35 The Money-Making Advantages of Being a Systematic Trader with Chris Cruden of Insch Capital Management - 1of2

Niels

Welcome to another episode of Top Traders Unplugged, thanks so much for tuning in today. I know how valuable your time is, so I’m grateful for you spending some of it here with me. I also want to thank you for sharing the podcast with your friends and colleagues. It really does help me expand the reach of the podcast so more people can learn from the amazing stories of my guests. On today’s show I’m talking to Chris Cruden, Founder and CEO of Insch Capital Management. Chris has a long career working for some of the leading firms within the alternative investment business, such as Dean Witter, back in the 1980s, and AHL in the early 1990s, and he has crossed paths with many of the legends of our industry, but perhaps the biggest influence in terms of mentorship, came from the years where he worked with Bob Tamiso, who helped Chris align himself with trading and how he defines himself. Having said that, Chris shares with me that all of the important things that he needed to learn about trading, he actually learned in the army. When Chris decided to start his own company, he chose currencies as his investment universe, which helps him stand out in a crowded world with diversified managers. All in all, a wealth of experiences shared by a true veteran. For those of you who are new to the show, let me just say that you can find all of the show notes including a full transcript of today’s episode on the TOPTRADERSUNPLUGGED.COM website. Now let’s get started with part one of my conversation. I hope you will enjoy it.

Niels

Chris, thank you so much for being with us today. I really appreciate you taking the time.

Chris

My pleasure.

Niels

Now, you’ve been around for quite awhile, if I may say, in the managed futures industry. At different times you worked for what I would consider the leaders in different eras, and let me explain that. For instance, I think of Dean Witter back in the day where the wire houses were a dominant force in identifying and helping some of those managers who later became legends in this part of the hedge fund universe to get started, to get their initial investors onboard, and where some of the people working for Dean Witter, themselves, went on to become legends in their own right. Ken Tropin comes to mind for example. Then you also spent some time at AHL, which we know today has been the source of inspiration and talent for so many European managers who, in some way have overtaken the US managers in the last ten years or so. Working for these two well-known firms that only takes you up to 1993, so I think there is quite a lot of interesting things that we can explore today. I really look forward to hearing you sharing all of these previous experiences and bringing us up to date, but I’m also intrigued about this fact: you spent the last twenty years focusing on currency markets, which has been a prominent asset class at times, but in my view, it hasn’t been so prominent, or maybe I should say it’s been a bit under the radar for CTAs in the past few years, where they have chosen maybe more diversified strategies. So lots of things to discuss Chris, but before we get to that point, I’d really like you to take us all the way back to the beginning and tell us how you ended up choosing this path in your life.

Chris

Well, delicately put that I’ve been in the business a long time that’s very polite. Actually I started off as a British Army officer. I went to Sandhurst. I was commissioned into the Golden Islanders, as a platoon commander, and when I left the British army, I went to what was then Rhodesia. If you were to follow a career path of such as I had as a very young man set out, is what they euphemistically call a contract officer. But the worst possible thing happened, and that is that peace was declared. So I found myself in a country renamed Zimbabwe and I found myself in South Africa without a job, but with a regimental tie. So I knocked on the door of a bank that was called Syfrets Trust, now part of Nedbank, and they gave me a job as a gold analyst. A Scottish gent there, called Mr. McTaggart, and I said to him, “well that’s very kind of you,” and he said, “not at all for a young Scottish boy like yourself, we’re happy to do it,” and I said, “but I don’t know anything about gold,” and he said, “well, the only thing you need to know about gold is the price it sells on the market, the price that it costs to get it out of the ground and the difference between the two numbers, can you do that?” I said, “yes,” and he said, “now you are a gold analyst.” Syfrets used to do much of its business with Dean Witter Reynolds.

After a couple of years, I made friends with some people from Dean Witter, who used to come over, and they said, “come to see us if you’re ever in the States.” So I did, and they hired me, and Dean Witter under a man called Ken Tropin at now Grand Capital, who was a visionary of his time had started up leading a managed futures department. Now in those days there really weren’t hedge funds in any sense. Our sort of trading was managed futures. You never heard of hedge funds at all; it was all CTAs. And Dean Witter was very, very successful. In fact, I think we did one of the largest new offerings. It was something like $250,000,000. It was oversubscribed by more than two times, and in fact, I think we handed back more money than we raised, which is not a problem that may people have these days. After the crash in 1988, I found myself back in London and was introduced to a man, Singer Friedlander. In those days the firms, like many of these firms, they’ve been consumed by a bigger bank, but Singer Friedlander, he said I haven’t a clue what you do, but I know some young guys who seem to do a similar thing and that was Michael (Adam), Marty (Lueck), and David (Harding) at AHL, and so I joined them. At the time I think we’d just moved to German Street in Mayfair, and of course everybody told us that you’d absolutely ruined your business, you’ve cut your own throat, you’ve hung yourself, nobody is going to go and visit you in Mayfair, and now, of course, we see that they were wrong about that as well. We had $5,000,000, and I think that number actually dropped shortly after I joined. I like to think that the two are not related. It dropped and we went on to raise more money and then did the first transaction with MAN, I think in 1990, which was very successful. In 1993, I found myself back in New York and joined with a man called Robert M. Tamiso who was very much a guiding light for me, and a great mentor for me. We were of the opinion, and this sounds really bizarre, but of the opinion that markets take on the characteristics of the participants, and because there were so many people becoming registered as CTAs that the markets would become crowded, easily spooked, overleveraged, in other words, a bad place to be. We looked for a market that did not have those characteristics, and the one that did not have those characteristics was the interbank foreign exchange market. Why? Because it was a professionals market. It was literally in the bank. So we launched our program, which in those days was called Kintyre. All of our programs, even to this day, we always give our programs a Scottish place name. Kintyre, within a very short period of time, had attracted more money and was far more successful than the main part of the Tamiso business which was diversified commodity trading, and it grew, and grew, and grew, and it was a very successful program – very different in many ways to what we do now. Of course, the program now is called Kintillo, and it was launched in 2000, but the idea is basically the same: systematic trend following.

Niels

Tell me, just before we jump here, let’s go back to the time when you joined AHL. I’m curious here…because we know today that AHL became so important, you could say in the European history of managed futures. At that time what did you and the founders of AHL, what did they know about what was happening in the States at that time and the managed futures industry, because of course this is kind of about the same time as the Turtle project finishes, yet there doesn’t seem to be a lot of knowledge, initially as far as I understand the story, of what the AHL founders were doing initially and what was happening in Chicago at the same time.

Chris

In those days we basically traded London markets, I think 7 to 12 markets when I first joined, so what we would describe as pretty much relatively speaking nosebleed leverage. We modeled ourselves very much on MINT. MINT were the heroes for us, and we did believe as well added more and more markets, getting more and more diversification, and became more, and more systematized, ala MINT, then we would replicate some of their success and that turned out to be true.

Niels

OK, interesting. So, anyway I was interrupting you, but please continue with your story and what happened following your introduction with Tamiso.

Chris

With Tamiso I had previously noticed, even when I was with Dean Witter in the early to mid-1980s, that the large offering we did, and we had what were called the cornerstone funds: we had three funds in varying leverages, plus Cornerstone Four, which was a currency product. Even in those days the successful CTAs were or tended to be systematic trend followers. The idea of the hard-handed trader was never really something that appealed to me, and my observation, even from the very early days…in those days we had John Henry, there was AO Management and Dinesh Desai, sort of ancient history names, but they were in the main systematic in their approach, and so the idea of AHL very much appealed to me because AHL was, and endeavored to become more, systematic, That’s something that very much attracted me to AHL – the same with Tamiso. I met Tamiso in London because he was a keen opera fan, so he used to come over, and we used to meet and share that interest. He was an extraordinarily systematic trader and a systematic man and I thought that was very attractive and sensible, something solid that I could understand.

Niels

What happened at the time at AHL when you started working with Tamiso that meant that you were focusing on currencies early on?

Chris

As I mentioned, the belief was that was shared by Bob Tamiso and myself was that the game was becoming too crowded and so we looked for another game that was not crowded and that was currencies, entirely bi-directional. Tamiso did say at the time the great thing about the currency markets is that they’re so big that we can’t screw them up. Whereas, if you look at the history of managed futures, when it bursts its way into a new market such as LME, which is basically producers and consumers with a very small speculative interest, when the credit and credit funds discover that, they tend to upset the balance of it and it becomes a less reliable market from our point of view. Not necessarily from the participants point of view, but from our point of view, where the speculative part becomes too big. It becomes sort of out of equilibrium.

Niels

It’s interesting because I remember back in the day, you say 1990, 1993 or there about, managed futures were still around a 10 billion dollar industry, so it wasn’t AUM huge. I do accept that many, many times it’s been said that CTAs or any strategy is becoming too big for themselves, or I agree that that notion can certainly drive you to go in a different direction.

Chris

I think it’s true now, with hedge funds, you have to ask how many hedge fund managers does the world need and could we get by with fewer. My guess is we probably could. I don’t know, it’s not a subject you brought up, but I would point out at Tamiso we were very successful in terms of returns, asset raising, it was a very, very successful program. At that time, at no time did we have price feed in the office, and when signals were generated, 7AM New York time, Carol, the lady in the office, would then call Pru who were our main broker at that time, in London and speak to somebody called Sid and ask him for the mid-range prices. Sid would give us the mid-range prices and then the trades would be done, and he’d fax back the fills and basically we were done for the day. So when you have that sort of memory of how these things can be done and be so successful, when I hear conversations later on in life about high frequency trading and technology, and nanosecond trading systems, and this, that, and the other, it makes me feel either extremely old, or extremely sensible that we never got involved in that sort of thing where the margins for success apparently are defined as being very, very, small indeed.

Niels

I think it’s an interesting subject, and maybe I can tap into your memory a little bit on that before we move on. You say that Tamiso was very successful at the time. Can you put words as to why, what made you so successful? What did you do differently, or what did you do just generally that people were attracted to?

Chris

I think in our way we had a, I’m tempted to say aura, some other people would say arrogance, about us that due to the leadership of Bob Tamiso, we were driven very much by quality of life and Bob was a very successful and balanced individual, it always seemed to me, and I would contrast him with some of the frantic, almost foaming at the mouth gabbiness of some managers that I meet now. I guess that came out in the way that we presented ourselves. As I say, some people saw it as a positive vibe, using a modern term, but other people saw it as arrogance, but we were happy with what we did and how we did it. We didn’t have any aspiration to take an awful lot more clients on, or an awful lot more money on, and remember in those days because the internet didn’t exist, there was an infrastructure limit to the amount of accounts or, in those days, bank desks that we could actually trade through and at one time we were dealing with 12, 14 or so. In this day and age, of course, it’s no problem at all, but back then it was. Bob, specifically, was very clear on who he did want to do business with and who he did not want to do business with. I suppose to some extent we at Insch, today, we still have that certain view. Insch doesn’t have any marketing and never really has had any marketing. If you ask what our biggest single failure is, I would say, my biggest single failure is that we are hopeless at marketing. That dates back to the Tamiso days where we weren’t a marketing operation. We’re a manager of money, not a management of people.

Niels

You talk about Bob Tamiso as a great mentor, and I think mentors have been very important for certain managers. When I did my conversation with Jerry Parker and he obviously talks about his experience through the Turtle program and the mentorship that he had early on from Richard Dennis, what was the most important thing that Bob Tamiso taught you?

Chris

To show up – always show up. You win by showing up, because most people are unable to meet that minimum requirement for whatever reason. One of which might be they were over geared simply have to leave the table. Showing up is very important. Bob’s best friend was and is Larry Hite from Market Wizards One, and Larry Hite was very often in our office in New York. Larry Hite was also a truly great individual, but entirely systematic. These are not people who didn’t represent their greatness by pretending that they knew tomorrow’s prices.

Niels

I seem to remember that there were some joint ventures being formed, maybe even with Hite’s group and MAN, so tell me about what happened when you, after a few years with Tamiso?

Chris

We did a joint venture with MAN, with Stanley Fink, who was another superb individual, and giant of the industry, as I said indeed was Larry. I can’t say enough good things about him. We did a joint venture and in effect they took over the marketing and other aspects of the Kintyre program, and the reason that they did it was, at the time, our currency program was substantially better than AHL’s currency program. If you’re representing yourself as a diversified commodity program, with X billion dollars under management, when in fact you’re really not, you’re trading an awful lot of indices, and awful lot of interest rates, and an awful lot of currencies, and relatively speaking not much pork bellies. So if you’ve got one of those main legs that is a little bit wobbly, you’ve got a big problem, and so they were on the lookout for a program that was demonstrably better than the one that they were using for currencies at that time, and I think that we filled that gap. So Bob and I basically parted company. Bob is much older than me. Despite what you say, there are people older than me. So I came back to the UK and started a new program under a new company which was Insch. Relocated it to Switzerland in 2004, and physically moved here in 2006, 2007.

Niels

Of course running Insch is a big part of your life today, I’m sure. But I’m just curious before we dive too deeply into other more business related things, what else do you spend your time doing?

Chris

On the ledger side, I like to play golf, and I like my cars, and I travel quite a lot to the UK and around the UK, but mostly Scotland. I have a close tie to Scotland. From a business point of view, I spend most of my time getting in the way of the research department, and generally annoy people here in the office. Not so long ago I had a medical issue and it both gratified me and depressed me to see that I wasn’t missed at all and that the business ran perfectly well, and some would argue with a lot of positive evidence that it ran a lot better without me. Being systematic traders, the reality is we are going to do what the system says we are going to do. There’s a good and bad about that. The good thing is we don’t have to worry terribly much. We can sleep perfectly well at night. The bad thing is it doesn’t make us terribly interesting people. The world, if you watch CNBC or something like that, they have the talking heads there, sort of pin-striped suited soothsayers and that sort of thing who are intimating either subtly or not subtly that they have some insight into tomorrow’s prices. We, of course, have no insight into tomorrow’s prices. So there’s a limit to how much we can entice people with what we can intimate. Basically, it is what it is. I did mention earlier that we’re not terribly good at marketing, and now you’re hearing a perfectly worked example of it. We will follow the system with discipline and patience and low leverage and, to go back to Bob Tamiso, this will enable us to show up again tomorrow.

Niels

Yeah, obviously we have many specific topics that I want to touch base on. I’d like to, if I can, in an elegant way phrase a more broad question to begin with, and that is when you decide to seek mastery in a particular craft, like building a successful asset management business, you can almost call it a quest that you embark on, and for some people this quest is to bring purpose in their life, for example. But your quest over so many years, what do you think has been the aim or the goal that you have been seeking in that long career?

Chris

First of all I’d say that Insch, at the moment…the fact that Insch exists, or is as big or as successful as it is at the moment is almost entirely accidental. When I first moved to Switzerland in 2006, it wasn’t really the intention to go back into business. It really wasn’t. Yes, I took and office, and yes I got a secretary and that sort of thing, but it really wasn’t the intention. It just so happens that we’ve been fortunate, and people have found us and the business has grown. So to answer your question, on the one hand, there’s nothing that drives the establishment and the growth of Insch forward, at least not from me. Now-a-days I would say when I look at some of the people that I’ve worked with: Michael, Marty, David, other people, other firms who passed through our I’ve known who were at AHL or where ever, and I see the success that they’ve had; and at Insch we, I, have not had that success and the reason for that is we’re not perhaps as driven as they are to become large. We’re not as good at running a business, perhaps as they are – they’re very good at marketing perhaps. Having said that, our numbers are better in terms of performance. So we’ve got one out of three right, but from our point of view it’s probably the most important one. Looking back to Bob Tamiso, again, we’re not unhappy with where we are. In a way, I would say wouldn’t it be nicer if we had just half as much as Aspect or three times as much as Winton, but we haven’t. We are where we are, and we’re happy where we are.

Niels

This to me is obviously what’s quite interesting, because as you like to point out, and obviously I’ve seen your numbers, so I do agree with you they look great. This is what’s interesting because to me, and it’s partly why I do what I do with these podcasts and that is to shed light on people where, or at least to encourage investors to maybe find the courage to go and think a little bit outside the norm and to take a chance, so to speak, on a manager who’s not mainstream and not top 10 in size and let’s help each other to get away from the fact that now-a-days most allocations are based on size rather than maybe skill or something else. That’s just sort of my own motivation, but I agree with you.

The first thing that I wanted to ask about, and in a sense maybe it ties a little bit back to what you just said about organizations and some organizations have become very institutional and have become very good at that. What about yourself? What have you focused on in building your organization and what does it look like today?

Chris

In Lugano here we have eight people. We have three on research; we have my partner Jeff Baker who’s been enormously helpful and influential in the building of the business, not only on the trading side, but on the business side; Purnur Schneider, who is an extraordinarily clever young lady and Head of Research; Filip Babic who’s just joined us. In London we have Rivaldi, who started off as a…I think his Masters is in Aeronautical Engineering, or some such thing, from Oklahoma, so I guess he’s about as close as we have to a real rocket scientist. I like young people. I like young people who’ve never worked anywhere else. I don’t want anybody turning to me and saying yes, but this is the way we used to do it at Merrill, because I’m not interested in how you used to do it at Merrill. The young people have good ideas. I like people who manage themselves. As I mentioned we need managers of money, not managers of people. If I noticed that your grandmother has died three times and you need to go to a funeral three times in a year than that’s probably going to attract my attention, but otherwise I let people get on with what they want to do. The Army term would be delegation is the key to command, and I think that that is probably true. And there’s other clichés: my door is always open and this other nonsense. We’ve had two people leave us in the last seven years, both of them involuntarily. It was to do with they had to return to their home country. They had completed their studies and visa situation here in Switzerland, and we’ve had one person that I really didn’t ask to leave, but it became obvious that they should leave, as is often the case, and so our turnover is extremely low and I think people are happy here. I must say we probably ruin them from working for anybody else because we are not hierarchical in any sense.

Niels

Why do you need two offices, Chris?

Chris

When I go to London, I need somewhere to go because it rains and sometimes I need to be indoors. We have a very, very good young man called Rivaldi Kwan in London, who worked for us here, in Switzerland, and because he is Indonesian he was not permitted to stay here, and I didn’t want to lose him, so it does no harm for us to have a representative office in London and I couldn’t find anybody better at all than to ask Rivaldi to operate it, and that’s what he does.

Niels

The next thing that I want to talk about I call it track record. But what I really mean by that is, obviously your program has been running for quite awhile, and with managers, especially in the systematic space, programs, models, approaches, risk management, and whatever it might be changes over time. Before we dive into the strategy, maybe, just from a pure track record point of view, if someone asked you how should I read your track record, what should I focus on, has there been some major changes, upgrades, innovations, whatever we call it that I should be aware of? Because in my personal experience I think people often look at track records and think that they should expect the same going forward and I would caution about that because as we all know, people, programs, change and so to some extent I would almost argue that it’s better, if you can get it, to look at a managers backtested version of the current configuration to see what the program is really doing today, but that’s very hard information to get hold of. So that’s why I’m interested in the whole track record issue just to bring light to that. How should investors look at your track record if they asked you?

Chris

That’s an awfully good and awfully big question. First of all I should say that we present our numbers in two different ways. The first one is without the deduction of any fees. It’s a straight alpha number and without leverage. So it’s one to one and there’s no credit for interest that could be important, some people say we should add interest, but that would make us look a bit bad. What you’re looking at when you look at the one to one is pure alpha. The other way that we show it is again without credit of interest but net of 2 and 20 and at 3 times leverage. Three times leverage is as high as we go. The reason being is that we like to think that we’re going to be staying in business, and 3 to 1 leverage, basically, gives us the same standard deviation as the S&P 500, but substantially higher returns. That’s why we, as a ball park, that’s as high as we go. Our program hasn’t effectively changed in any sense at all over the years. It is systematic trend following. We started off with 10 markets. It’s always the majors; we don’t do emerging markets. We added a couple of Swiss crosses in 2008 and then about two years ago we added Euro/Can and Euro/Australia. So now we trade 16. It should be 7 times 7/21 crosses, but in actual fact, due to obvious reasons we only trade 16 of them. In our business, there are four main drivers for our currency system, basically. We can dance around it a bit and dress it up a bit, but there are basically four main systems, one of which is interest rate differential or what is now called the carry trade. There is momentum breakout. There is some form of volatility trading, and there’s some sort of purchasing parity type programs. Those are basically the four bricks. UM for our kind of system is built in the main, on interest rate differential and breakout. So you will quickly see that over the last four or five years, the money that we have made has not been made from carry trade, because with interest rates where they are, there’s not a lot to be done there. So any money we’ve made has come from interest rate differential. So this goes back to another part of your question, when you look at the full length of somebody’s track record, and ours is 14.5 years now, you look at what was possible, generally speaking (this is thumbnail), but generally speaking what was possible, and what do you get for the rolling T-Bills – the risk free rate; what do you get for doing nothing – the risk free rate. Now at the beginning of this century we can say that the risk-free rate was 4% or 5%, something like that. So if I made 5 times the risk-free rate, your returns are 25%. Today if I make 5 times the risk-free rate your returns are what – 2.5%?

Niels

Yeah, at a maximum.

Chris

But basically there is some equivalency in how you can compare those things. As an investor you have to look at literally a macro view for this particular asset class what was doable – what is reasonably doable, what was a reasonable expectation? If you look at the stock market, for example, it’s doubled over the last X number of years. Well, that’s reasonable. Now if your manager has done twice as well as that, I guess you’d say, looking backwards, not forwards, but backwards that’s pretty good. If he’d done half as well as that, you’d have said actually that’s not too good, is it? In our business what has been reasonable from currencies over the last four or five years has not been a particularly exciting number. But that doesn’t mean it won’t be because you invest for tomorrow, not for yesterday. Something else that you mentioned earlier I think, in our business, that is to say the hedge fund, if that is what we are; managed futures business, if that’s what we are; there’s a lot of groupyism. Investors like to be seen to be with the new hot-handed guy, so people crash to earth pretty quickly in this business occasionally, and take the investors with them and we’ve seen that time, after time, after time. We call that the faster gunslinger syndrome. If I tell you, for example, last year we were up 20%. You’d say 20%! I met a guy last month; he was up 20% just that month! And you’d say, well, OK but I don’t know how many times I’ve been pushed out of the way by a faster gunslinger, turned the corner and there he is face down in the street. Guess what, there’s another faster gunslinger coming up again. There’s always one, but they tend not to have very long careers.

Niels

So looking at the program today, and as you mentioned, is it fair if we’re going to try and visualize it that for the four things that you mentioned that that is what a currency program can do, that as long as you know roughly, would you say that those four, and I’m asking out of ignorance here, are those four categories you mentioned: the carry, momentum, volatility, and purchasing power are they individually able to produce the same level of return but a different times, of course?

Chris

Yes, yes. What I would say is that over time by far and away the most successful of the four has been the interest rate differential carry trade, next would be the breakout and then probably various times volatility. There’s a danger here for investors because currency managers that have done well over the last couple of years you can almost say, well you’ve done well but you haven’t done it on a carry trade basis, have you? And you probably haven’t done it on a breakout or momentum type basis either, so you’re doing something else, what’s left? So you’re doing some sort of volatility trade. OK, that’s fine, but is that going to be the environment that is going to present itself tomorrow? A lot of managers, they do continually change their system, and that’s fine. They do it for two reasons, one because they think that they’re going to improve returns by changing their system, and secondly, more dangerously, it’s because they sense that this new approach is the approach that, from a marketing point of view, is more likely to attract fresh assets. So you’ll see people describe themselves as vol traders, why, because they read in the Wall Street Journal that people are writing checks to vol traders. Are they really? I don’t know.

Niels

It’s kind of like when the CTAs start calling themselves hedge funds because nobody likes CTAs.

Chris

That’s right, that’s right, you see as you heard me say just now, I don’t know if we’re a hedge fund, I don’t know if we’re a CTA. As a currency manager, we have always been basically the red headed step child of both industries. We don’t trade futures; therefore, we don’t manage futures I suppose. Hedge fund, there’s a bit of a misnomer anyway because there’s nothing to hedge. So you tell me, to me it’s a label that really doesn’t matter but I suppose for allocators you’ve got to tick boxes, put you on one form as opposed to another form it’s important, but not to me.

Niels

You mentioned the work environment just before, and I think that’s an important thing I’d like to dive into a little bit before we move on to the strategy itself and how you go about it, but I think it is important for investors to understand in which environment should then expect a strategy to work, and as you clearly mentioned, for your strategy, over the last couple of years, carry would have been very difficult to work with due to what the central banks have been doing, but try and explain to me what the environment has actually been like for a currency program in the last say 5 years from when we really have had intervention, if we can use that word, from authorities, because we know that traditional trend following has been difficult, but how do you then put it into perspective of say your strategy in one area of the diversified universe, how do you see the environment and how its changed and what might change it again?

Chris

From our point of view the environment has not been favorable. Having said that, next to our peers, we’ve done extremely well. Some of them, FX Concepts, for example, and there are many, many others have had horrific and fatal periods…some of them. We haven’t; we’ve done pretty well. Having said that, because we have done well doesn’t really mean that it’s been ideal because it has been anything but ideal with volatility as low as it is, it’s been very, very difficult. But as I say, we come in, we show up every day, and we do what we do and we’ve done OK. We have not changed our system. We do anticipate return of volatility. That is very, very positive for us and for other trend followers, genuine trend followers, that should be a very good thing for currency managers. I would say that being in this sort of period previously, I would say 1992, 1993, followed by 1994 would be a similar period of time, we say our business of volatility doesn’t rise, it jumps. A lot of people in our business, I suspect, who have changed their systems, may well get caught out by that jump. They will have changed their system to fit with the environment as they see it now just in time for the environment to change.

Niels

A quick question here, you’ve been around, and as you mentioned you can go back to previous times and say 1992, 1993, 1994 looked similar and if you just stay with what you do, and so on and so forth, and things will go back and models will start producing returns again to levels that you would expect. Now we here often, and we’ve certainly heard in recent times that this time it’s different. So I would like to ask you if you can explain why these things actually aren’t different and why things tend to return to the norm regardless of the fact that certainly the things that the authorities have done this time clearly they are different. They’re using new techniques and new things, but you seem to be under the belief that it’s not going to last forever, and the markets will return to how they always behave. Where does that belief come from?

Chris

Although the tools that they’re using now are new, I don’t think anyone would think that what they’re doing is sustainable. They cannot continue to do it, and indeed, if you look at the Fed, they’re not. They’re cutting back on QE and this, that, and the other. Currency markets are different to most markets, or to any other market I can say because they are completely bi-directional, which makes them ideal markets for the popular press phrase would be currency wars, or competitive devaluations, or confederate rate rises, or whatever it is. Because of the tools that have been used, not in spite of them, but because of the tools that have been used, I can easily see that not only will the environment looking forward will become more favorable, it will become very much more favorable and very quickly. I just don’t know when that very quickly will start. It may well have already started. I don’t know.

Niels

Just for the benefit of the listeners here, why do you say that it’s going to be even more favorable? What is it in that statement that you feel that the markets, and say the currency markets, which obviously is your expertise, what is it about them that… It’s kind of a cycle, isn’t it that if you stretch the rubber band too much then you are going to have an even bigger move when it comes back. Is that what you see in currencies, that they can do whatever they want for a period of time, but once they let go things are going to be even better, and we’re going to have above normal returns for a period of time? Now we’ve had sub returns for awhile.

Chris

The potential for substantially higher returns exists. Whether or not we, Insch, will be able to participate in those I don’t know. I couldn’t make that representation, but what the action of the authorities has done is they have certainly put us in uncharted territory, not only for us, but also for them. They have also, from my observation, the tool kit is a little bit bare. They are sort of running out of ammunition. Generally speaking, another sort of broad observation would be that central bank intervention itself, in the currency markets at least, hasn’t been particularly successful when you take a step back and look at it. You see the Australian and the Japanese interventions recently, this is not something…they can slow it down, and they can reverse it for a short period of time, but once they’ve actually intervened, then the trend that was established before the intervention resumes and on it goes. So I don’t think central banks are, to the market, at least for the currency markets is as scary as they were way back in the 1990s for example, and less so now given the extraordinary intervention sort of tools that they’ve used that have increased the risk of exactly what they had hoped to avoid.

Niels

I want to go and talk about the program itself, Kintillo, and would like you to describe how you’ve structured it and so on, and so forth, but before we go there, I wanted to ask you if there is a particular objective with the program. Now obviously one objective could be just to say well, we want to make money every year, but there could also be other objectives, for example there could be a certain period of time where you want to make money or be more certain that you make money. Is there any objective in your design of the program that you’ve tried to achieve?

Chris

The answer to that is no. The system is, in fact, designed to produce absolute returns, so after many, many years we’ve been able to do that, and from that we’ve been able to make a number of observations. For example, it has a very strong positive benefit to an equity portfolio. Our positive months seem to happen at a time when the equity markets have negative months, and on it goes. So the benefit of including our particular program, I assume other similar programs in a portfolio that is otherwise predominated by equities is quite pronounced. It wasn’t designed to do that; it just has.

Niels

Why do you think that is, because it’s not a natural conclusion I would have drawn if you just trade one asset class, that that would have a particular correlation to another asset class in particular when we’re dealing with currencies as you said every time we have a currency pair we’re dealing with two different countries, so to speak, and their economies, it would have been easier for me to assume if you were trading equities themselves and you just have some models that would react very quickly when markets started to fall. Why do you think your correlation has been as it is?

Chris

I really don’t have a direct answer to that. I really don’t know. What I’ve just said is an observation, it wasn’t created to do that, it just has, and it’s a very stark benefit it has to an equity portfolio. I would say that one of the reasons might be is that currency markets are, first and foremost, markets of capital flow, so I guess if people are selling stocks they’re putting it in a currency and people are buying new businesses or selling businesses or investing or divesting on a sort of a much larger scale than simply buying widget PLC or something like that. Perhaps that’s got something to do with it, but in any event, whatever the reason, it is a pronounced fact.

Niels

You mentioned that you were trading sort of the G7 currencies and you’re obviously pairing them up, but the currency markets have kind of changed in the last 20 years, certainly with the introduction of the Euro and other things. How has liquidity (I’m just curious) how have you observed liquidity in the foreign exchange markets in recent times. People talk about equity volumes being at the lowest level for many, many years, and so on, and so forth, but what does the interbank market of currencies look like now-a-days?

Chris

We only trade the majors, so we don’t trade any of the emerging or submerging currencies. We just basically trade the main currencies crossed against each other. So it’s 7 times 7/21. As I mentioned, we trade 16 of those, and we trade very infrequently relatively speaking. Our winning trades are held on an average for about 16 or 18 days or so and our losing trades are help for 6 days on average, and that’s been the case over the full period of the track record. So, liquidity and transparency are amongst the most important attributes that any market can have. In fact I remember at Dean Witter, 100 years ago, I think there was a list of 7 characteristics that a market must have in order to become considered investable, but I forgotten what 4 of them were, but the first three were liquidity, transparency…well, now I’ve forgotten what the third one is. But the point is that the currency markets are blessed with liquidity and transparency to a far, far, far greater degree than equity of fixed income markets.

Niels

Do you trade futures or do you trade the interbank market? The reason I ask is that with the recent crisis, we know that banks became much more suspicious of each other, let’s put it that way, and maybe didn’t trust large lines in dealing in facilities with each other. How did you experience that, or what were your experiences with this?

Chris

We just trade spot, so for our business it couldn’t be more simple and straight forward, although I suppose you could say it’s a derivative business because it’s a pretty child proof derivative business compared to some, so we haven’t experienced any issues at all in that regard.

Niels

Tell me about, if you would, can you take me through the program, the structure, the sort of overall look and feel of it and how you divide it into different types of models and their functions?

Chris

OK. I mentioned the four types…forget volatility and forget purchasing power, in the main most currency programs like ours are made up of interest rate differential and momentum breakout. Ours is about 70/30 favoring interest rate differential. It is a matrix. One of the things that I think we probably do that is slightly different is that we don’t regard the crosses as currencies per se. If I say to you, for example, dollar/yen you’re immediately going to start thinking about Japanese exports and economics and all of this, that, and the other. Well, of course the computers don’t see that, they just see a row of numbers that have or have not changing relationships with each other in terms of volatilities, or correlations, or whatever. So what we have is 16 rows of numbers, and we try not to think about…the computers do not think about them in terms of being countries, if you will. They’re just rows of numbers. When we put on a trade and our system is entirely probability based. The reason that it’s based on probability is because we are not predictive in any sense. We have no idea what tomorrow’s prices are going to be. I wish we did. If we did we wouldn’t be having this conversation, but we don’t, and so at the time of instigation all trades are risk equivalent and the reason they are risk equivalent is precisely as I said, if we knew that this trade was better than that trade we wouldn’t make that trade, we’d just make twice as many of this trade, but we don’t know. So all trades are risk equivalent at time of instigation. What will take us out of a trade is an increase in volatility, but if on the upside and on the down side, high volatility tends to terminate a trend, low volatility tends to initiate a trend generally speaking. So that’s the way our system works.

So if we look at some of the positions at the moment, we see that we are long two risk units of DOLLAR/YEN. We went long on the 1st of September when they 1.0492-93, and it’s currently 1.0920-26, so that’s been a successful trade for us. We have a losing trade; we are long 1 risk unit of EURO/CAD at 1.4182, and it’s currently 1.4152, so that’s a losing trade. Each of these trades have their own trailing stop, which is based on time and volatility, which, hopefully, keeps us out of trouble when volatility in that particular trade does pick up. As I mentioned high volatility tends to terminate a trend. Low volatility tends to initiate a trend. We are extremely low geared. It ranges from 1 to1, to 3 to1, and the reason for that is that you’re always…as Dave Harding used to say at AHL you always make money in this business if you don’t go broke first. What is going to make you go broke is leverage. So if you intend to be in a position to show up again tomorrow, you’ve got to keep your place at the table, and that means you don’t lose all of your money. No matter how certain the trade looks. We trade entirely systematically entirely disciplined, because, and I think most people can identify with this whether they tend to use the information, or not is their choice. Our observation would be people lose money for two main reasons, the first is emotion – hope, greed, and fear; bad inputs for trading strategy and the second is ego. If you get something right, you might bet a little more, now you know something. Get two things right suddenly you’re a genius, and you’re on CNBC. Now you’re going to increase your gearing, and you’re a truly, truly dangerous person. So if you can remove emotion and ego through a set of rules, which is what we do then you’ve already got an advantage over other investors. At least that’s the way that we see it. We don’t claim that we have any predictive or special insight at all. We leave that to others.

Niels

Is it the same models that trade all 16 crosses?

Chris

Interesting enough, the Tamiso program was unbelievably enough. In those days, we traded forwards, and we traded 28 different crosses with one algorithm. It was a one size fits all algorithm – unbelievable. That’s what we did. Kintillo is a lot more sophisticated. Each of the 16 crosses has its own algorithm. People these days get terribly excited about the word algorithm and think you’re a really clever chap because you have an algorithm, but an algorithm is simply a set of rules. If you have a set of rules you either follow them, in which case you have a set of rules or you never follow them in which case you don’t have a set of rules. We do follow our rules. So we make no representation to anybody other than we will follow the rules that we’ve set out.

Niels

So is that to be understood, that there’s kind of one model – a set of rules becomes a model, so there’s just one model for each currency pair.

Chris

That’s right, well the model itself is made up of different component parts, but it’s like anything else, it’s like a machine or a car, the more moving parts you have the greater the probability, that word again probability, of breakdown. So you can… I think in our industry generally there’s a sort of love affair with perceived cleverness, which is not unrequited, but it’s certainly not terribly helpful I think, we are in love with cleverness when simplicity should be found to be more attractive in my view.

Niels

No, no, I completely agree, but tell me, what could be the difference between two models then? In a sense that once you start deviating away from trading one model across all markets you always have the nudging question about optimization and so on and so forth. What would be the difference if you should visualize it between the algorithm you use for one currency cross and the next one?

Chris

The parameters would be set differently, so for example the parameter for the majors, what defines volatility for one cross would be different to another cross and that’s a source that builds to the risk equivalency of the price streams, if you follow me.

Niels

So the principle, in a sense, is the same. Meaning that you’re looking for some kind of breakout as the main methodology?

Chris

Absolutely, absolutely. They are remarkably simple. I think people would be either surprised or appalled at how simple the rules actually are. They’re encoded in computer speak, because it’s more efficient for us to do this, but certainly with Kintyre, the Tamiso program, you can literally write it out and work it out by hand if you had the interest and the time. Kintillo is slightly more complex than that, but not much. You come into a point where, and I speak on a lot of panels and meet a lot of people and they tell me how terribly clever their system is, and to which I always say, well could you write it down on a single sheet of paper for me because I’m not terribly bright. Well no, you don’t understand. Well, any time anybody tells you that you don’t understand it means you probably do. What it means is that they have convinced themselves that they are very, very clever indeed. We haven’t. We’re very simple indeed. We describe ourselves as sort of not the genius, but the idiot savant. We don’t know very much about anything, but what we do know we really do know.

Niels

I feel that I have to deviate a little bit here and ask you a question because I think it’s so important to understand and that is, what do you think the larger managers with the 50 or 100 PhDs, what do you think it is that they do, actually, because performance wise, sometimes, not always, but sometimes, it’s very, very difficult to tell the difference between the firm that has 50 PhDs and the firm that has 1 PhD or no PhDs. What do you think actually they do other than creating more capacity. I do understand that that can be a big part of research which is to find out how do we execute 10 billion. That I understand, but what else do you think that they achieve with all of this research?

Chris

The answer to that is I don’t really know. There are one or two very, very good examples of firms that are extremely well run from a business point of view, from a research point of view, from a trading and execution point of view, who you would say is a level of genius brimming full of PhDs. I would speak of Winton for example. You would think of some others, which I won’t name, who are sort of want-to-be Winton’s, who might come out of the blocks looking like geniuses, but soon stumble and fall on their face and just look a bit silly for all the semi-intellectual nonsense that they have spewed forth. Why I don’t know. You’d have to ask them. I really don’t know. Tamiso would say that this is an extremely easy business. There’s nothing to this business, because you keep score in dollars and you get a printout every night. Are you up or are you down: a black number or a red number; a plus sign or a minus sign, this is not hard. Now you might have all sorts of reasons as to why the number isn’t as big or there’s a minus number or whatever, but it doesn’t change the number. The same with prices for that matter. You see people talk about the price of the stocks or whatever it is, that’s all very well and good but you might think the price is wrong and you often hear people say, well the price is wrong, we’ll have a view on that, you might think the price is wrong and you might be right – it might be high or low, it doesn’t matter, the fact of the matter is it doesn’t change the price. What do these PhDs do? I don’t know. Maybe they argue with the price.

Niels

I wanted to go back and ask you about your models because you mention the fact that you are a trend follower, but you also mention the fact that volatility and increase in volatility and I want to make sure that I understand it correctly. Can increase in volatility completely cause an exit of that model, or is it a reduction of position size? The reason I ask that is because we know, of course that trend following as a general rules means that the trend actually has to change before you get out. So I just wanted to see whether there was a bit of a twist here when you talk about trend following that in fact it’s trend following but it’s with a chance at least to actually get out during the trend because of changes in volatility rather than a price change.

Chris

Yeah, the volatility is generally what takes us out. One of the problems that we’ve had over the last year, I suppose, 11/10, 10/11 months is volatility has been so low it’s resulted in us being in all 16 trades all the time. Now the average holding period for a losing trade has remained the same, 6 days. The holding period for a winning trade has dropped from 16/18 days down to about 6 days as well. So that’s the statistical definition of the trend followers nightmare which is getting whipsawed. Now over this last month we’ve noticed that we are now getting taken out of some of these trades. This is brilliant. This is excellent, because, now, for example, instead of having 16 trades on, we have 12 trades on. This shows to us that volatility is slowly returning, and this is an environment which is more acceptable and more amenable to our type of system. I can’t speak for other people who describe themselves as trend following, but certainly from our point of view this is a positive development. So just to confirm, each of the 16 markets and therefore crosses, and therefore models, they work completely independently, so all 16 could be involved. So if it’s to do with the Euro, there is no overriding exposure limit on that?

Chris

No, because each price stream has its own characteristics which vary from time to time. It really has its own stop and the stop is based upon volatility so the volatility of Euro/yen is entirely different than the volatility of Euro/dollar.

Niels

You’ve looked at obviously many different indicators over time I’m sure. I’m just curious, in general, if we are going to help the listeners and maybe the people who are aspiring to become a manager of funds at some point in their career, are there any indicators that you feel are more…..

Ending

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