Cross-asset carry: an introduction

July 15, 2017

Carry can be defined as return for unchanged market prices and is easy to calculate in real time across assets. Carry strategies often reap risk premia and implicit subsidies. Historically, they have produced positive returns in FX, commodities, bonds and equity. Carry strategies can also be combined across asset classes to render diversification benefits. Historically, since 1990, the performance of such diversified carry portfolios has been strong, with Sharpe ratios close to 1, limited correlation to benchmark indices and less of a downside skew that FX carry trades.

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Explaining FX forward bias

July 8, 2017

Forward bias in foreign exchange markets means that a positive interest rate differential precedes currency appreciation. It has been an empirical regularity in developed FX markets in recent decades. The forward bias contradicts traditional theory: positive risk-adjusted interest rate differentials are supposed to be offset by expected currency depreciation. An academic paper explains how FX forward bias arises when central banks ‘lean against the wind’ of appreciation through sterilized FX interventions.

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FX strategies based on quanto contract information

June 17, 2017

Quantos are derivatives that settle in currencies different from the denomination of the underlying contract. Therefore, quanto index contracts for the S&P 500 provide information on the premia that investors are willing to pay for a currency’s risk and hedge value with respect to U.S. stocks. Currencies that command high risk premia and provide little hedge value should have superior future returns. These premia can be directly inferred from quanto forward prices, without estimation. Empirical evidence supports the case for quanto contracts as a valid signal generator of FX strategies.

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The “low risk effect” in financial markets

May 27, 2017

Low-beta and low-volatility securities can produce superior risk-adjusted returns. Thus, portfolios of calibrated low- versus high-vol stock positions have historically generated significant alpha. Other asset classes display similar ‘low risk effects’. Their plausible cause is many investors’ limited access to leverage and willingness to pay a premium for securities with greater exposure to market performance. Some investors may also pay a premium for lottery-like payoffs with large upside potential. For leveraged portfolio managers this creates relative value opportunities in form of ‘betting against market correlation’ or ‘betting against volatility’.

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Volatility risk premia in the commodity space

May 6, 2017

Volatility risk premia – differences between options-implied and actual volatility – are valid predictors for risky asset returns. High premia typically indicate high surcharges for the risk of changes in volatility, which are paid by investors with strong preference for more stable returns. For commodities volatility risk premia should have become a greater factor as consequence of their “financialization”. New evidence suggests that indeed volatility risk premia on commodity currencies have predictive power for subsequent commodity returns, while crude and gold premia have predictive power for other asset classes in accordance with the nature of these commodities. Since estimation of these premia takes some skill and judgment this points to opportunities for macro trading with econometric support.

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Fake alpha

March 4, 2017

Statistical alpha can be divided into fake alpha, which is a premium for non-directional systematic risk, and true alpha, which reflects the quality of the investment process. Fake alpha arises from exposure to conventional factors that are not correlated with the market portfolio. Failing to distinguish fake and true alpha can be costly for investors and strategy developers. Fake alpha is easy and cheap to produce and after periods of high risk premia on conventional factors it can post impressive performance statistics (or backtests). Subsequently, investors overload on managers or strategies that use these factors and related performance inevitably deteriorates. This goes some way in explaining the negative historic alpha on actively managed funds.

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Volatility risk premia and FX returns

February 18, 2017

Volatility risk premia – differences between implied and realized volatility – are plausible and empirically validated predictors of directional foreign exchange returns, particularly for EM currencies. The intuition is that excess implied volatility typically results from elevated risk aversion, which should be indicative of undershooting. When calculating the volatility risk premium it is important to compare short-term implied volatility with realized volatility of that same period. One would expect positive returns on currencies whose very recent volatility has been less than feared.

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Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.

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