How French trend-following hedge fund Metori Capital scored success with revamped CTA model
In recent years, the relative underperformance of hedge fund strategies compared to the S&P 500’s returns prompted many institutional investors to cast doubt on the value of this industry to their portfolios.
But the dramatic swings in markets brought about by the coronavirus pandemic this year have proven a wake-up call for investors, according to Nicolas Gaussel, founding partner and CEO of Metori Capital Management – and firmly demonstrates the worth of a non-correlated trend-following strategy to investors.
Paris-based CTA specialist Metori was established in 2017 by a team of former Société Générale and Lyxor Asset Management employees, who spun out to independently manage the Lyxor Epsilon Global Trend Fund.
Originally an internally managed strategy offered by French investment management giant Lyxor, Epsilon is a statistics-focused, price-driven, UCITS trend-following hedge fund. After Metori’s launch, Epsilon was onboarded onto the Lyxor alternative platform and its management sub-delegated to Metori, a set-up praised by European investors.
Having started his investment career at HSBC in 1996 as a quant researcher, Gaussel joined Société Générale’s Alternative Investments group in 2001, initially as head of structuring and later managing director and head of Asia.
When Société Générale Asset Management merged with Lyxor Asset Management in 2009 in the aftermath of the Global Financial Crisis, Gaussel became head of quantitative strategies and was later named CIO of Lyxor in 2013, tasked with coordinating fund management, structuring and research.
After the Epsilon fund’s former manager left, Gaussel hired Guillaume Jamet, his trusted Lyxor colleague of ten years, as the new principal manager and CIO of the strategy. The pair promptly set to work on rebuilding the fund, which at the time had been run as an internal hedge fund strategy at Lyxor.
“We had started to dig more into Epsilon back in 2010-2011, trying to better understand how the fund was managed,” Gaussel recalls.
“It had a very typical trading approach, quite different from our mathematical finance background.”
As work began to revamp the Epsilon strategy, Gaussel – who graduated as engineer and with a PhD in mathematical finance – and Jamet, who had a PhD in pure mathematics, drew on their quantitative background and expertise in portfolio theory.
“We had always been in quantitative strategies and derivatives, and as statisticians we see market trends as processes,” he explains. “One thing we really wanted to understand was where the performance of a CTA comes from, and what the main ingredients of a CTA are.”
He remembers being “very surprised” to see how Jamet managed to quickly identify a new class of models able to generate performances closely correlated the fund and to the wider SG Trend Index benchmark.
But that was only the start of the journey, says Gaussel.
“As a trend-follower, like other investors, at the end of the day you have the same objective – to find out whether there is a trend, or whether it is purely noise,” he explains.
“If you make 5 per cent performance with a volatility of 40 per cent, that’s just noise. But if you do 5 per cent performance with a volatility of just 1 per cent, it’s a trend – the aspect of the curve would be a straight line. So the aspect of a trend is really the trend divided by volatility. When you follow a trend, you can go long or short – you don’t care whether it’s positive or negative.
“In general, people have an equity bias in reading market trends: they monitor the S&P500, the Eurostoxx, possibly the USD/EUR, and they stop there.
“But for a CTA, it’s not only about equity trends, it’s also about trends across commodities, short-term rates, bonds and currencies: those markets can trend while equity markets are rangebound.”
Expanding on this point, he explains that while the first ingredient a trend follower needs is for markets to trend, they also need a diversification effect.
“If you run a trend-following model on one single asset it’s unlikely to perform very well. The Sharpe ratio will be low,” Gaussel observes.
“So the second ingredient you need is a diversification effect to move away from a low Sharpe ratio in a trend-following strategy on one asset, towards a reasonably good Sharpe ratio when you do trend-following on 50 or 100 assets.
“If assets were independent, the increase in Sharpe ratio would be the square root of the number of assets: you could go from a 33 per cent Sharpe ratio to 100 per cent Sharpe ratio with just 9 independent assets. So you are in search for independent factors and you know there won’t be so many of them.”
This analysis formed the basis of Epsilon’s revised investment strategy, using factors analysis and signals so that the fund would ultimately be better primed to navigate correlation and capture investment trends across a range of assets.
Three years after the overhaul was complete, Gaussel, Jamet and Laurent Le Saint, in charge of business development of quantitative strategies, opted to spin out from Lyxor.
“As an internal hedge-fund within an external hedge fund platform, Epsilon was at odds with Lyxor positioning. For the Lyxor CEO, pushing the internal hedge funds model could possibly undermine its fiduciary platform positioning. This wouldn’t have been reasonable,” Gaussel observes.
“So in 2016 we agreed that the natural thing was to put the fund on Lyxor external hedge fund platform, but to then have our team spin-off and have the management of the fund delegated to it.
“Lyxor would retain the distribution and platform work and our team at Metori would fully focus on developing and improving the investment process of Epsilon. We have created a fully independent company that is 100 per cent owned by us.”
Gradually, as the fund’s performance improved, the fund’s assets steadily grew, from around USD350 million when the Metori team first spun out, to some USD750 million today.
“All in all, it’s been a success for us and for Lyxor because it has showed that this model was a good choice,” Gaussel observes. “We have more than doubled the AUM and the performance has been solid.”
The strategy has successfully navigated 2020’s market disruptions, advancing 7.8 per cent so far this year, while the benchmark SocGen CTA Trend Index is down 0.3 per cent over the same period.
During the Q1 coronavirus crash, the programme lowered the numbered of its positions across the board to less than 20 - for two main reasons, says Gaussel. First, the high correlation in equities meant it was essentially pointless to be short each of them, and secondly, the move helped limit turnover and rebalancing costs in the portfolio.
“If you look at 2020, you will see that correlations are very high, due to the Covid factor. The trends, due to the mean reversals, are low. So risk budgeting-like strategies, which do not take too much correlation into account, probably have been over-exposed and suffered during this period.”
At the same time, the fund has made gains in bonds and in particular short-term rates, which helped offset losses in equities.
“We designed the model first to really identify factors across the markets and second to be able to go through trendless markets without losing too much,” he notes.
“In this current central bank environment, with reflationary policies which may break trends, our model can identify that markets will have periods where there is a very limited number of trends. It is well-designed to be able to detect and weather this kind of environment.”
Looking ahead, Gaussel sees a renewed focus on CTAs in the coming months, albeit with a different perspective among investors from that which drove appetite following the 2008 crisis.
He sees growing interest in CTAs in general, adding that Epsilon is competing for RFPs in Japan, Spain and Germany, with Metori also expanding its focus towards China.
“We are fiduciary before being systematic. If we are systematic, it’s because we think it’s in the best interests of investors. Should we be in a situation where we need to have a discretionary element, we would do it, without any hesitation. But that’s never happened. Where we feel something might be improved, it’s the model itself that we improve, not the output. That’s our philosophy.
“Yes, the Sharpe of a CTA should be below 100 per cent, but if you look at things in the long-term, with a Sharpe ratio of 80 per cent you will have drawdowns, like for any strategy which is not a scam, and you have to accept that.
“But you also have liquidity; you have a zero, or close-to-zero, correlation with equities, and your positive skewness and negative kurtosis makes it unlikely that years of performance can be wiped out in a matter of weeks.”
The combination of those features ultimately makes CTAs very attractive for institutional portfolios, he concludes.
“Strategies such as ours are up this year in the mid-single digit performance area. It may not be extraordinary, but our emphasis on risk control and decorrelation still shows the value of having them in a portfolio.”