Aref Karim, principal of Quality Capital Management, which has just launched its 14-year-old managed futures strategy through an onshore Ucits III fund vehicle, says CTAs stand to benefit for greater investor interest thanks to their non-correlated absolute return stream and ability to act as portfolio insurance during periods of systemic turbulence, as well their liquidity, transparency and regulation.
GFM: What is the background to your company and funds?
AK: We launched the Global Diversified Programme through managed accounts in December 1995 and established a BVI-domiciled offshore fund, QCM GDP Otus Fund, in June 1999, followed by a US feeder fund in February 2009. We established the DB Platinum IV QCM GDP Index Fund as the sub-fund of a Luxembourg-domiciled Ucits-compliant Sicav on 11 May. As of 10 June the programme had a total of USD611m in assets, including USD524m in managed accounts, USD72m in the offshore fund and USD6m in the Ucits fund.
GFM: What is the structure of the new fund?
AK: The DB Platinum IV QCM GDP Index Fund is available denominated in euros and US dollars, and offers daily liquidity. The fund was launched with an institutional share class only, but a retail class will be offered shortly. The fund carries an annual management fee of one per cent and an incentive fee of 20 per cent, and its total expense ratio is 1.80 per cent.
GFM: Who are your key service providers?
AK: The fund administrator and custodian is RBC Dexia Investor Services Bank, the auditor is Ernst & Young in Luxembourg and the clearing broker is Deutsche Bank. The collateral custodian is Bank of New York Mellon and our law firm is Linklaters.
GFM: How and where do you distribute the funds? What is the profile of your current and targeted client base? Are you looking for distribution in emerging Ucits markets such as Asian and Latin America?
AK: We are planning to distribute our Ucits fund in all jurisdictions where there is an interest and appetite for onshore regulated vehicles, with a priority focus on Europe and a secondary focus on Latin America, Asia and Middle East.
The QCM internal marketing team is working in partnership with our existing third-party marketing relationships and capital introduction relationships to identify investor interest, and principally with Deutsche Bank’s distribution and sales team and network to market and distribute the fund. The current and targeted client base mainly comprises institutions and funds of funds.
GFM: How would you assess the impact of the recent global financial crisis and economic downturn on your business?
AK: In 2008 the environment was exceptionally strong with considerable directional volatility in the markets. QCM strategies were up 59 per cent, taking advantage of the rise of commodities in first half of the year, and in the last quarter the rise of fixed income investments and the dollar as a flight to quality took place. Last year saw shrinkage in volatility as the risk premium eroded in most assets, which was challenging for QCM as for most CTAs.
GFM: What are the advantages and disadvantages of offering hedge fund strategies within a Ucits structure?
AK: The advantages include the EU passport. A Ucits fund can be sold in approximately 40 countries to almost any type of investor, retail or institutional). It will be easier to distribute the Ucits fund than the offshore fund in Europe because it is domiciled in Luxembourg.
The Ucits III rules allow more flexible investment decisions and are common to all funds. A range of Latin America and Asian countries recognise Ucits funds as authorised investment vehicles. The Luxembourg regulator specifies minimum requirements on transparency, liquidity, and diversification. This is a source of comfort to investors and in many cases results in minimal due diligence as the standards are deemed sufficient.
One of the concerns that are foremost in an investor’s mind is the recent experience of gating and reduced liquidity measures imposed by hedge funds. Ucits makes basic guarantees on daily liquidity. In addition, concerns raised by investors mainly revolve around measures to mitigate counterparty risk. They favour this product because of the collateralisation rules set by the regulator.
The disadvantage is the impact of the exposure rules. If exposure levels are breached, the asset manager may ask the trading adviser to reduce positions, possibly resulting in different returns from the offshore fund trading the same strategy.
GFM: What is your investment process?
AK: QCM’s investment process is driven systematically to generate skewed positive returns using a flow-based proprietary capital resource allocation model that integrates risk management and trend-following approaches.
It tries to generate absolute returns trading a diversified portfolio of 115 futures instruments in all major asset classes. Risk is moved around in a portfolio of long-term and short-term trending positions with a view to generating disproportionate upside returns in relation to downside risk taken to achieve those returns.
GFM: How do you generate ideas for your funds?
AK: All ideas need to be phenomena-based and must have some logical reasoning in terms of capturing inefficiencies or risk premiums in assets. The ideas need to be implemented with tools that encompass wide margins of error and are less dependent on pure market timing sources of return. A few parameters that address the main issues drive an ongoing research process at QCM, where the team is encouraged to think outside the box.
GFM: What is your approach to managing risk?
AK: Risk management is integrated into the systems. QCM uses a proprietary dynamic portfolio allocation tool called the Advanced Resource Allocator, which targets a portfolio risk budget and operates with individual market position risk limits. A volatility management tool is integrated to size positions.
GFM: How has your recent performance compared with your expectations and track record? What are your performance expectations for the future?
AK: Recent performance in managed futures has been challenging. In 2008 the QCM GDP was up 59 per cent, but in 2009 the managed futures industry underperformed and our strategy was down 12 per cent. In the first five months of this year it was down eight per cent, but QCM has a long track record over more than 14 years, over which it generated some 600 per cent return. In the last five years it has achieved annualised returns of around 20 per cent.
GFM: What opportunities are you looking at right now?
AK: The models are currently positioned more defensively on non-risk assets such as fixed income and short-term interest rates, the dollar and gold. Equity and commodity exposure is low.
GFM: What events do you expect to see in your sector in the coming year?
AK: We see managed futures playing a bigger part in a portfolio as uncertainties prevail in traditional markets in the current economic environment. The fact that these strategies generate a non-correlated absolute return stream and serve as strong portfolio insurance during systemic times makes the sector compelling as a candidate for a portfolio. Managed futures are also highly liquid and transparent, and furthermore regulated.
GFM: How will these developments affect your own portfolio?
AK: We expect to see asset flows into these strategies and therefore more growth. We will continue to research and innovate new strategies and ideas as competition increases among managers to outperform. Investors should benefit as a consequence and be able to diversify among larger sets of styles in managed futures.
GFM: How do you assess investors’ current expectations?
AK: Clearly investors are gripped by anxiety about the uncertainties in the global economy. They are more risk-averse and probably prefer to be more underweight in risk assets such as equities and commodities. They are also seeking portfolio insurance in the event of another downward leg in the markets, but have been disappointed with the performance of managed futures in 2009 and this year as CTAs grapple with a low-volatility environment.
GFM: What differentiates you from other managers in your sector?
AK: QCM runs a holistic and systematic model-based strategy that treats all assets agnostically. It also refrains from making its models cluttered with too many diversification tools or indicators. Instead we rely more on market diversification, trading a large portfolio of different asset classes, use few trend-based indicators and largely adopt a dynamic asset allocation process through the Advanced Resource Allocator tool. A risk budget is deployed based on relative opportunities through mainly an asset allocation process.
GFM: How do you view the environment for fundraising over the coming 12 months?
AK: It is unfortunate that investors in the CTA space are largely performance-conscious. They always feel they can time CTAs and end up missing good runs such as in 2008. Conversely some invested in 2009 chasing performance and have been disappointed by underperformance.
There is a general perception that CTAs are risky strategies rather than considering them as portfolio diversifiers and insurers. Fundraising will ultimately depend on how the global economies deal with the prospect of a double-dip recession and the possibility of sovereign debt defaults. Investors may become more risk-averse and go into cash or near-cash if difficulties persist, but if economies start to improve, a flow back into risk assets is likely and CTAs should benefit from increased fundraising.
GFM: How do you expect your market to be affected by proposed regulatory changes such as the EU’s AIFM Directive?
AK: CTAs are generally well regulated and the strategy is liquid and transparent. Exchange-traded futures instruments are used, which means they are automatically regulated.
GFM: Do you have any firm plans for further product launches?
AK: We are looking to launch a new product at the beginning of the fourth quarter this year.