Bruno Pannetier, CIO, Old Park Capital
Automated Trader: What led you to your position as CIO at Old Park Capital?
Bruno Pannetier: I've been in the financial industry since 94 and spent most of my time working for French banks and in the structured products industry. I was one of the people who created the industry of so-called retail structured products based on stocks or indices to provide a way for retail investors to get involved in the stock market, but usually in the capital guaranteed or protected way. These products were sold through retail, bank, or insurance networks throughout Europe.
You have all kinds of bells and whistles in the structured products world, but usually they are pretty standard. In 2002/2003, I had this idea of working on a new direction of structured products.
The whole idea was instead of working on static baskets, to work on a dynamic basket, so basically define systematic rules, which will define the weights of individual stocks in the basket. And this became a new industry, which is at the confluence of the structured products industry and the asset management industry.
Defining a dynamic basket is actually defining dynamic strategies and this gave birth to what is now a big industry in the structured products world. In any bank today you have a team dedicated to these dynamic or strategic indices.
I started this when I was working in France, but it became big when I came to London in 2005 to join Bear Stearns as a senior managing director and head of structured products, with a main mandate to target institutional investors with dynamic strategies.
We were actually competing in the alternative management world, because what we were offering was an alternative to hedge funds.
We were doing extremely well on the equities side of the business, but obviously Bear Stearns had another side, the credit business, that was not doing that well, and brought the bank down. So when Bear Stearns collapsed, I took the team to Macquarie Bank to set up a new department, named the Institutional Investment Solutions Department, and continue the exact same business - creating, trading and marketing systematic dynamic strategies with a focus on low volatility, low draw down.
This was between the summer of 2008 and spring 2009, and we raised $1.6 billion at Macquarie in a difficult environment. But because Macquarie was more focused on funding and financial crisis related issues, we decided to go independent. We started Old Park Capital in May 2009.
AT: How big are you?
BP: We have $300 million in assets under management. We are 15 people based in London with two main businesses, an institutional business and discretionary wealth management business. We have some UK clients, but most of our clients are International clients.
AT: Can you explain how your most successful strategy works?
BP: Maestro has become a flagship strategy and we have been managing the strategy since January 2007. It's been managed by the same team from Bear Stearns, so continuously since then across three institutions - Bear Stearns, Macquarie and Old Park Capital. Maestro returned on average 22% per annum, per year since we started trading it, with around 9% volatility. We have had only gross positive calendar yearly returns
We monitor the consistency and relevance of the strategy's rules on an ongoing basis. The bulk of the rules of the strategy have not changed since we started. One thing that changed was to add the S&P 500 along with Eurostoxx 50 futures to get a better trade activation frequency and to augment the efficiency of the strategy in terms of capital utilization.
But otherwise the strategy is extremely consistent, the probability of a trade being a winning trade when we activate the trade has been around 75%/80% and it has been around 75%/80% in a very consistent way.
The rules are based on an arbitrage opportunity. We have identified a mechanism to exploit the discrepancy between the trading hours of the futures and the trading hours of the underlying, and this works for most equity and bond futures.
When both the futures and the underlying market trade, they trade the same way, the futures takes its guidance from the underlying market. But when the underlying market closes, the futures usually continues to trade for some time, but then it trades in a completely different environment because it is orphaned, it is blind.
It trades without the information support of the underlying market and after the close of the underlying market the futures tends to take its guidance from other factors, other sources of information, other markets.
Capturing the deviation means that if there is an upside deviation compared to the settlement price we will sell the futures. If there is a downside deviation we will buy the futures with the view that the futures will mean revert to the settlement price, which is the reference price, when the cash equity market reopens the following day.
That discrepancy is what the maestro strategy arbitrages on a daily basis. This is a strictly daily strategy i.e. in respect of each underlying instrument we have no position at all at the close of the corresponding underlying cash market.
AT: Any major surprises from the strategy?
BP: When we started in 2007, we entered almost straight away into this very high volatility period in 2008. The actual increase in volatility was significantly positive for the Maestro strategy because from 2008 to 2011, we generated 46.2% gross return per annum on average.
The key to the strategy as a main driver of the performance is simply the frequency at which the strategy is activated.
We were really surprised by the way the strategy is so sensitive to the dynamics of volatility, not so much the absolute level of volatility, but the dynamics of volatility because this is what drives the frequency of activation
Eurostoxx volatility fell off a cliff in 2012, when we went from north of 40% at the end of 2011, in the wake of the Euro sovereign debt crisis, down to 19% in September 2012, and then continued to go down. This falling volatility meant our strategy was not activated as much, and the frequency at which we have a deviation which is large enough for us to take a position fell from 70% to 80% between 2008 and 2011, down to 30% in 2012 and 2013.
This was a major surprise and also translated into our returns. We went from 42.6% in the period from 08 to 11, and 31.6% in 11 down to 2% in terms of return in 12 and 5%/6% in 13.
Going from a period of very high activation, suddenly to period of very low activation pushed us to add the S&P futures in mid-2013. If we are not fully activated on the Eurostoxx then we can take a position on the S&P.
AT: Any other indices you want to add?
BP: The Nikkei is a natural and mature market, it works very well with the strategy. The key for us is to integrate this in a way that makes sense with the timeline. The problem of adding it is how it will mix because not only the strategy has to work on the index that we select, but we don't want to have a position in the Nikkei that would cannibalize any position we may have on other indices.
AT: What kind of technology do you need to invest in?
BP: There are two types of technologies that a firmlike us uses, the first is the technology to design the product - so appropriate risk system to test strategies. We have developed ourselves in C++. In terms of data, we use tick data, so we have all the data of all the trades on a particular price series.
To trade, we use electronic execution through REDi, a system developed by Goldman Sachs, SwisKey, a system developed by UBS, and we have recently added Trading Technologies.
AT: What are your future expectations?
BP: Firms like us have suffered over the last two or three years due to the fall of volatility. Why would you bother with alternative investments if you can just invest in equity and bonds, and get returns?
But right now, I think this is one of the first times in recent history where an increase in interest rates would impact both equity and bond markets.
You can see what happened between mid-April and early June this year. German bunds went down by 7-8% and DAX went down by 11%
This is very unusual but also it has significant consequences in terms of portfolio construction. Traditional investors combine equity and bonds in their portfolio relying on a certain level of cross diversification between these two asset classes.
Even in the financial crisis, equity went down significantly but bonds went up significantly.
Now traditional investors have absolutely nowhere to hide because equity and bonds may fall exactly at the same time and cash returns are negligible. They have to go to other asset classes. It's a really important time to diversify one's portfolio.