Frederic, you launched Swing Capital with partners Robert Sipko and Michel Nahmany in September 2006. What main functions do you each have within the business?
Robert has a strong technological background that was instrumental in the back-testing and set-up of our system and which we use on a regular basis for all technological related issues. Michel Nahmany and my self both oversee the day to day trading and risk-management of all positions. On top of that, both managing partners use their core skills where Swing Capital needs it the most. As COO Michel is in charge of all the operations and deals on a daily basis with all prime-brokers and service providers to ensure proper execution and reconciliation of all transactions. Our structure is small but efficient and as such I also have to wear multiple hats, one of which is the business development aspect of Swing Capital. As you could imagine, it wasn’t easy to get the first seeding. As a matter of fact it took us close to 2 years to find the seed money after we completed the back testing. I think it is pretty common for all launching hedge funds to be in a chicken and egg situation where nobody wants to give you money before:
A: You have a real track record
B: You have more assets under management (AUM).
The absurd thing is that big allocators with all their team of analysts and PHDs ask the same static and archaic questions which lead them to the same kind of managers fitting an old risk reward model that is obsolete. We have plenty of funny stories involving FoFs that looked at us from above with high standards of integrity and lengthy due diligence process. Unfortunately they preferred to invest in large managers with extra large assets and reputation like Madoff or Amaranth and the list goes on.
In short we have just started to capitalise on our great performance after 2 ½ year of real track record. A savvy English business man once told me: “People want to see you suffer before they give you money”. I believe him know.
Why did you originally set up the company and what was Swing Capital designed to provide and capitalise on?
The primary goal of Swing Capital was to launch a 100% systematic program that would be different from most of the other ones. Most of systematic programs are trend following and since both managing partners had an extensive FX market-making experience, we wanted to create a counter trend program with the goal of capturing short to medium term volatilities in the currencies. The first objective was to create a systematic program that would remain low to negatively correlated to both standard and alternative portfolio and return 15 to 20% yearly on average. We have evolved quite a bit from this first perspective on contrarian trading in the real world.
I believe that our goal to be 100% systematic was utopic for 2 main reasons:
1. 100% systematic doesn’t exist. There will always be some kind of discretion somewhere in the process.
2. Systematic programs might work for others but did not suit our way of trading.
Although our back testing and live testing (both in and out of sample) was as thorough and realistic as can be, many aspects of daily trading in the real world made it difficult to apply. One good example is the stop-loss factor. Although a stop loss was given to desks from inception of every transaction just like in the back tested results, you quickly realize that it will happen often when market makers take you out of a position when you should still be in. This creates an enormous discrepancy with your virtual program running in the background. To make a long story short we started in a period (Sept 2006) where volatilities were at record low for many months thus creating an environment not conductive to counter trending programs like ours and making our stop losses very appealing to market makers bored with the carry trade markets. When every Long-short Equity and carry trading hedge fund was making good profits in the second quarter of 2007, Swing FX experienced its worst draw-down (7.5% in 3 months) and lost one client. At this point we had the choice to either continue our 100% systematic quest or to adapt. We chose to adapt. We became Hybrid and added consistent qualitative overlay to all aspects of our methodology.
Swing stands for Systematic Winning Generator and Swing FX is your flagship managed account program. Can you tell us a little about what type of program it is and what sort of algorithm lies behind it?
Swing FX is a unique Hybrid program combining a systematic counter trend and multi timeframe signal generator with the manager’s unique qualitative overlay in execution and risk management. The signal generator puts together multiple indicators all based on technical analysis. Once a particular price sequence is discovered in more than 20 currency pairs monitored, it is matched on a multi timeframe basis in order to fine tune the position entry. The sequence will always give a contrarian signal mostly on an intraday basis in order to capture an intermediary trend exhaustion level. One key aspect of the trade is the position sizing which will always be scaled in and out of the trade. When we adapted our trading methodology we added more qualitative overlay to that process. For example the position sizing will vary whether the manager’s macro view matches the counter trend signals or not.
What underlying trading techniques did you base Swing upon and what unique characteristics do you think it has?
Since both managers had extensive market making experience in the currencies, both were use to get other people’s positions on a regular basis. In that situation we had to find great short term indicators that would give us an edge in the market. In building the cornerstone of Swing’s methodology, we used those same indicators that we had used in the real trading life and back tested on a multi timeframe basis. When combined with our macro view and execution experience, this system captures great volatility on a regular basis.
What types of diversification were taken into consideration within the overall global Swing model?
The overall Swing model uses different types of diversification but the most important is a timeframe diversification which allows entry fine tuning on top of avoiding overexposure on the same kind of trades when major shifts are experienced in the market.
What's the average length of time you hold positions for?
Anybody involved with trading currencies knows well that any position ever taken in history is a good position. That’s right, however you can’t keep the position forever; you have to put a stop loss somewhere. One key aspect of any position taken in any markets is the horizon of the trade. Swing Capital is not looking to capture the next 6 months but rather the next 6 hours to 6 days timeframe. Our average trade duration was less than 5 days when we started, it is now less than 3 days with the majority of our trading done intraday in order to massage our overall core positions while we are still in front of our computers. This allows us to reduce overnight exposures. So if you are like us and believe that all positions are good positions and that you have a system that gives you good risk reward signals that the intermediary trend will shift than all you have to work on is the position sizing. We have found the right position sizing that allows our pain threshold to be protected. These days whatever position size you are thinking of taking scale in and out of it.
How important is algorithmic FX trading likely to become for managers like Swing Capital and do you expect to increase your use of algorithms to help manage risk and set parameters for each trade?
In short, No. We do not believe in a 100% systematic approach to trading currencies in the short term. The last couple of years have been so violent in so many ways with volatility parameters shifting from extreme lows to extreme highs that we are much more at ease with adding flexibility and qualitative overlay rather than rely on quantitative rigidity. For our type of shorter term trading it is clear that the erratic profile of this portion of the trading spectrum makes it very hard to capture when using strict parameters. Also everyone using electronic platforms will agree that it is hard to count on the illusion of liquidity that is being offered these days.
Do you supplement your normal portfolio strategy with any opportunistic trading?
As expressed earlier, yes we employ qualitative overlay on every part of the trade. Our goal is to capture an intermediary trend which will last a maximum of a few days. In order to do so we need to use a unique set of qualitative parameters that will allow us to better our average position. We can use more leverage intraday and will always use a lot less leverage overnight with the focus in reducing overnight risk of being taken out of a good position. The only way to do so is to reduce the position size and to push the slop loss away in order to risk up to a maximum to what you would have risked before with the larger position. The big difference here is that you will not get stopped in the twilight zone for nothing.
Since your launch more than two years ago have you made any important changes to your methodology and the way you execute signals?
Yes. We have made major changes to our execution and risk management methodology. Here are a few:
- We have added discretion in execution of the signal
- We now scale in and out of a position rather than go full capacity on each signal.
- We have substantially reduced the overall leverage in the portfolio and now make a difference between intraday leverage and overnight leverage. Although both are multiple times lower than what they were before, we do use more leverage intraday in order to capture intraday volatility while we are in front of our computers and we use considerably less leverage overnight in order to be able to push our stop losses further. That way we are not in the target zone for overnight market makers.
- We have essentially adopted a hybrid approach where on top of matching our multi timeframe technical signals, we will overlay our macro view. The size of a position will vary depending if all criteria match or not and what time of the day we are.
- Although we do monitor 20 pairs of currencies and about 10 timeframes in each, we try to confine our trading around 4 pairs in the majors. These pairs have been very lucrative for us since we have adapted our approach.
- One of the simplest rules that we have added in our methodology is to reduce all positions to a minimum when a return of 2% is reached on a monthly basis. We simply enter in a capital preservation mode. We are not looking for homeruns anymore, we are looking for singles and doubles and that is how we have captured 27.89% last year in a relatively steady fashion.
How do you regulate the implementation of each and every transaction within the overall portfolio?
We monitor 20 pairs. We get about 2 core signals per day on average, however when screening the shorter term time frames we automatically get more signals which we use to massage the core positions on an intraday basis. We try and keep a maximum of 4 different positions at a time. We have a small infrastructure and we have realized quickly that there was no point in spreading ourselves thin while increasing the overall risk of the portfolio. With the current volatility you can make a lot of returns by running small positions.
The past few months have seen increased volatility and extremely turbulent global markets. How has your system coped with these tough market conditions?
We have had a record year last year and have quadrupled our AUM by February 2009 with great short to medium term prospects. There is no secret, it took tremendous adaptation skills and risk management overlay. We did it and will continue to do so.
Given the demise last year of several large global financial institutions, have you at times experienced any problems in accessing liquidity and would you consider using a wider variety of FX trading venues in the future to improve execution?
We turnover our portfolio about 5 times per day on average and we do 99% of our execution so you can imagine that we have seen the liquidity reaching appalling levels of illiquidity. On that subject let me take a moment to comment on what is “The illusion of Liquidity”. Although we have the luxury to trade on some of the most liquid platforms in the industry, I can testify to the fact that I don’t think that the overall depth of the market is well represented in what we see flashing on those trading platforms. All these market makers use fast algorithms in order to pip you here and there but I am pretty sure that none of them can hold any type of real position. This situation exaggerates everyday moves in currency pairs that are suppose to be a lot more liquid. Add to that the fact that we have lost major players and have seen forced mergers and yes the liquidity is not what it use to be.
Swing FX is contrarian so we always go in the position against the tide which reduces the lack of liquidity or slippage in general. Having said that we do have to use different platforms in order to circumvent that lack of liquidity. In the future we will probably incorporate the use of one of our major brokers trading desk and will most likely trade the futures in Chicago to access another type of liquidity.
Your stated methodology is based on hands on experience combined with thorough back testing. Is this the real key to your success and what advice would you give to asset management firms considering adding currencies to their portfolios and trading strategies?
Although we miss the good old days with greater liquidity and numerous more counter parties that we use to call direct, it is clear that the FX market remains the most liquid market in the world. As such it is an asset class worth considering when constructing a portfolio. As the most liquid asset class, it can be traded in an unlimited amount of fashion and can provide uncorrelated returns to standard portfolios.
The key to our success remains the qualitative overlay that we add on a daily basis to our contrarian technical signals. Our expertise gives us an edge that no quant in this world can incorporate in its best algorithm. The markets have become so violent that you need to adapt regularly which you cannot do if you are 100% systematic.
Looking to the future where do you expect to be focusing your efforts to grow your business and take advantage of profit generating opportunities with the currency markets?
Swing Capital has gone through the first stage of obstacles in launching a hedge fund which are:
Decide what type of structure to adopt. We have chosen a managed account set up which makes it entirely transparent and flexible for the client on top of making sure that the manager cannot debit 1$ from the account where the client grant trading access. In light of the recent well publicised fiascos in the hedge fund industry, our managed account set up has suddenly become a lot more appealing.
We have seen our assets grow from 6M to 24M in the last few months with major participants now more inclined to allocate to our Swing FX program since we have reached critical mass and have a much larger capacity. Some prominent institutionals have already reserved some capacity.
We have also completed more than 2 years of real track record with considerable success in a period of chaos. Having returned almost 28% on our notional assets last year with clients typically using a 4 or 5 to 1 leverage, it is easy to understand that our clients in the Swing FX program have more than doubled their money with us last year and have started to spread the word out there.
Our challenge is to streamline our back office operations to make it easy for any client to invest in Swing FX from anywhere in the world as long as we can manage the give up agreements with our main prime brokers. Some prime brokers have phenomenal STP solutions that make it extremely easy for small operations like ours and allow the managers to focus on trading rather than the operational work.
Raising assets is crucial however we would like to think that the worse is over and that the light we see at the end of the tunnel is not a train. We have leveraged our business development effort by teaming up with some pro-active third party marketers that are getting some momentum in raising assets which gives us enough time to adapt our position size slowly but surely.