Ian, you began advising clients over 17 years ago and established Naismith Capital Strategies in 1996. With this substantial experience behind you what have you discovered about the skill-sets required to become a successful money manager?
Know how to act disciplined when a trade is not going your way. No matter if you are trading stocks, bonds, commodities, real estate, currencies, etc. - begin with a predisposed plan of action when the trade is moving against your desired outcome. There are really effective ways of accomplishing this discipline – whether it be hedging techniques, trailing stop loss orders, selling at predisposed profit targets, etc. These all are logical and practical, but the meaningful part is pushing the button once a confirmation has sounded. In addition, when the markets are too volatile for trading, simply sit aside and watch.
You formed Sarasota Capital Strategies with your business partner Anthony Welch, in 2002. What prompted you to set up the company?
It happened due to a turning point in philosophy and strategy for both of us after the roaring 1990’s. In the 1990’s, Tony and I bought and sold individual stocks – which was quite easy, given the market conditions. When I mention “bought,” I do mean we bought on the dips, and when sells occurred, it is because a stock was not “going up fast enough.” When 2000 came and delivered a bear market for the previous years’ high flyers, buying on dips did not work. Thus, in the latter part of 2000, and especially starting in the early parts of 2001 and lasting into 2003 – judicious allocations and stop orders became the norm. During that period, Tony and I decided to concentrate on trading indexes employing technical analysis using relatively new items called ETFs. We had known each other well since 1992, and since we were in concert with our thoughts, we decided to combine forces. It is hard to believe the roaring 1990’s was more than a decade ago.
What type of investment style does the firm undertake?
We are an absolute return style firm that primarily uses technical analysis with common sense overlays. Once in a while, unusual occurrences happen that provide opportunities that cannot be possibly measured by a rigid technical model. A great example, recently the Powershares DB US Dollar Bull ETF (UUP) could not issue new shares. Within minutes, demand overtook supply and the ETF was trading up 2% while the US Dollar Index was flat. In less than 2 minutes after this anomaly, we started selling the majority of our 21% position of the ETF to realize a nice gain; that, in a perfect technical world – should not have happened. By the end of the day, we replaced the sold shares for another fund that was tracking the US Dollar efficiently and wrote covered calls on the small amount of remaining shares of UUP. On the flipside, fourth quarter of last year, our firm simply hedged through most of the mayhem. Because of unprecedented volatility, momentum and/or contrarian models did not work, so we chose the boredom of neutrality. It worked beautifully.
Sarasota is the investment advisor for The Strategies Currency Fund, a series of the Northern Lights Fund Trust. What are the investment objectives of this fund?
The main objective is to realize consistent total return with an emphasis on keeping the draw down and volatility to a minimum compared to individual currencies and other asset classes. Regularly, advisors who have invested in the fund tell us “we don’t have to worry about your fund in our portfolios.” This is what we’re all about. Keeping the fund consistently performing is a balancing act between the simultaneous use of non-US Dollar currencies and the US Dollar Index. We believe using those opposing currency groupings help smooth out the return of the fund. Historically, in times where non-US Dollar currencies are showing strong trends, we tend to correlate with the trend – and when the US Dollar Index shows a strong trend, we tend to correlate with the trend. The combination of capturing ranges of return when non-US Dollar currencies are strong, and capturing ranges of return when the US Dollar is strong – gives us consistency.
What are your main day-to day responsibilities in managing the fund?
We make sure the fund is adhering to the models that were created and keeping our eyes on opportunities that cannot be measured in a technical system. I’m a system driven person and Tony is an opportunity person – it works out very well. Early each morning, we know exactly where our exit or entry prices are on a currency by currency basis. If either limit is breached, we take action. Once trading begins, we look for intraday irregularities that might become opportunities. We also make sure that the trades are fairly priced compared to the intrinsic value of the items we are trading. Besides the trading and monitoring, we do the normal mutual fund type things like prepare written reports, approve expenses, marketing, etc. Joe Garbade, our operations person, does an incredible job with day to day reporting and compliance.
The Currency Strategies Fund invests primarily in exchange traded products and/or mutual funds, the value of which are tied to currency prices What do you like about exchange traded products and what advantages do they offer for investors?
The vast majority of the mutual fund clients and audience to the fund are advisors and regional brokers. Right now, we believe that a fund of funds makes sense because the items we choose to trade do consistently track the prices of the currencies they are designed to replicate. It is easy for advisors and other professionals to use our fund because most understand how ETFs or mutual funds work, and it is simple for them to track as well. They can explain the fund it to their clients. As the fund grows, we will be integrating other tools for trading that will complement our ETF trading, but at the same time, give us more choices, liquidity, and at the same time will reduce overall expenses of the fund. In other words, we want to use tools that will get us to our goal – and sometimes ETFs are the way to go, and sometimes they are not.
You use proprietary technical analysis to determine which currencies you believe will outperform the U.S. Dollar. What tools do you use to assist you with this and what momentum characteristics is the analysis based on?
We are looking for out performance from either side of the pair, whether the winner is the US Dollar or not. Primarily, we have used Tradestation for building our unusual indicators and auditing of the code is verified by good old-fashioned Microsoft Excel. Momentum is measured on the ascension on consistency of price, but, we do receive contrarian sells when consistency is compromised and contrarian buys when consistency is re-established. One beauty of Tradestation is that you can view your indicators in a columnar format that is sortable. This eliminates the need for 6 different video monitors in the workspace. We can see more actionable information for trading on one 21” screen than we’ve seen on multiple screens in other offices. We like it simple. The hard work has already been done developing the models, thus, the trading signals derived from that hard work is clear and simply displayed for action.
What measures determine what initial allocation to a currency you may make and then whether to increase or decrease it?
This is not mandated by prospectus, but, we use equal weighting due to the overwhelming history that equal weighting enhances performance starting around 3 year rolling period and improves dramatically in longer timeframes. Equal weighting also smooths out volatility in portfolios. Thus, we have imposed investment limits on a currency by currency basis. Currently, the maximum investment limit we have for each G-10 currency ex-US Dollar is 7% and 4% for each emerging market currency. By prospectus, gold has a 10% investment limit. However, by prospectus, the US Dollar index can receive 100% allocation if it is in a raging bull market or is having a sharp rally because we would like to participate in those events as much as possible. It would be rare for us to be completely out of the US Dollar Index or 100% in the US Dollar Index. We can also expose the fund to 100% short term safe havens in times that excess volatility is occurring. The increasing or decreasing of each position happens when we receive a signal from our model. The adjustments are incremental to reduce the amount of noise trading when volatility is occurring.
What key steps do you take to mitigate the various types of risk associated with your investment style?
By nature, the inclusion of all types of currencies including the G-10, emerging markets, gold, and US Dollar Index gives us an actively managed single solution palette that advisors cannot find in the United States right now. The fact that we are not strictly an anti-US Dollar play only helps mitigate risk. In addition to the currency choices, the allocation limits, predisposed stop loss triggers, hedging techniques, covered call writing, and the ability to retreat to 100% safe havens gives us many levels of insulation in nasty markets.
Do you expect to see significant growth in currencies being packaged in the form of new exchange traded products and what shape might these take?
Well, we don’t see much more need for duplication of single G-10 or really liquid single emerging market currencies. However, we believe the market may see many baskets of various currencies. Wisdomtree has many currency baskets that have been in registration for quite some time. Of course, it will take demand from advisors and investors to make currency ETFs successful.
What's the average length of time that you hold your positions for?
We don’t limit ourselves to time holding periods. When we receive a signal or see an opportunity – we act. Some of the biggest mistakes made by advisors are adhering to a predisposed time period. What advisors should be adhering to are price periods – meaning, if the price of an item reflects a trade that is capturing positive return with acceptable amounts of volatility, then it makes sense to participate whether the time is a week, month, or year. In volatile markets, our holding periods are compressed. In streamlined markets, our holding periods are extended. We would rather have more turnover with less volatility and draw down, than little turnover with more volatility and draw down.
Risk Management, design and back testing of strategies and optimising trade execution are just some of the areas where trading tools and technology are now making a significant impact on how many firms trade currencies. How important is trading technology to your own team and in what ways does it help you maximise trading operations?
Trading technology is everything to us. It is imperative that we understand the past before starting a trading system using real money, so, we make as many mistakes as possible in the backtesting world. It requires numerous hours of studying what algorithms – based on history - increase chances for consistent, repeatable results and at the same time, we defer that the future may be a totally different road than the past. With that said, having smart trading habits improve total return. This means finding patterns intraday for buying or selling to improve overall cost. It also means not overpaying or underselling in relationship to intrinsic value. We have the technology to monitor these items in real time. However, technology means nothing if you do not translate the technology into action. The amount of money saved due to our trading diligence is astounding.
Is your trading technology infrastructure built in-house or provided by specialist vendors?
The trading technology is provided by specialist vendors. For real time tracking of intrinsic value, volume and bid-ask spreads/sizes, we use Tradestation. The intraday trading algorithms were also built in Tradestation. We use HydraTrade for executing the trades. So we have Tradestation on one screen and HydraTrade on the other. It is very simple. In addition, all of this is easily portable. When Tony and I travel, it is almost seamless to trade. As a backup, we can call the head trader at our clearing firm, Ceros Financial Services, for trading purposes. We have a long term relationship with the folks at Ceros, and we know we can count on them. If we need to search for liquidity for buying or selling ETFs with shallow volume and/or large bid-ask spreads, we can rely on WallachBeth to find the liquidity. So, a combination of machine and human resources is the way to go.
Do you plan on utilising any algorithmic trading techniques or are you already applying them?
We are already applying algorithmic techniques – however, the trades are being done by humans, not automated computer only trades. It is algorithms that dictate what currencies we’re in, the allocation of each, and how we trade in and out of the currencies intraday.
In the future, where are you going to be looking to grow your business and search for new and innovative ways to utilize your investing expertise?
Much like we have already. A). Identify gaps in the investment landscape; B). do homework and build intelligent models that advisors can use and not lose sleep; C). create and launch the product; D). educate and convince the advisory community to fill the gaps that exists in their portfolios. The beauty of this job is that there are still many opportunities in the investment landscape and we would like to have a stable of products that fill those gaps. They may come in a number of forms, but the intent is to provide value to the investor.