The Lyxor Epsilon Managed Futures Fund first launched back in 1997. It was only in 2011, as demand for UCITS-compliant alternative fund strategies started to grow in Europe, that Lyxor then decided to launch a regulated version of the flagship.
The Lyxor Epsilon Global Trend Fund is a daily liquidity UCITS IV-compliant fund. Both strategies are medium to long-term trend followers and between them total aggregate AUM is approximately USD300m (including managed account mandates). The UCITS fund currently has net assets of around USD60m.
Since inception, the Lyxor Epsilon Global Trend Fund has generated annualised returns of 4.70 per cent with a volatility of 12.60 per cent and a Sharpe Ratio of 0.20.
Speaking about the overall investment philosophy in running the funds, Guillaume Jamet (pictured), Principal Fund Manager, says: “We want to stick to a pure mid- to long-term trend-following approach. We want to avoid style drift. We believe there is a lot of upside to achieve through smart allocation, and smart monitoring of correlation. This is one of the key features of the Epsilon programme. We also focus on the limitation of churning, the limitation of selection costs; we work a lot on that.”
From a risk management perspective, the Epsilon Managed Futures Fund has a 15 per cent volatility cap, whilst the UCITS fund has a 10 per cent cap. The long-term target is between 70 and 80 per cent Sharpe Ratio with an annualised return profile of 12 per cent and 8 per cent for both funds respectively.
Up until 2014, the Lyxor Epsilon Global Trend Fund tracked the Epsilon Managed Futures Fund as closely as possible. However, changes made to UCITS regulation restricting the use of commodities meant that at the start of 2014, Lyxor sought to differentiate the performance of the UCITS fund.
“We lowered the leverage of the UCITS fund from 15 per cent volatility to 10 per cent and we also removed commodities from the investment universe because of the restrictions under UCITS; we didn’t want to try and get exposure via swaps, or specific indices. To stay fully compliant we just decided to remove commodities altogether. Also, for some clients commodities are a line risk,” says Jamet.
Not that this has had any detrimental impact on the Fund. Indeed, 2014 was a stellar year with investors enjoying returns of 18 per cent. The main fund, because of its ability to trade commodity futures, generated an even more impressive 33 per cent.
“The big picture last year was that a long position on bonds contributed strongly to performance. We also had a nice contribution from currencies – long USD, and more specifically long USD against energy-linked currencies. For the Lyxor Epsilon Managed Futures fund, we strongly benefited from the steep drop in the oil price. The performance between the two funds is largely as a result of this commodity exposure,” explains Jamet.
The fact that CTAs enjoyed a return to form last year, following a tough three-year period, was intrinsically linked to improving conditions within global markets; specifically a reduction in asset class correlation. As a trend-follower, the Epsilon strategy obviously relies on the existence and continuation of trends but as Jamet stresses, “it is also important that we have low correlation across all asset classes, and all markets. This environment was far clearer in 2014 than it was the previous year.”
The approach of trend following is to avoid fundamental and absolute price level considerations. Take US Treasuries for example. Last year, everyone was expecting a rate increase from the Fed yet the central bank has only just recently announced that it will not happen as fast as people think. This has hurt people who were already in the starting blocks to go short US Treasuries.
“For us, we are agnostic on fundamentals. All we do is look at how the market moves and react accordingly,” says Jamet.
One of the most important aspects of working at an organisation like Lyxor is having the fundamental capabilities to run strategies – structuring, legal, middle and back-office, IT infrastructure.
This means that portfolio managers like Jamet are free to concentrate on the core task of managing the fund, improving the model with the research team, improving the execution set-up, improving the front-office IT infrastructure and so on. It’s a strong base to work from. After all, the team has more than 17 years’ systematic portfolio management to draw upon, along with a support staff in Lyxor spanning risk management, research and execution.
The Lyxor Epsilon Global Trend Fund trades 60 futures contracts globally. The portfolio construction is highly systematic. Whereas Jamet develops a clear view on a particular trend, the model uses price momentum signals that act as a trend expectation. This takes the form of the expected Sharpe Ratio number for each contract being considered.
On top of this, there are two other key inputs. As Jamet describes: “These are predictors of correlation and volatility. Once you have these in place, you can take the next step, which is building the portfolio. For each market one could do equal risk budgeting but we believe this is too simple an approach. You may suffer pitfalls when correlations are high. Our approach is far more involved.”
When it comes to looking at the degree of correlation within the portfolio, there are no hard and fast limits to which Jamet adheres. What is more important is that the strategy has the ability to adapt. This is achieved by monitoring short-term correlations, which allows the model to relocate in a prompt fashion.
“At any given time equity markets are normally highly correlated. You might want the correlation between CAC 40 and the DAX to be below 70 per cent, but this will never be the case. Therefore, what is important is that you are always aware of the high correlations in markets and adjust the portfolio accordingly.
“You have to act consistently. While equity markets might exhibit a high degree of correlation, commodities like cocoa, or currencies like the South African Rand have very little correlation to equities. But if those correlations start to rise, then you must always be on top of this and react,” explains Jamet. Indeed, one of the key attractions of CTAs to investors is the diversification benefit of the contracts they trade.
“Correlation is a dynamic parameter; that’s why there is a temptation among some managers to stick to an equally weighted risk budget approach,” adds Jamet.
Through the end of January 2015, performance in the Lyxor Epsilon Global Trend Fund has been solid; up close to 8 per cent.
“This is a good time to capture trends in the market. Equities and FX were the main contributors to performance in January,” confirms Jamet.
On winning both awards this year, he comments: “We are pleased to be rewarded twice for our Epsilon strategy. These awards come as a recognition of the quality of our investment process and the sustainable performance we generate since close to 20 years. Epsilon’s performance of 56 per cent over the last two years to the end of February 2015 is the result of relentless research and investment efforts by Lyxor’s portfolio management teams.”
