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Opalesque Futures Intelligence

Uncorrelated Investing Market Commentary

Friday, June 28, 2013

While much was made of the negative impact of the recent move higher in interest rates, below are several CTAs who benefited from the moves and their related market commentary.

Rate Move Plays Into 2100 Xenon's Bond Trading Models

The sudden plunge in bond prices played right into the strengths of 2100 Xenon's fundamental bond trading models in May, earning the Global Long/Short Fixed Income portfolio an estimated +2.4 per cent. The more diversified and higher volatility Managed Futures (2x) portfolio benefited from bond trading but it was not enough to prevent a loss for May of an estimated -1.42 per cent. The Australian markets were especially difficult last month for Managed Futures (2x); trading the Australian stock market and the Aussie Dollar cost the portfolio more than two per cent. Still the story remained the success of 2100 Xenon's Yield Curve and Momentum Dispersion models, which both benefited from yield curve steepening. Also, short-term bond trading revived for its first winning month of 2013.

"Trend-following models, however, struggled because they remained stubbornly long bonds and short the dollar."

Trend-following models, however, struggled because they remained stubbornly long bonds and short the dollar. So far in June, 2100 Xenon remains short the global bond market, though recent volatility has forced the portfolio to systematically scale down its risk. Other exposures include a long bias in equities and a short bias in gold. Currency and commodity exposures remain mixed. The 2100 Xenon Managed Futures (2x) Program was down an estimated-1.42 per cent in May. The 2100 Xenon Long/Short Global Fixed Income Program was up an estimated +2.40 per cent in May.

2100 Xenon is a Chicago-based commodity trading adviser that provides diversified alternative investment strategies to the institutional and retail marketplace. 2100 Xenon manages a full range of managed futures products invested across global equity, fixed income, currency, metals, energy and commodity markets. The investment team has significant experience in managed futures portfolios. 2100 Xenon is an affiliated asset manager within Old Mutual (US) Holdings, the U.S.-based asset management business of Old Mutual plc. Listed on the London Stock Exchange, Old Mutual plc is an international financial services company providing asset management, insurance and banking services worldwide.

Reynoso Interest Rate Program Captures Rate Move

The month of May started with yields on the 10-year note hitting a low of 1.63% - a low in yield going back to December. This level represented a sharp drop from the 1.85% yield a month earlier. From that point, we saw a spectacular rise in yield, hitting a high of 2.23% on the 29th. We were positioned to capture most of the move, resulting in a gain of 14.60% for the month, bringing the YTD return to 6.44%. Despite the initial 22 bp 10-year note move against the program's position in April, the favorable move in May resulted in a net gain of 6.37% over the volatile April/May period.

"The program takes a stance which profits from rising yields"

The program takes a stance which profits from rising yields, with discretionary options overlays for alpha enhancement and "tail risk" option protection against significant adverse price moves. Through the month of May, those options positions contributed a negligible cost to the returns, which we consider quite a feat in a market which accelerated as quickly as witnessed. Looking ahead, we'd be surprised to see a similar move this month. That being the case, we've "tightened" our hedge and overlay, potentially forsaking similar outsized gains in the program in return for locking in a good portion of last months profits. As always, these options will be adjusted throughout the month as events unfold.

CIO Joe Reynoso has 28 years trading experience with options expertise, including having co-founded a multi-national options market making firm (Helios).  The flagship Volatility Program launched January 2002. The program trades options on S&P500 futures seeking to capture options mispricings by being either long or short. The Long Commodity Program launched January 2012. The program primarily trades grains and softs. Return differentiation is achieved in part by excluding energies and precious metals from the portfolio. The programs are traded on a discretionary basis utilizing a proprietary model for the volatility program and technical's for the commodity program. The trading program has a history of trading customized portfolio mandates for institutions.

Dix Hill Partners Notes Importance of Yield Curve Volatility

In May Dix Hill's directional exposure in the yield curve varied across countries.  The fund reversed its small long (bullish) US position in early May to a moderate bearish position and cut back its short JGB position. German and UK were reversed also to small bullish (long) positions.  The main driver of our profits in May was the bearish US position in the yield curve.  US macro economic data, led by a stronger than expected April payroll report, retail sales, housing and consumer sentiment, appeared to be a catalyst a sharp increase in Treasury Yields (10YR Treasury Yields rose approximately 50BP in May).  The renewed signs of strength in economic data, coupled with statements from the Federal Reserve of a possible "ease in asset purchases,"  led to expectations from investors that the FOMC will scale down the pace of its asset purchases gradually, potentially as early as 1Q'14. May was an example of not only how the multi-factor framework was correct on the direction of US interest rates but also the importance of bond market volatility in alpha generation.   In the US , the MOVE Index, which  reports implied volatility across options on the 2YR, 5YR, 10Yr and 30YR Treasuries, is currently stands around 80 versus a low of 49 in early May.  For basis of comparison, the MOVE Index averaged 68 in 2012, versus its longer-term average of 102.   This recent increase in volatility may reflect increased uncertainty regarding the future path of Federal Reserve policy, which, in turn will be closely linked to evolving macro-economic dynamics.   In contrast, the limited spikes in bond market volatility in the last 1-2 years reflected "flights-to-quality" that were less fundamentally driven and less predictable.

"May was an example of not only how the multi-factor framework was correct on the direction of US interest rates but also the importance of bond market volatility in alpha generation."

In Japan, Dix Hill's small bearish position benefitted as once again the JGB market was highly volatile, mainly due to the BoJ bond buying and pledge to boost inflation to 2% in the next two years.   Japanese GDP and Manufacturing data were also better than expected resulting in a spike in yields to 1% (on an intra-month basis), the highest level in more than a year.   Germany and the UK small bullish positions led to small losses as economic data from both regions was mixed across the board.

As of early June, our U.S. interest rate outlook has switched from very bearish to moderately bullish.  Despite a better-than-expected U.S. employment report on June 7, forward-looking labor market data has softened, as has the performance of U.S. equity markets in recent weeks. In addition to these soft macro readings, the recent back-up in U.S. interest rates has pushed market valuation to neutral. This neutral reading is the first non-negative valuation measure (based on proprietary estimates), in some 17 months.  Bearish technicals are acting as a partial offset to these factors, leading to a less-than-maximum position size on our U.S. long. Slightly long German Bund positioning has been increased to fully long. From a macro perspective, German export indicators appear weak, and the recent back-up in Bund yields offers better valuation in the short-term. We are positioned similarly long Japanese JGB's for similar reasons-weaker leading macro indicators (such as a recently falling Nikkei), as well as a possible mean-reversion value play relative to the recent JGB yield backup.  We remain only moderately long UK Gilts. In this case, the local UK macro data we track has improved a bit, acting as a bearish offset to positive valuation. Finally, we have established very small steepening trades in Treasury 10'-s v 2's as well as Eurodollar futures.

Dix Hills Partners, LLC is an SEC registered investment manager and CTA, managing investments in global interest rate futures strategy since July 2003.  Current AUM is approximately $410mm and their  research calls are utilized on over $1.5B in assets through our partner Federated Investors.   Dix Hills' investment decisions are based on a systematic interpretation of macroeconomic, valuation and technical factors and their relationships to global interest rates.  As the strategy is highly fundamental and value oriented, the strategy performs best when market participants are responsive to economic information.   Currently, we are focused on sovereign bond yields and the drivers thereof, with exposure in US Treasuries, German Bunds, UK Gilts, Japanese JGB's and Eurodollars.  While our investment approach is best described as fundamental, Dix Hills Partners' process is data-oriented and highly systematic in terms of implementation.  Furthermore, our average margin to equity ratio is in the 3%-5% range compared to a typical CTA range of 16% to 22%.

The opinions expressed in this section are solely those of the authors.  Past performance is not indicative of future results.

This article was published in Opalesque Futures Intelligence.
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