence ongoing. They monitor for risk and leverage and concentration risk. They keep books and records. They do strike NAV's. They provide compliance over site and regulatory over site, right?
So, the benefit there is that it's not really something that we think provides us an edge if we were to in-house it, and also, the expense for us would be very significant. So, for us to outsource it, and actually in this case at Worth Ventures, they provide a hedge fund sleeve. So we're part of their co-mingled, diversified program, but at the same time we have an independent, standalone investment sleeve. This means, that our investors, rather than managing multiple managed accounts, we can aggregate funds into the Prolific sleeve, and we can manage the funds on an aggregated basis there. And it's a third party oversight, it's a third party independent oversight of that money, and striking bid and the NAB's, and recording the numbers, etc., etc.
Sure, that makes sense.
So those are some of the things I that are necessary when you're trying to start up something from an emerging manager perspective. The other way is, is that if you are somebody who is very well known in the business, and maybe you've been managing money for 20 years at Goldman Sachs and you have a whole team there, and you spin out of Goldman Sachs, it's very likely that you can get funded with hundreds of millions of dollars and you may decide to set up your whole entire infrastructure from scratch and run the whole thing, but that's of course because you have a very large asset base starting off, right?
Sure, yeah absolutely. I just have one last question, I promise, regarding that which is organizational, but I do find your background super interesting and very relevant. I think sometimes people underestimate the importance of the organization actually, especially in these kinds of businesses where usually there are not that many people. So the people who are there generally have to work very well together. So, in your experience in the past, and maybe it's probably the Bloomberg experience for the most part; and looking into the future, and hopefully Prolific Capital will grow, and you're going to have to face the same challenge with your own organization, but how do you build a strong culture in an organization in your opinion? What's been your experience in that?
That's interesting that you ask me that because you know I worked for Bloomberg for about 15 years, and Bloomberg has an incredibly strong culture. It's a real talent and effort to build such a culture. I think it takes a lot of effort and a lot of time, and it is a very valuable thing to have. It has something to do… There's a lot of elements that go into this, but I'll give you an example from Bloomberg. I'll give you a few examples from Bloomberg, which sort of really captures the culture in many ways.
For one, Mike made sure that our incentive across the organization, regardless of the various departments was singularly focused on the Bloomberg terminal. So, everybody in the entire organization was remunerated - the bonus was linked to the performance of the sales and the growth of this product. So, that's one way just to align the organization in a very powerful way. The other thing is something that is extremely powerful, and I think insightful, from Mike, and that is that he had one pricing policy. So regardless of whether you took 2 or 1,000 terminals, the price would be the same per unit. So, imagine the impact on the entire organization, all the people and the culture as a consequence, is that when price is off the table, the entire organization has to focus on supporting and validating the cost of this terminal.
The value proposition has to be always very clearly understood and articulated, because there is no discounting, right? That means the analytics have to justify the cost; the sales people have to justify the cost, the support people have to justify the cost, the contract people have to support the cost. The entire organization has to sort of rally around validating this cost of the product. So, this was a very powerful thing, and I think Bloomberg recognized this in the way that he competed with the Reuters and various other market data vendors. Mike was basically prepared to say, "Listen, if you can't support the price point, we're just going to close down the business."
Yeah, I mean it's interesting, it's fascinating, and maybe I'm completely wrong here, but it seems to me that that kind of philosophy would work very well in our industry because everything, everyone in an organization of an alternative investment fund, or hedge fund, or CTA, or whatever we call it, are all focused on (or should be) creating the best possible output of the program because that's what's really going to make a difference to the investors whom we ultimately are privileged to serve and care for.
That's right, I mean I think that two or three things that are absolutely paramount is that number one, you have to be able to show a positive and attractive revenue stream. You have to as an emerging manager, I think it's important to show a differentiating value proposition. Another way to say that is, you have to have a low correlation. In our case we benchmark against BTOP50, so I think it's important for us to show a low correlation through that peer group. Thirdly, your risk-adjusted returns have to be really good, another way also to say that, right? Your sharp ratio has to be very attractive.
I think those are the key components to sort of how you market or present our product. If you have those three, I think you have a shot. It's not that it's easy because it's hard to break into this business for sure. I think those are sort of the three components in which if you can keep producing, the quality in those three categories, I have to believe that over time you'd be able to grow your assets.
Well it's for sure a very tricky proposition, and I think the reality is, is that what… 80% of the investable assets, they go to the established managers such as the ones in the BTOP50. So, there's a very long tale of smaller managers and emerging managers that have to fight over the scraps. So I think, unfortunately, that is the reality. You can see what I have done, and when I gave you information on our business, I included a 30-year simulated track record, right? So of course, you have to take it with a grain of salt, and some people will completely discount it and so forth and so on.
What I try to do is I try to say that, "Look, it's supposed to give you a profile, it's supposed to give you a profile of the type of investment returns, the type of volatility, the type of risk, the type of behavior that you should expect when you invest with us." So, if you have that profile, it's a profile that you can use to apply to our real-time results and going forward. It's a measure to see if we are going to behave inside of that historical profile. Right? Because if you do behave, if you are able to behave along the lines of that historical profile then it should give you underlying confidence in the investment proposition because that's essentially what you communicated, is this profile.
This is what the client should expect going forward, this kind of behavior. The other thing I think is valuable, and a friend of mine when I asked him for advice, he's in this business himself as a hedge fund manager and very successful, I asked him when we launched, "How do we attract clients? How do we get our clients more comfortable with our strategy?" These questions are sort of along the lines of the question you just raised. He said, "I think one way and a very good way, is that you should communicate your investments and your strategy and give real examples on how you made money and why you lost money and so forth and so on." And he said, "Why don't you send out a monthly update, like a newsletter, to perspective investors and explain to them why you did this trade, and why it worked or why it didn't work?"
So, we've done that ever since we've launched, and I think that was very good advice because it gives the client an insight into your process. You know, why you take a trade, how much risk you assume, what you look for, when you took off the trade. Did you lose money? Did you make money? What were the ratio winners to losers? And what was the proportionality of the gains to the losses? All these sorts of things, and I think over time, somebody who will familiarize themselves with these examples will become more comfortable.
Sure. I think that's true, I mean I believe in that and I actually did note in the material you sent me that you wrote about the recent events in the Swiss Franc, even though you weren't positioned in it at the time, you did go to some length to explain to your potential investors and current investors what would have happened in terms of P&L, had you been involved in that particular trade on the wrong side. I do agree with you that that helps explain. Now, the challenge that all managers have where there's not a long, real track record, but even people with a long, real track record face the same issue, and that is, we make changes to the systems, they're not static. So, how do we make investors comfortable with that in your opinion? Meaning, do we give them a new backtest every time we change the system?
These are the real issues, and people might think, "Well why is Niels bringing this up to date?" Well actually, these are real live examples, challenges that we face every single day when we talk to investors. Even firms that have been around for 20, 30, 40 years, their systems are so different today than they were when they first started." Then maybe people will say, "Well I'm buying their ability to continue to innovate." And that actually is a valid argument for sure. But, of course, you could always ask yourself what you want to see. Do you want to see a 20-year track record with lots of changes? Or do you want to see a 20-year simulation of the current systems to get a feel for what it's really like today?
So, I don't know whether you have any thoughts about it, but I do find that this is… and maybe this is part of the reason why investors apparently still find it difficult to embrace the systematic strategies even though they've been around for a very long time and have been very successful? It's undeniable. But, it's also undeniable that it's one of those real love/hate relationships that investors find themselves with. They end up often buying performance, which is the worst thing you should do because you end up buying the highs and selling the lows, and you become your own trend follower of trend followers which is not a good thing. So, I just wonder whether you've had any experience in this with where you are?
Well yes, I certainly have encountered those challenges. I would say it's amazing, there are some investors out there that are incredibly black and white about that they don't understand quantitative systems and they don't want to touch them because they don't understand them, and that's the end of it, and forget about it. They don't care what returns you have and what risk-adjusted returns. They don't care about anything they don't understand, and they don't want to touch it. They will just look at fundamentals, right? It's an amazing thing. I can't really quite comprehend why that is, and to those guys I usually say to them, "Have you ever heard of Jim Simons?"
It's just incredible! But there really are quite a few investors out there who are adamant about this. They just would not invest in quantitative strategies. And to me personally, I mean I guess I'm almost on the other side of the equation because what I love about the quantitative strategies is that everything is so quantifiable, you know? I know exactly what my risk is. We talked about a profile, investment profile, and risk-adjusted returns, right? I think when you're quant, you can get such a clear picture that immediately if the strategy is not performing to that profile and to that expectation, then it gives you a clear signal that something is wrong.
Whereas if you're a fundamental value player, there's no signals. It probably just shows you that it's a better value, you know? That what goes against you just becomes a better value! So, it's sort of a real conundrum. I do think at some point the historical simulations, and the presentation of historical simulations, and their track records become less relevant. I think that at some point we will drop it. The issue again is, is that when you are an emerging manager and if you're going out and you want to talk about what you do, and you're talking about 2 months worth of performance, there's nothing to talk about! There's hardly anything to talk about! So that's where it comes from I think, you know? You have to have something to talk about!
Yeah, it's very true Kim, indeed. It's not really my forum, it's your forum here today, but I do want to share a little bit of a story in terms of when you mentioned this thing, you're probably on the side where anything that not's quantitative, you feel uncomfortable with. And I think that most people in our business probably feel the same. Someone shared with me a story about… and he was apparently the risk manager for a large bank and oversaw the risk of these bank's proprietary trading and so on and so forth. And during the crisis in '08, '09, he was basically saying that a lot of those traders that apparently people feel so comfortable within their approach. I mean they were sitting under their desks just shaking their head, having no clue what to do. And I think it just shows you the power of having a systematic rule-based strategy, always knowing what to do and never being in a situation like that. It's clearly not the way it's been perceived from the outside, so there's still a little bit of a learning curve on that. But anyway, let's jump to the heart of our conversation, perhaps. Namely, the strategy and the program itself, so just from a 30 thousand feet point of view, tell me what you're trying to achieve with the program itself.
Okay, so Niels, at the core we are die-hard believers in the idea that markets trend, and that they have sort of Asymmetrical characteristics. You know, when they move, they tend to move more than when they're stagnant, relative to their stagnant behavior. When they move, it's sort of disproportional to that which gives the underlying opportunity to catch a trend, right? That is what we believe deep at the core, and so as I mentioned to you a little bit earlier is that the issue now is, is that if you believe that then the question becomes: Well, what's the best way to capture it? Right? And there are people who have been in the business and have been very, very successful at capturing these underlying trends for the past 30 years. Research has shown, maybe even go back to a century or maybe even longer, that these core concepts, they work.
As I mentioned earlier, the problem is, is that some of those strategies have a lot of volatility and maybe perhaps too much volatility for the investor. Or should we say that the competition has become much greater so that in order to have a fighting chance in this space, you have to do better, right? You've got to be better, you've got to be different, but being different, it means that you have to really have better risk-adjusted returns and/or you have to have a low correlation, right? You can't just be like the next guy, because then why should I give it to you as an emerging unknown when I can give it to somebody who's been in the business for the last 10, 20, 30 years, and why should I take the risk on you? So that's really where we focused all of our efforts. It's can we carve out an edge that is a substantial edge, an edge that we think is scalable, and that we think can be consistent and produce essentially competitive returns that are somewhat differentiating in nature to the more established players.
I think in many ways, in order for people to understand an individual program's ability to do so and deliver the things you just mentioned, I think we need to add one thing, and that is the environment. Because to some degree I guess, all systems are designed to function in a certain environment. So, if you're a trend follower, you want trends. Now, I know that… and we're probably going to get into that in much more detail, that you're trying to cater for perhaps a little broader environment, if I can call it that, then just the pure trend following environment? But, talk to me a little bit about the environment that you're trying to… or at least I could say where you know you're going to be doing, or should be doing well, but also talk to me about the environment where actually you're not expecting to do so well.
Right. Okay so, let's see where we'll take this. I would say that first of all, as an emerging money manager, and emerging I mean somebody who doesn't have hundreds of millions of dollars under management, by definition, has an advantage. So the advantage that we have is that we are smaller and more agile. What that means, is we can invest in shorter term time frames, without having the kind of impact and slippage that a big guy would have, and we can traffic in markets where the big guy can't traffic, or he can only traffic to such a limited extent that it really doesn't have much impact on his portfolio.
So for instance, in our case, we are weighted in our models, in our asset allocation. We are weighted approximately 60% to the commodity markets, and about 40% or so to the financial markets. When you look at the big guys, they are probably as much as 75-80% in the financial markets and a balance in the commodity markets. So right there you have a very significant differentiation just for the fact that you're small.
So besides that, I think then you started looking at, and you start drilling into what is the core differentiation in the underlying markets and so forth. And I would say that… let's go up a minute and before we go into the deals of the differentiating points the model. But I was saying, how does our investment proposition, our investment strategies, how do they make money? In what kind of environments would they make money? In what kind of environments would they not do so well?
So, the kind of environments that we like are environments where you see economic, political divergences. So most recently in the economic policies between Europe, say Japan and the United States, when you look at the last 6 to 9 months, you've seen some pretty significant divergences. Whereas before, more or less immediately after the financial crisis in '08, there was a tremendous amount of collaboration and coordination of monetary policies, which resulted in the stagnation of the markets and the sort of declining volatility and directionless activity, sort of immediately after the financial crisis. Maybe, not immediately, meaning maybe not the first year and so forth but it settled down and volatility was extracted out of the markets, and the financial markets, so very little directionality.
That kind of environment is a very difficult environment for us to navigate. At best I would say it's a break even proposition for us, and certainly not a great opportunity to make a lot of money. When you look at the last 6 to 9 months, you see that kind of geopolitical monetary coordination in our policies and actions have diverged, and the markets have moved very significantly, right? So, you see the big movements in the dollar, and that has been a great opportunity. You also saw some other situations, like supply in demand shocks, so the supply situation in the oil markets really changed the dynamics there, you've got very significant moves, right? Or you could have climate shocks in the agricultural markets. So, a year ago coffee was trading around $1, it went to $2, had a lot of volatility. You had some disease in the hog markets and the hog markets had some very significant movements. So any type of occurrences that shifts demand supply in a significant way or causes divergence across continents, that data is processed by market participants and investors. It causes the markets to shift from point A to point B, and when those shifts occur, it's an opportunity for people like us to extract the revenues from that. When the converse happens, it's difficult. You know, trading ranges and declining volatility, quiet markets are challenging - challenges for us.
Sure. How many markets do you actually trade Kim?
Okay, so the way that we look at it is, is we look at it across market sectors. So, we look at about 8 market sectors, so we look across the financial market sectors such as currencies, rates, equities, energies, metals, softs, meats, and we look to allocate on a fairly even basis across all of those markets.
Okay. Yeah, because there's always this discussion about whether you should be fully diversified or whether you should be overweight in certain sectors, but I mean I take your point on board and I fully agree with you in terms of one of the advantages of smaller managers is clearly that they can give you exposure to some markets that the larger funds can't. Even though, admittedly, a lot of the very large funds in the last year or 18 months have certainly delivered very competitive returns, so, that's a very positive thing. Now, tell me a little bit more about again from the overall point of view, about the models. So, how have you structured the program in terms of different models in order to achieve your objective and the desired performance profile?
So Niels, I think it's very important to have processes: processes for how you develop models, do your research; processes for risk management; processes for portfolio construction; processes for execution, you know, seeking the best execution and so forth, because processes are repeatable. Processes are clearly defined, and it gives you a framework for discussion if you want to change anything and why you want to change it and so forth and so on. I think… and for building an organization, I think these types of things are very important.
So, I could share with you, for instance, a process of portfolio construction and risk management and the way that we look at it. I will give you sort of a little bit of an insight. When you start off, from an investor's point of view, and I'm, of course, an investor myself in our business, I think an investor naturally will start off with saying, "Well, for every million I invest, how much am I willing to risk? What percentage of my capital am I comfortable risking?" So, in our case we said, "Well, we're willing to risk a max 15%-20% of our invested capital. Then the second thing we said was, "Okay, well I could put my money with one of the big guys, and then we'll get a certain return profile, an expected return profile, but we want to be different and better than the other guys." So we said, "If the average in the industry is around .7 sharp ratio, we want to come up with something that is at least above 1 in order to introduce this sort of competitive differentiating in value proposition."
So, that's where we started off and said, "Okay, we're willing to risk 15%-20%, we want to come up with something that produces something better than the 1 sharp." Then we said, in terms of our models that we wanted the models to be able to work across a wide set of markets, and we made a decision that these wide set of markets would cross these 8 sectors and that we would want a more or less even allocation across these sectors. So, our allocation is somewhere between 10% and 15% across 8 sectors.
We did that partly because we just wanted a broad diversification - true diversification, and partly by doing correlation analysis, historical correlation analysis among these various markets, and to verify that indeed, do they really have low correlations? Indeed, that's what you find, that there's not a lot of correlation between meats and metals and metals and oil and the soft commodities and so forth and so on. So, there is real value to broad diversification, but you could come up with saying that, "Oh, well maybe the best producing market is the meat market, and so I'm going to allocate 80% to meats and write 20% to the rest." We didn't want to do that; we wanted to have pretty evenly distributed allocations. So, that was one component. If you drill down and you look at the markets underneath these sectors, we line them up, so there are approximately an even amount of numbers, individual markets underneath the sectors.
So, depending on the assets under management, we would allocate to the individual markets underneath these particular sectors. So the minimum allocation that would be acceptable to us was 1 market in every sector. So, 8 markets, right? But if we had the capital then we would take it to 16 markets, right? So, 24 markets, to 32 markets, to 40 markets, 48 markets, 56 and so forth. So, that's sort of the philosophy that we approached when we were building it. So currently we're running around 32, 40 underlying markets per million, because we've been running managed accounts right now, but we're looking to move it into a fund structure.
So, the fund structure becomes very interesting for us, because it's going to enable us to add some additional underlying markets inside of these sectors, and it's also going to give us greater granularity in terms of the risk weighting across the board, because each contract has a certain size, and so the granularity becomes better. So we're very excited about this opportunity to put all the money in one basket because we're going to be more granular in our allocation, and more granular in our risk management and fine tuning the amount of contracts we can put on and so forth.
Then we look at, okay, we also want time series diversification, so currently we've been able to run 2 time frames, because we've been managing these underlying accounts of 1, 2 million each, and we haven't been able to diversify across… beyond 2 time frames because of the size constraint. So, ideally we like to run at least 3 time frames and our time frame's average holding period on the short term is around 3 days, and medium term is probably around 3 weeks and longer term around 3 months. Currently, we're allocating 50%/50% across the 2 time frames where we want to move to an allocation of about 1/3 in each time frame. So again, sort of a philosophical perspective of an even weighting because the reality is, in our case anyway, the shorter term time frames actually have better risk-adjusted returns, higher sharp ratio, but we are sort of making a deliberate decision that, no, we want...
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