Romael, when was Harmonic established and what services does it provide?
Harmonic Capital was established in 2002 by Richard Conyers and David Pendlebury as a London-based quantitative macro manager with the aim of generating returns by understanding investor behaviour to predict market moves. We specialise in fundamental spread-based trading strategies, producing returns that are uncorrelated to major stock and bond markets.
Who are the key people involved in the firm and what are their main day to day responsibilities?
Across the firm, Harmonic operates a collaborative and collegiate structure. This holds true within all departments and especially so within our research team. Our CIO Richard Conyers heads the Harmonic Investment Committee, and works alongside our deputy CIO Patrik Safvenblad and investment partners Per Ivarsson and Samir Sheldenkar.
Technology has also played a key role in our success - many of our systems are built in-house to provide catered solutions to our specific needs. These systems are built and supported by our team of developers under the management of our CTO Matt Bunch.
What strategies do you specialise in and what markets does Harmonic operate in?
Harmonic aims to produce returns in all market conditions from a portfolio of uncorrelated investment strategies. Our focus is on creating spread based strategies that are ‘market neutral’ with no beta to bond and stock markets. Harmonic currently trades liquid financial and commodity futures markets together with interbank currency markets.
What type of clients does the firm work with?
Harmonic’s clients are primarily institutions such as pension funds, banks and sovereign wealth funds. The North American institutional market is a specific target for expansion in the near term with a particular focus on public and corporate pension plans. We believe our macro and currency expertise is well suited to the needs of the North American institutional market and can be of significant benefit to investors.
What investment programs does Harmonic currently run?
Harmonic currently runs two investment programs – Macro and Currency. Both the Macro and Currency programs aim to provide absolute returns in all market conditions, at appropriate levels of risk. The Macro investment approach focuses on spread based trading strategies in a broad range of liquid futures and currency markets. The Currency investment approach uses a combination of spread based and directional trading strategies in a broad range of liquid developed and emerging currency markets.
Unlike some firms who take more directional risks, Harmonic takes the majority of its positions in spread form. What advantages does this bring?
Spread trading means that strategy positions in an asset class are always taken versus another market in the same asset class (e.g. bond positions are always taken versus other bonds). The portfolio can therefore profit equally in both rising and falling markets.
The biggest advantage of this approach is for the investor. This spread trading approach means that the program is designed to have very low directional risk at any point of time.
When using our program as part of a larger, traditional or alternative portfolio, this significantly reduces the concentration risk that often comes when combining the occasionally large directional exposures of directional macro trading with traditional portfolios. Spread trading also reduces correlation with both traditional and alternative asset classes. In fact, we expect our strategies to be less than 0.2 correlated to a wide range of traditional and alternative benchmarks over the long term.
Similarly, we believe that spread trading also makes our own portfolio construction more resilient. Since our bond trading has no directional bond exposure and equity trading no directional equity exposure, we expect to be unaffected by factors such as changes in stock-bond correlations.
A further important benefit is that we believe spread trading enables more efficient risk management. We can reduce or close losing positions or strategies without expecting to have a negative effect on the headline portfolio risk.
How would you describe the investment principles by which Harmonic Capital operates?
Successful active management requires a disciplined approach to both alpha creation and risk management.
We believe we have a unique approach to alpha creation. Trading strategies are based on an understanding and careful analysis of pressures in the global economy. Our premise is that long-term investors will react gradually, rationally and predictably to changes in yields, exchange rates and risk among other factors. By modelling the behaviour of these investors, we aim to capture alpha as we position ourselves ahead of investor flows.
We understand that our strategies cannot be expected to capture all market moves or to be profitable in every market environment. Therefore, risk management is crucial to the long-term strength of our programs. Our most important risk management approaches include:
• Spread trading to reduce directional risks
• Close-to-equal allocation to markets and strategies to avoid concentration risk and over-fitting risk
• Absolute discipline when reducing exposure to losing positions and strategies
Since we seek to capture macro returns driven by rational investor behaviour, we believe our views are best expressed in the most liquid futures and FX markets. Being active only in liquid markets allows us to nimbly adjust position sizing in response to changes in risk and opportunities.
Many investment managers use pattern recognition or technical analysis as the source of their trading signals. What are the processes that are used to generate yours?
All traded strategies are based on easily understood economic mechanisms, such as ‘countries with strong equity markets tend to see appreciating currencies’. We then try to model the dynamics of this mechanism. In principle we ask a series of questions such as ‘How fast?’, ‘How much?’, ‘Does volatility matter?’, ‘What are the risks to this strategy?’. The answers to these questions then form the basis for the exact model specification.
What frameworks have you developed to enable you to leverage your research in the most effective way in order to develop new investment ideas, alpha generating models and more robust risk management methodologies?
Our research process is based on a peer review process where all members of the research team provide structured feedback of all aspects of new research proposals. This allows us to stimulate the creativity needed to develop novel investment insight, while tapping into the significant experience of the team when testing hypotheses and when transforming the investment thesis in to a well-defined trading strategy.
All strategies are tested in our proprietary research environment which is used by all of the team and allows a large number of tests to be carried out efficiently.
Why is the way you allocate across strategies and markets considered to be a particular strength of Harmonic which differentiates the firm from many other macro investing managers?
We are different from most macro managers in the sense that our portfolio exposures are built bottom-up from a large number of sub-strategies. Internally, these strategies aim to be equally weighted with no one strategy favoured over another.
The main benefit of this approach is that the allocation to underperforming strategies and markets can be reduced without expected negative effects at the overall portfolio level. In addition, spread trading seeks to ensure that our strategy returns are ‘real alpha’ and not derived from hidden long bias.
Once you have developed ideas for new strategies how do you go about modelling these and testing them?
As part of our peer review process, all new strategies are subject to numerous predefined tests designed to ensure robustness (e.g. over time, across markets) as well as parameter stability.
The same tests are updated daily for live strategies. This allows us to identify situations whereby market environments have structurally changed. An example from recent years is that several strategies have become slightly more short-term as the market response has become faster.
What are the key functions and responsibilities of the trading desk?
Our trading desk operates over three time zones, trading G10 and Emerging FX as well as futures contracts in bonds, interest rates, commodities and equity indices. While the key responsibility of the dealing team is best execution of all client trades, they are also responsible for validating the pre-trade data feeding into our models where we currently look at over 400 inputs ranging from price data to economic and yield data.
Another important function of the dealing desk is to monitor slippage and the costs associated with execution. The team provides valuable input into ongoing costs and how these might be reduced, to the benefit of our investors.
While we are systematic and employ absolutely no discretion in executing trades, the dealers provide a valuable human verification to ensure sensible data flows into the models and work closely with the research team to validate proposed trades.
How did you go about building your trading desk infrastructure and what issues have influenced the trading technology you use?
The desk was built so that all dealers execute and monitor all asset classes, which often means trading several asset classes at the same time. Efficiency and accuracy is essential and therefore, over the years, technology has played an increasingly large part in improving the process and tightening controls. When an off the shelf solution has not fully satisfied our needs, we have chosen to build in-house systems. A good example of this is building our own FX order management system and aggregator which trades the majority of our FX flow electronically via bank API feeds. This allows us to maintain full control and opens the door to meaningful partnerships with our banks.
A further example is how we have chosen to utilise a hybrid approach to algo trading. We overlay relatively transparent algo strategies from our preferred vendors alongside our own in-house pre-trade analysis to determine the appropriate parameters. This is beneficial to us as it provides a fuller understanding of how the trade has performed when we analyse each trade using in-house built post-trade analysis tools.
Another key consideration is catering to the bespoke needs of our investors. For instance, certain markets and counterparties may need to be excluded for a particular mandate. Also, special reporting requirements are often demanded by sophisticated institutional investors. In all cases, Harmonic responds by tailoring its infrastructure to cater to the clients’ needs.
What post trade analysis do you perform and how does this add value to the dealing function?
Aside from periodically monitoring the quality of execution alongside the research team, the dealing team also analyses the quality of FX pricing, providing feedback to our panel of banks on a quarterly basis providing granular detail which gives our dealers a thorough understanding of market pricing, improves our relationship with banks which in turn improves the quality of pricing benefiting our clients. On a regular basis, we also monitor the quality of the data that we use, market liquidity and how this relates to our trade sizes and capacity.
Many investment managers have experienced difficulties for one reason or another since 2008. How has Harmonic performed over the last few years and what underlying factors have influenced this?
There has never been an easy period for active management and the period from 2008 is no different. The global economy has faced numerous challenges over the period; the 2008 fallout and Eurozone crisis are just the tip of the iceberg. From the perspective of a macro trader, these developments are equally risks and opportunities.
Our strategies have had challenges, but have overall performed well in a period that has been challenging to traditional directional macro managers. Our flagship offering, the Harmonic Macro program, performed well in 2008 and generated positive returns in the period from 2008 to 2014. The key driver behind this positive result is that we have seen significant economic divergence across countries. This divergence spills over into profitable spread trading opportunities. Looking forward, we see good chances of further economic divergence as the global economy adjusts to the recent fall in oil prices (good for Sweden, bad for Norway) and rally in the US Dollar (good for Europe, bad for the US).