“Delivering sustainable value” lies at the heart of the investment philosophy at Wermuth Asset Management, a German family investment firm co-founded by Jochen Wermuth and Dr Dieter Wermuth with principal offices in Wiesbaden and Moscow. In 2003, WAM opened up its Greater Europe Fund (GEF), which had been running since 1998 with internal capital. Underpinning the fund is a quantitative model that picks stocks by assigning them a “long”, “short” or “neutral” tag.
Sergey Ilchenko (pictured), Head of the Quant Department, along with Yury Roslavlev and Tikhon Moiseev, advises a spin-off version of GEF, called the Wermuth Quant Eastern Europe Strategy (WEELS) fund, which focuses on Russian equities. GEF has been using the quantitative approach since February 2012.
“In WEELS we employ a similar strategy to the Greater Europe Fund. The main difference is that GEF uses 2x leverage. GEF can take up to 200 per cent net long and 60 per cent short exposure,” confirms Ilchenko.
The team developed auto execution software for trading. However, it incorporates human analysis when necessary, benefiting from the macroeconomic expertise of Dr. Dieter Wermuth.
“What differentiates the fund from other Russia-focused funds is that we combine fundamental analysis, which we use as a risk management tool, with technical analysis. For example, if a company’s stock price is affected by market rumours, the quant model can’t detect these. In such instances, we switch off trading. We’ve already done that a couple of times this year where technical analysis is temporarily sidelined and a more discretionary approach is taken,” explains Ilchenko.
The WEELS portfolio only targets the most liquid large-cap Russian stocks that can be liquidated within five days at most, but preferably within one day. “We are limited to around 40 stocks in total,” states Ilchenko, adding that the current AUM of the strategy is approximately USD17million. Funds that invest in Russia tend to be long-biased because Russia’s equity market is undervalued; the costs involved for shorting are up to 10 per cent p.a. of the transaction value.
Entry and exit points are decided by a trend-following system which also generates signals telling the advisor for how long a specific position should be held. For example, a ‘short’ signal might be two days, “medium” would be up to one week, while “long” would be up to one year. The system works for both long and short positions in the book.
“This helps to smooth net exposure. In choppy markets, short-term trading strategies are not as effective as long-term holding strategies,” says Ilchenko.
Consistency of performance is very much the name of the game. The fund’s best performance came in 2009 when it generated returns of over 50 per cent. To minimise drawdowns, Ilchenko explains that for every equity position the algorithm uses an embedded call option. This helps create positive skewness, meaning the strategy is more likely to have large positive than negative returns.
Recently, the team started to use an FX hedge overlay. Even though the fund was up 6 per cent in 2011 in dollar terms, Ilchenko says it could have ended in negative territory. “This is a true hedge and tends to be employed only when there is a ruble depreciation. By using futures we are able to control downside currency risk.”
The fact that Russia’s stock market is prone to significant swings actually benefits quant funds like WEELS.
“As long as that continues we will try to make money from the ups and downs. One of the keys to our success is having a systematic strategy that is consistent over time,” states Ilchenko.