Managed Futures Today Magazine

QFS Asset Management takes a unique view of managing money and profiting from the markets. It focuses on risk first and foremost, and then it builds an expected return model from within the risk model. But that “upside-down” process comes naturally to chairman Sanford Grossman, Ph.D.,  and CEO Karlheinz Muhr.  They both built investment firms based on risk management. Sanford Grossman founded QFS in 1988 and Muhr co-founded Volaris in 1999 (later sold to Credit-Suisse) and Cenario Capital Management in 2009.

QFS bought Cenario in April 2011 and merged the firms’ respective strengths. It’s now a 40-person organization with 14 investment professionals, and the combined firms have $2.2 billion under management.

QFS trades four asset class programs: Currency, Global Macro, Fixed Income, and Volatility. In the March-May quarter, two of its programs, Currency and Global Macro, placed ninth and 17th respectively in BarclayHedge’s Top 20 Managed Futures Managing at Least $100 million.

MFT: How does QFS approach the markets?

KM: Most money managers build their methodologies from the question “what return do I want?” We turn that upside down and start by asking how much risk we want to have in the portfolio. After we’ve established a risk budget, the market will tell us what the expected return is at any given point in time. Everything we do after that is to manage the expected return: our trades embody our processes’ reaction to shifts in expected return opportunities within a determined risk budget. Our approach to forming expected returns is bottom up and fundamental, implemented through a sophisticated process and methodology that we’ve developed through many years. That approach is designed to allow us to move in and out of markets rapidly to capture the changing global opportunity set. Of course, there are times when markets aren’t driven solely by fundamental information. Our drawdown control methodology drives our process to exit losing positions in a fast and expedient way.  The depth and liquidity of futures and FX forwards markets, and option markets on them, allow us to do this.

MFT: Your currency trading program has done quite well. How do you analyze the currency markets?

KM: In currency trading we look at countries like corporations. We believe that over time, money will flow from low-growth countries to high-growth countries just as it does with corporations. Money will flow from countries that are imprudent with their currency management to countries that are prudent with their currency management.  You can think of it as exploiting the dispersion of global business and monetary cycles: We “borrow” (sell) from countries where growth prospects are poor, short-term interest rates are low, and monetary policy is or will be loose. At the same time, we “lend” (buy) to countries where growth prospects are good, short-term interest rates are relatively high, and monetary policy is or will be tight.

We use deep economic fundamental analysis to make a judgment call about countries and markets we want to be in. Almost all our positions are long/short; long one currency and short another. Think of it as the low-growth country funding the high-growth country.

MFT: Does the same philosophy hold for your other market programs?

KM: Certainly. It is the same approach of long-term economic fundamental analysis, risk budgeting, and managing to the expected return.  We run four programs: Currency, Global Macro, Fixed income and Volatility. In all cases, we’re in the deepest and most liquid markets around the world.

The Global Macro program uses stock indexes, currencies, fixed income, and commodities to implement the strategy. In the context of the equity markets we might use a commodity as a surrogate for an equity market. For example, some equity markets are so highly correlated with the oil market that you might as well just buy the oil futures.

MFT: It sounds like your investment horizons are long term, but you’ve mentioned moving in and out of markets very rapidly. Please explain.

KM: Our fundamental economic analysis is a long-term view. Our expected returns often reflect a year or 18 months of what we want to capture, but the scaling of positions is entirely determined by the markets. If volatility increases and our losses increase, we’re out quickly. If this is a very gradual process, or there is a lot of noise in the markets, we’ll be in the positions for six or eight months because we don’t want to be subject to being whipsawed. In the last few weeks (Aug. 1-12), we rapidly moved out of positions and took our risk down to very low levels. This is the incredible value of these deep pools of liquidity in futures and forwards markets that allow managers like ourselves to deploy these strategies both into the trade and out of it rapidly.

You can’t do this directly in the credit or equity markets. I can usually get out of huge positions in futures or forwards in seconds or minutes. If the opportunity opens up again I can rapidly move back into the positions. But in the credit or equity markets, the guy who provided liquidity to me on the way out is going to charge me a hefty premium on the way back in. In futures and forwards the market is so deep that the liquidity premium getting in and out is small. This applies to currency, equity, and credit futures. People don’t fully appreciate the immense value of these instruments. In other markets your expected return might be high in illiquid paper, but what happens when everything explodes?

MFT: So you actively manage the long-term position with short-term trades?

KM: Think of long-term expected returns like a boat. If you drift in a boat off the coast of Jamaica, you will certainly end up off the coast of Ireland and Scotland because of the Gulf Stream. The real question is, will you end up in 50 fragments or one piece? Risk management makes sure you end up in one piece, and our dynamic programming approach to optimization allows us to aggregate short-term market factors with the longer-term macro forces with sophisticated sequencing and timing. We’re trying to capture this long-term drift but in the meantime we might experience storms that blow us in many directions. You have to be able to take risk down to lower levels at times when volatility is very high.

MFT: How has your risk management weathered the storms?

KM: We do have some considerable monthly volatility, but you can’t have high absolute returns without commensurate volatility. Otherwise you’re a “Bernie Madoff” fund; high returns with no volatility equals fraud. Some of our bad years are down 10 percent while the good years are up 20, 30, or even 60 percent. Overall, it is a very positive skew which is only possible if you have a very disciplined, repeatable risk-management process in place at all times. We accept that we can’t perfectly predict the markets. All we can do is have an idea of the long-term risk premiums between markets that we’re trying to capture.

MFT: How does this affect your correlations to other markets?

KM: Our correlations to other markets and other managers are so low because we look so far out on the expected return curve. Not many managers have as long a time horizon as we have.  Most managers are more oriented to short-term signals and trend following. We’re not a trend-following shop.  But in a portfolio we compliment the trend-following and high-frequency programs because we’re uncorrelated with them. It’s not that one is good or bad — it’s how they fit together.

MFT: Your currency and global macro programs have long histories — 19 years for the currency program and 14 years for the global macro program. Have there been any significant changes made to the programs?

KM: The core model of how we get into positions and how we get out of positions doesn’t change. The fundamental views of which long/short pairs we invest only changes when the world changes. If all of a sudden our view were to be that the developed markets will grow faster than the developing markets, then we’d have to change our positions, but that doesn’t happen overnight.