Peter Kambolin is the common sense CEO behind Systematic Alpha Management, an Award Winning CTA Firm which has come through the tremendous market forces of the past 10 years. Their staying power is a testament to their success as conscious, ruled based traders.

This episode is about his hero’s journey from immigrant origins in Moscow to founding a lasting, top financial service company headquartered in New York City.

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In This Episode, You’ll Learn:

• About the effect of the 2004 internet bubble and how Systematic Alpha created a “market neutral” CTA strategy in response
• What it’s like to win global CTA awards yet still have to hunt new business due to capital flows towards large investment firms
• Peter’s story of moving from Moscow to New York and how he entered the finance industry
• The surprising story of how Peter was inspired to start his own firm at 21 years of age
• How Peter and Alexi work together to maximize each others strengths, and control for each-other’s weaknesses
• About the transition from long term to short term CTA strategies
• Why living in New York yet playing in Miami helps stoke Peter’s creativity
• The story of the dramatic period of March-August 2011 in which they experienced a drawdown that let to a drop in AuM from 721 million to 50 million due to investor redemptions.
• The effects of the coordination of global economic decisions by government on volatility and it’s effect on the overall environment for Systematic Alpha Management’s CTA programs.
• Why Peter considers Systematic Alpha to be a stronger firm after the steep drop in AUM they experienced in 2011.
• Where Systematic Alpha’s value proposition is and the importance of a CTA position in diversification
• How to get out of losing trades when liquidity is a problem

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Niels

For those who are new to the show, I just want to let you know that you can find all of the show notes, including a full transcript of today's episode on the TOPTRADERSUNPLUGGED.COM website. Now let's get started with Part 1 of my conversation. I hope you will enjoy it.

Peter, thank you so much for being with us today. I really appreciate it.

Peter

Sure.

Niels

Peter

Niels

Peter

Niels

No, that is true, and actually, in a sense, that's exactly why we are having our conversation today, because what I found over the years is that you're right, it is a difficult strategy for people to comprehend, and I think by documenting it this way, where people can go back and listen to you telling the story, you explaining the strategy many times is needed, really is why hopefully people will get a much better grasp of what you are doing after listening to our podcast. Before we go into the details about the company today, I'd like you to go even further back. I know you just touch upon it a little bit before in the introduction about roughly when you met your partner and so on and so forth, but I'd actually like to go back even further, and if you would share a little bit about your background from even before you started your introducing broker, just for people to get a feel for you as a person, and your partner as a person, and then how it evolved. Because at the end of the day, although we are talking about systematic trading, systems, and models, it's all based on individuals and people in the background, so I think it's important that we try to give people as much as we can in that respect as well, so if you wouldn't mind, just take us back to where it all started and how you ended up in the systematic trading world which is not where most people end up now a days.

Peter

Niels

So these were equity investments predominantly, at the time?

Peter

Yeah, we were just trading stocks, nothing to do with futures at all. Alexei 's bedrock is very different. He is the quant ( quantitative analyst) at our firm. He has PHD from Princeton University. He worked in academia for a couple of years, he wrote a number of articles - scientific articles and finance related articles that are very well sited in the media. He had a different trajectory. He worked at big firms. He had a lot of experience, so, I would say, if you look at us today, we have, on one hand, a somewhat similar background and on the other hand our personalities are very different. He is the quant, I am the common sense guy. I'm the business guy, he is the brains and blood of the company. So I think our tandem together is very good. I remember one investor told me once that if both of us were professors he would never allocate to us. Sometimes it makes sense to have a common sense guy next to a PHD guy. I think we have that combination. We've been through a lot over the last 14 years we have been together - good and bad times, and we know each other well. We know each other's weaknesses and strengths and we're trying to make sure that everyone is doing his job, and of course, at the end of the day, we have to have a common decision on any things that we do, so we, both of us, have to basically approve or disapprove certain decisions. Some research related decisions driven by Alexei , and some business related decisions introduced by me. This is how we work, and that's where we come from.

Niels

Now, you mentioned that Alexei was with TrendLogic, and I remember the name, but I have to admit I don't remember the specifics. The name suggests that it was some kind of trend based strategy.

Peter

Niels

OK, because that was my question exactly, then the transition from being with a trend based firm, for you then to go and look at short term trading, so that explains the direction that you took even at that time.

Peter

Yeah, it was a combination of things. Alexei worked with them on some mean reverting strategies, number one, at the Bank Paribas where he also worked, he was doing fixed income spread trading which somewhat resembles what we do, but we do it via the equity index and currency futures. We end up trading fixed income markets, but the idea is similar - we would go long and short, in highly, highly related markets, expecting a reversal with some kind of a mean of the spread. So these ideas came from how Alexei 's experience at the French bank, and, of course, as I mentioned before, we wanted to have a strategy that will have no dependence on the direction of the equity markets. Our data to S&P, to other hedge funds, and to CTAs is what's interesting, is close to zero.

Niels

Now, obviously we'll go into much more details, but I just wanted to ask, again, one of these sort of introductory questions before we launch into that. Obviously running Systematic Alpha Management today, is a big part of your life, but when you are not working, what do you like doing Peter?

Peter

Well, I live in two cities. I live in New York and that's where I work, and I also live in Miami, that's where my family lives, so every weekend I go to Miami, more or less, unless I travel for business. I think it helps a lot in my business endeavors as well, because when you are away from the city, when you are away from the office, and when you walk on the beach, sometimes some of the greatest ideas can come unexpectedly. You might play with your kids and all of a sudden you're realizing, "why don't I do this, or that?" So this has been my lifestyle for the last 8 or 9 years. I work in New York and I live in Miami.

Niels

Yeah, that's very interesting...that's excellent.

Peter

Of course I love sports. I love to ski. I love to play golf. I love to play tennis. I like to go out with my friends. In Miami there's some very interesting people now-a-days living there. Most of my friends are Russian for reasons, just easier for me to communicate I guess with them or to understand each other. There are some very wealthy Russians in Miami now-a-days, but again, for whatever reason, I never talk business with them. I don't try to recruit them or get their money under management. I prefer to stay just friends. I did have one experience with one of my friends. He allocated a million dollars and six months later his return was flat and he was complaining big time, "why don't I make money for him?" I told him, "look, just take your money back and let's just continue being friends."

Niels

That's probably a good idea. Now launching a little bit into the business side of things, maybe you could start by just giving a brief overview of the programs that you run today, when they started, and how the assets under management in each program, where they stand today?

Peter

Niels

Great stuff, great stuff. Now before we jump to the first real topic, I just wanted to ask one thing, so I think for the purpose of this conversation we're going to be focusing on the original futures program, but in terms of overall objective for that program, are you focusing on a particular environment? You mentioned that the experience came about from the equity market going down, but the futures program, is that designed to make money in all conditions, or are there certain environments that you in particular are looking to make money in that program?

Peter

Niels

Now, normally I would go in and ask certain questions, but I think you bring up a topic that I just want to dive into a little bit more if that's OK, and that's the thing about your looking to...or you prefer, in a sense, conditions where the volatility, if I understand it correctly, of say the US equity markets and European equity markets is somewhat similar and their not diverging too much.

Peter

It could be high or low, but somewhat similar.

Niels

Yes, yes, and of course, in a sense, we've lived in a world where central banks and the introduction of monetary unions and so on and so forth, in my view at least, have meant that to a large extent economic cycles have become more coordinated, if I can use that word, especially in the western world. But we also see a lot of pressure building up inside these economies. We've used different methods of solving the crisis' and not all of them have been the same, and not all of them have been working equally well. We certainly see now, again, that Europe has certain issues that maybe the US hasn't. Now, in a situation where the world starts to become more fragmented, and maybe not so coordinated, what does that do to a relative value or spread strategy that you're running? What are the things that you might be alerted to where you would say, "hmm, something is going on here which is slightly different to what we would like to see?"

Peter

Niels

I guess that's probably maybe part of the reason why you decided to launch the Multi-Strategy program that builds in certain levels of trend following, which I guess will benefit from divergence.

Peter

The idea for the Multi-Strategy program was to mix, in one portfolio, two streams of returns, that are not only uncorrelated, but in times of stress, for the spread component, it has a negative correlation to each other. So our directional models tend to produce their best returns when spreads are suffering and vice versa. That was the idea. Stand alone, I would say, the directional component that we have in the Multi-Strategy program the quality is not as good, stand alone, as compared to the spreads, but in combination with the spreads, the product makes a lot more sense. The idea was to reduce the likelihood of a large drawdown. At an expense of having maybe a larger correlation to CTAs, having some data maybe to some markets, and at the expense of not having as stable returns as we're used to having in the spreads alone.

Niels

Of course, absolutely, within trend following it's inherently unpredictable in terms of the return stream.

Peter

So that's one or two months per year that would produce your total P&L for the year. The spreads we had runs where we would have 10 consecutive positive months, small gains every month. A different return profile.

Niels

Absolutely, absolutely, great stuff Peter. Now, let me go back to my normal questioning here, and I want to start off talking a little bit about your organization. I wanted to find out about how you set it up. Obviously you mentioned that you had a big change in AUM, and maybe that's also impacted how you do things today, but talk me through a little bit how it's structured, and also how you've come about using technology to your advantage. Not everyone keeps every single function of the company in-house. Certain people choose to outsource some things, but of course, being a short term, you know, with very quick turnover (let's put it that way) in the portfolio, clearly you have certain requirements that the longer term or medium term guys wouldn't have, so talk to us about that.

Peter

Well, even at the current level of AUM, we maintain all the main functions of the firm in house, and we have five main functions. The main one, of course is research, researching the models and programming, the trading and programming, the back office functions etcetera. The trading that we have is fully automated. We have our own back office because we service managed accounts, and a lot of functions of the back office side were also automated by us in house. Our research uses proprietary software that we built to back test the models, not on a daily frequency, but using one minute resolution of data going back many, many years to estimate the parameters that we trade. That back testing tool we've been developing for the last 7, 8, 9 years. It's been upgraded constantly. We have the capability of running various analysis out of sample, in sample, test, etcetera, to make sure that our models are robust. We have compliance, obviously, in house.

Niels

Peter

If we look at the industry overall, I would say that investors have a lot easier job analyzing and understanding returns of the long term CTAs because the correlation between them is often 60%, 70%, and they can see which ones are good and which ones are not so good. When you analyze returns of the short term CTAs it's a lot more difficult because correlations drop significantly, and there are some good short term guys, and some not so good short term guys. It's more difficult to understand the source of the returns. It's more difficult to understand during which market environments this particular short term program could do well and not do well. I think if investors were to spend some time and understand and analyze the short term players and find the ones that are really good, it would enhance their returns quite a bit. so it's more difficult to find a good short term trader, but if you found one, you should stick with them, even if they are having a local difficult time. Every manager, I would say, with 10 years of track record, at some point will have a drawdown, it's impossible otherwise.

Niels

Absolutely, that is a certainty. Given the fact, if we stay on this subject a little bit, given the fact that it sounds like you have done well during a period where most managers - and I actually would include short term guys as well, because I don't think it's been that easy for the short term traders either, and you seem to have done well. So, would you say...is that driven by the fact that you are relative value, if I can use that word, or spread traders, rather than outright looking for directional bets in the markets, take aside the time frame, but the fact that you do something differently to a trend follower, whether it be short term or medium term or long term, is that the key reason why the environment has not really been that difficult for you?

Peter

Well, even when you make money, you always think that the environment is tricky…

Niels

True.

Peter

Yes, what we do...what we are doing it's very different from 99.9% of CTAs. We speak with a lot of allocators, which ultimately interview a lot of managers, and so the feedback that we get from the investors, from the allocators, is that our programs are very unique, they do not know any other managers that are doing what we are doing, with the exception of maybe one, two names, but even in those cases those other managers will have their own details, their own risk allocation, their own ways of doing things. For example, this one firm that we know is doing somewhat similar to what we are doing, but if you look at the correlation between our returns and theirs, it's going to be close to zero as well.

Niels

Sure.

Peter

It's remarkable. So one of the advantages that we have, I believe, is that we do not have a lot of competition in what we do, because very few if any firms are looking at such short term price changes and not only that, but in a market neutral relative value type of trading. Being a minority helps, and if you are doing a good job, you could stand out, and this is our goal to stand out, and of course not every year we will be the best manager out there. There will be times when long term CTAs will have very nice performance and markets will go up almost every day, and we would underperform, no question about it. But there will be other periods when we will be doing a lot like everyone else. That is why it's very important to have us in a portfolio, because we will most likely have negative returns when other managers could be doing fine, and on the other hand we could generate our best returns when all the other managers are doing poorly. So on the portfolio level, we add a lot of value. We're not only providing absolute returns at the end of the year, that is very nice to have, but on the reduction of the portfolio risk level, we are adding a lot of value as well. I hope investors will recognize that over the long term.

Niels

Sure. Now Peter, before we jump to the next area. I wanted to jump forward a little bit, because this might be sort of a little bit of a research question, but I know from doing my research on your strategy, that you often mention that you don't change the core of the model, but you do a lot of optimization on a regular basis on the parameters. But when I have spoken to other short term managers before, they often tell me that actually model decay is a big issue and that a lot of their models tend to work for two years and then they have to come up with some new models. Is that something that you're kind of (neutral is maybe not the right word), the fact that you do market neutral strategies and so on and so forth, do you think that's what's helping you not necessarily having to come up with new models on a regular basis, and your models being quite robust in terms of longevity?

Peter

Yeah, well, the core essence of the strategy is, on one hand very simple, and on the other hand is very persistent. If we just step back and try to understand what we're doing.

Niels

That would be great actually.

Peter

Looking at most liquid and highly related or correlated global equity markets, again, let's look at the example. FTSE 100 and S&P 500, correlation between the two indices on a data level historically ranges from 70%, 75% up to 90%, 95%, and it's very stable over time. What helps drive our returns is a very simple fact that these equity indices, they open for trading in different time zones, and hence their liquidity intra-day is not the same at any given hour, it's shifted in time. When Europe opens, S&P futures trade, but they're not as liquid as they will become latter on. When US closes, 4 o'clock New York time, European futures trade, but they're not as liquid as the S&P at that time. So what happens is that, while on the daily level, on average, if you average across many, many days, going back, correlation stays high intra-day. These markets could temporarily diverge from one another for liquidity reasons. These are not fundamental divergences, these are liquidity driven mis-pricings, and that's why, when volitility is high, this is a good environment for us, because these divergences tend to be larger and more often. When volatility is low, people are not afraid, they're not scared, and they do not make these little mistakes - they have time to react to whatever news is coming out. When volatility is very high, and news is coming out, sometimes people don't have enough time to make the rational decision and they tend to over buy or over sell certain markets, and most people are concerned about a directional or particular market. They are not concerned how FTSE is traded in relation to the S&P. Most people don't even care about that. On the other hand, that's all that we do. So, if you think about it, these time zone differences will always be there, the remainder of time. We wake up, let's say the UK and US, 5 to 6 hours apart. If we talk about Asia the time difference is more than that, 12 to 14 hours. So, that type of structuring event, or fact will stay forever.

Niels

Sure. Obviously I'd like to go into a little more detail, but just to make sure that I kind of understand what you are saying is that, essentially that one of your strategies is to buy or sell a certain spread between the FTSE and the S&P that normally would take place, as an example, more or less at the same time, in the morning where liquidity is somewhat different between the FTSE and the S&P.

Peter

We execute our long and shorts at exactly the same time.

Niels

Exactly, so that's the key.

Peter

What we see, in the early morning hours, Europe is the leader, S&P futures could be the laggard. I'm talking about 2, 3AM New York time, in the early morning hours. At around 3, 4PM New York time, it's the opposite. Futures on FTSE and CAC and DAX and SMI are traded, but cash markets are closed, and that's the time when S&P is leading the way and the European indices are following the example. Sometimes if they under react to the moves in the S&P, that will produce a move in the spread in a certain direction, and what's interesting is that the next day when European markets reopen, cash markets reopen, they often would price in whatever was underpriced the day before. If it doesn't happen, S&P futures could react and adjust to the European level. So that produces, often, moves in the spread in a certain direction and then reversal of the spread that we would trade, and that's exactly what we are looking for.

Niels

Right, OK. From memory, I seem to recall that your average holding period is about a day or so, so it's not so much the difference between the liquidity from the morning where you say the FTSE is the leader and to the afternoon where the S&P might be the leader that you are looking for, or did I misunderstand that?

Peter

The average holding pattern is traded about one day, or 8 to 10 trading hours - that's the way to describe it. If we see a reversal within an hour we will take it of course. If we have a position that is not reversing, we could be stuck in the position for two or three days, potentially, and there are two ways we can exit a losing trade: we have a hard stop - if markets are totally diverging from one another, and we very rarely hit the hard stops, less than 1% of trades are stopped that way; the other way we can get out of a losing trade is in a small reversal, eventually the spread would reverse, but not to the level where we took the trade originally, but if we hold the position for longer than 1 day, we want to get out of that trade as soon as possible. On the small reversals we would often, in a fully automated way - systematized way - we would get out of the trade with a loss, looking for another opportunity in the future. After one day our predictive power is getting weak. We can predict direction of the spread with very good accuracy within one day. In fact, our hit ratio - percent of profitable trades is on average about 65% profitable. So roughly 2/3s of the trades are positive, and only 1/3 is negative. That hit ratio is strong only because we have very high predictability within one day. Beyond one day markets are very efficient, if markets are diverging for two, three, four days, that means they're diverging for fundamental reasons, not liquidity reasons, and if that is the case, there's no reason for us to hold a position for another day. We're trying to basically cut the losses if we have the losses and wait for another opportunity.

Niels

Sure. Let's try and put some numbers on so it makes it easier for everyone to understand. Let's just say that the S&P was trading at a price of $1,900, and the FTSE was trading at a price of $5,900, so a difference in price of 4,000 points, if you take it that way, so is it correctly understood that what you might be looking for is that if that price spread goes to, say 4,050, and you think that within the next 1 day of trading that the spread really should go back to 4,000, is that the kind of difference you are looking for?

Peter

Well, our spreads are not just pair spreads, we actually have a third leg, the spread is a British pound contract in this particular case. We have to take into account the fact that FTSE futures are denominated in the British pound, while trading the US dollars. So we have a currency leg that hedges the currency exposure that we have. So it's a triangular relationship. Let's assume that currency is not moving, and let's assume S&P is up 1%, and FTSE is flat, at some point it will trigger a trade where we would go short S&P and long FTSE, expecting FTSE to catch up, or S&P to come down, or both to take place. If that reversal could happen via the currency move actually, it's possible that the currency leg will move in reaction to the move in the S&P that will push out P&L onto positive territories. All three legs are very important. Sometimes...I'll give you another example, let's assume that FTSE and S&P are flat, but the British pound is moving let's say 1%, that will potentially trigger a trade which will reverse, ultimately, not because the British pound contract reversed, but because equity markets - FTSE and S&P will start re-pricing themselves in relation to one another, depending how the currency moves. There's some intricate relationships between both equity markets and the currency, and all of them we are taking into account, and we could potentially trade.

Niels

Sure, this 3D way of looking at it, is that required, or could you also do spreads between say markets both denominated in US dollars?

Peter

Niels

Fascinating. Tell me Peter, how many markets do you trade all together, and how many combinations of spreads to you have in your portfolio?

Peter

Yes, well, we trade approximately 20 to 25 different markets that include...

Ending

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