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FX MANAGERS

Interview with Alessio de Longis

Vice President and Portfolio Manager at Oppenheimer Funds

Alessio de Longis tells us about the dynamic environment which encompasses currency trading.

He presents how his Oppenheimer Currency Opportunities fund works – by continuously adapting to changing currency market conditions.

While a systemic approach can be profitable for a while, the market switches and presents traders with various different conditions – debt crises, interventions, “currency wars” – one would have a hard time using a single strategy in all these conditions.


FX Manager

Oppenheimer Funds

Strategy

Oppenheimer Currency Opportunities Fund

Location

New York

Assets Under Management

$52mln as of 4/30/13

Type

Discretionary implementation. Informed on both fundamental and systematic research.

Instruments

T-bills, forwards, options

Traded Currencies

G10, EM and frontier

FXTM

How long have you been trading foreign exchange for and what first attracted you to this industry? Tell us about your career evolution? 

AL

My career started here at OppenheimerFunds in 2003, when I joined as an Intern from graduate school. I was hired in the research department of the Global Debt Team to develop an econometric model for the US balance of payments. The objective was to develop a solid framework to understand and forecast developments in US trade and capital flows as a result of macro trends in domestic and global demand, exchange rates and interest rates. The major focus of my academic studies was in international economics and econometrics, so this opportunity represented a perfect fit with my interests. In early 2004 I was hired as a Research Analyst for the team. I spent the following 3-4 years performing qualitative and quantitative research to inform investment decisions in G10 sovereign fixed income and currencies. Then, over the next 3 years, my investment focus shifted more towards currencies, concentrating my research efforts in combining fundamental macroeconomic analysis into a systematic process aimed at generating currency investment decisions. This process was then used as a complementary currency overlay strategy in our international fixed income portfolios. Finally, over the last three years I have performed a dual role of portfolio manager for the Oppenheimer Currency Opportunities Fund and senior currency strategist for the Global Debt Team.

FXTM

What do you particularly like about your job?

AL

I like the ongoing exposure to global macroeconomic events; understanding the complex dynamics and interrelation of economic and social developments, and their repercussions on a global scale. Every day I am exposed to a highly dynamic environment where intellectual capital is put to work to understand complex situations, finding solutions and making actionable decisions. I enjoy working together with very intelligent, driven and intellectually curious individuals. Learning never ends. While this may seem overwhelming at times, that desire to learn new things and succeed is the main driving force in my day to day.

FXTM

In which way is trading currencies different from trading other financial instruments?

AL

Currency markets are very deep and liquid, with the largest amount of daily turnover than any other asset class (about $4trl/day), and they are mostly traded via over the counter (OTC) derivatives such as forwards and options. Unlike other asset classes, currencies trade 24 hours around the clock, representing one of the most liquid vehicles to express global macro views.

FXTM

When and how was the company born?

AL

OppenheimerFunds, Inc. has been helping investors achieve their financial goals since 1960. We are one of the nation’s largest and most respected asset management companies. The company was formed in 1960 as an affiliate of the brokerage firm Oppenheimer & Co, Inc., but is now majority-owned by Massachusetts Mutual Life Insurance Company (MassMutual) and is a member of the MassMutual Financial Group. See our Company History at www.oppenheimerfunds.com.

FXTM

How is the company structured today in terms of headcounts and offices?

AL

The firm was founded in 1960 and is based in New York City with additional offices in Rochester, New York and Centennial, Colorado.

 

FXTM

What do you consider as being the key positions in an FX Management company?

AL

There are four main investment functions, all distinctive, highly specialized and equally important. These are: portfolio management, research analysts, execution traders and risk managers. The separation of these functions allows team members to gain more specialization in their skills set, deepen their competencies and become the best at what they do. At the same time, a close working environment, with ongoing collaboration and daily discussions allows each member to understand other members’ perspective. Minimal overlap and deep collaboration allow these members to achieve superior outcomes in the investment decision process.

In particular, traders understand and learn about order flow, and the general pulse of the market; they follow news and intraday dynamics, allowing them to keep best execution as their top priority, while providing relevant market color to research analysts and portfolio managers. 

Research analysts provide the foundation of the investment process, focusing on global macro developments, country specific fundamentals and balance of payments analysis. They work extensively with large datasets and information, performing qualitative and quantitative analysis, and interpret economic data releases. They use statistical and econometric analysis to understand how macroeconomic variables affect one another and ultimately foreign exchange markets. The main research objective is to understand and “anticipate” events.

Portfolio managers analyze the information and research received from traders and analysts, combine it with their own analysis and interpretation of phenomena, and focus primarily on structuring trade ideas and sizing portfolio allocations to synthetize views and investment themes in a balanced portfolio.  Similar to research analysts, portfolio managers focus on “anticipating” events, but have the added responsibility to “adapt” to developments and perform “risk controls” around investment positions.

Finally, risk managers oversee the entire portfolio structure and work closely with portfolio managers to understand embedded risk exposures on multiple levels: traded instrument, investment idea, overall portfolio, etc. The objective is to provide a separate and independent analysis of portfolio risks, making sure these remain within pre-established and rigorous limits.

FXTM

Which authorities regulate the company, OppenheimerFunds,?

AL

SEC, CFTC and FINRA

FXTM

You are in charge of the currency program. How do you describe your investment strategy?

AL

The strategy is structured around two building blocks:

1) Provide US retail investors with “directional” exposure to foreign currencies as an asset class, with the potential to benefit in periods of generalized US dollar depreciation, while seeking to collect diversified currency income with limited duration and credit risk. The asset class can be seen as a potential hedge against the inflationary consequences of US dollar depreciation, particularly import price inflation.

2) Active currency overlay program: qualitative and quantitative fundamental macro analysis informs the currency selection process, with the objective to identify and overweight those currencies with the highest appreciation potential, while reducing exposures to those currencies that are expected to lag or depreciate against the US dollar.

While small short currency positions are implemented on a regular basis, the bulk of the strategy retains a “directional” bias that is short US dollar / long foreign currency, as per the objective described in point 1.

FXTM

How did you create and develop your current FX management strategy? Has it changed over time, and if yes, for what reasons did you decide to change it?

AL

It’s a research driven investment process.

Research is based on fundamental macro analysis of the real economy as well as global capital flows and balance of payments, using both qualitative and quantitative methods. The objective is to identify the direction of business cycles and capital flows, focusing on growth, inflation, monetary and fiscal policy. We also develop and analyze systematic investment strategies, monitoring several investment themes that may be driving currency markets, such as carry strategies, price momentum, macro-momentum in commodity prices, interest rates, equity markets and credit markets.

A discretionary process is used for implementation of trade ideas and portfolio structuring. Discretion is used to combine both qualitative and quantitative analysis, as well as signals and themes emerging from systematic strategies. Trades are implemented mainly via foreign T-bills, FX forwards and options. In particular, much effort is dedicated to creating option structures to find flexible, risk-efficient and cost-effective ways to implement investment ideas.

Yes, the strategy has evolved over time, adapting to a changing currency market. Initially, the implementation of trade ideas followed a more systematic approach, in line with ex-ante defined trading and portfolio allocation rules. Later, unprecedented political developments such as the European debt crisis, “currency wars” and central banks interventions created a non-suitable environment for several systematic strategies, which were developed using samples of historical data that are not accurately representative of today’s macro conditions. This led us to move to a discretionary investment process, focused on merging new currency market realities together with traditional quantitative analysis.

FXTM

How do you manage risk in the company?

AL

As far as our FX strategy is concerned, the overall risk control process is built on several components: risk controls on individual trade ideas, on individual securities and at the portfolio level. 

Trade ideas implemented via FX forwards incorporate stop-losses and trailing stops, while options structures are designed with desired capped risk profiles on an ex-ante basis. Delta hedging programs are also utilized. Collateral investments in foreign  short term fixed income instruments are made within sovereign credit limits, as well as typically maintaining limited duration risk to less than 1.5 years ( as noted in the Fund’s prospectus).

Soft and hard monthly stop-losses are also included on the entire active overlay, allowing us to step back and re-assess the market with reduced risk exposures.

At the portfolio level, the active currency program operates within a pre-established tracking error limit.

FXTM

Could you give us an example of a trade that you might have implemented in the past but that you would not repeat today? What is the most important lesson you learnt from past trading decisions?

AL

As clearly illustrated by many benchmarks of currency managers’ performance, the last three years have been the most challenging period since the early 1990s. Particularly in 2011, we have been confronted with unprecedented interventions in both G10 and EM currencies. In January 2011, the Chilean Peso lost 7% in the two days following CB’s intervention announcement. In September 2011, the Swiss Franc lost 10% vs. the US dollar following the announcement of the EURCHF floor at 1.20. These are examples of currency positions we held during that period. Sudden market re-pricings, due to unexpected policy announcements, made stop-losses ineffective, since most of these re-pricing occurred with no actual flow. To some extent, these risks are still present in many currencies, and we have adapted by making a more extensive use of option strategies, aimed at capping downside risk by construction. 

FXTM

Do you use a blend of strategies or one only?

AL

We use a blend of strategies, combined into a single portfolio. Strategies are not looked in isolation, but rather provide venues to express several macro themes we believe are likely to influence currency markets. We select currencies that are poised to outperform (underperform) when we expect multiple fundamental forces (i.e. strategies) to support (undermine) them. Examples of fundamental forces are the direction of interest rates, commodity prices, equity credit markets’ performance, economic data momentum and expectations, central banks’ policy preferences for currency strength or weakness, etc.

FXTM

What are the market conditions that you consider ideal, and which ones are the most challenging, for the performance of your strategy?

AL

As per the structural “directional” feature of our Fund (long Foreign Currencies / short US dollar), generalized US dollar bear markets provide an ideal environment for our asset class and investment opportunity set to potentially deliver attractive returns. Conversely, a sustained US dollar bull market offers a less attractive opportunity set for foreign currency investing. Despite low correlations, generally foreign currencies tend to share positive (negative) trend-performance as dictated by US dollar bear (bull) cycles.

As per our active currency selection process, this tends to perform better in periods when economies around the world witness diverging business cycles, combined with diverging monetary and fiscal policy. In this environment, fundamental macro analysis finds a fertile ground, where currency trends tend to emerge and persist, offering more potential for good risk adjusted returns. Macro-momentum driven strategies also tend to perform well in this environment. Similarly, strategies informed on the release of economic data around the world perform well in this “fundamentals friendly” environment.

As well documented, carry strategies tend to perform better in low volatility markets, but an indispensable pre-condition is enough dispersion in the level of interest rates around the world. Low and converging interest rates are detrimental to income oriented strategies.

High volatility markets are not necessarily a bad outcome, as long as volatile currency moves also show a good degree of directional persistency. Instead, the most challenging environment for currency markets is one of “high volatility of volatility” where large and volatile ranges occur in the context of no sustained trends. Price action tends to be erratic and unstable, with minimal directional persistency. Stop-levels are easily triggered, and false macro signals are often generated, causing the typical “buy high, sell low” negative outcome.

Both systematic programs and discretionary investment decisions tend to suffer, especially when volatility is caused by exogenous shocks such as recurrent headline risk, and central banks interventions (actual or verbal).

FXTM

Can you give us an example of a memorable winning trading decision?

AL

The most memorable winning trading decision dates back to the last few months of 2008, before the birth of the standalone currency fund, when we were running our systematic currency overlay program in our international fixed income funds. In early September, several models flashed warning signs of a synchronized global economic slowdown. In particular, the rollover in key cyclical commodity markets such as industrial metals and energy pointed to a bearish outlook for commodity currencies such as the Australian and Canadian dollars, while also signaling potential outperformance of “defensive/repatriation” currencies such as the US dollar and the Japanese Yen. In the next few weeks, the cross AUDJPY fell by more than 30%. This trade was dramatically fueled by a global unwind of carry trades, caused by the bankruptcy of Lehman Brothers, the rescue of AIG and the panic that unfolded in the last quarter of the year. While the escalation of the credit crisis provided incredible support to the trade, I am convinced the “slowdown trade” was going to be successful even without those dramatic events. That said, the systemic market sell-off contributed to a successful trading decision with speed and magnitude that were unprecedented. Of course, past performance doesn’t guarantee future results.

FXTM

Do you use Emerging Markets currencies? And do you think individual traders should use them, considering they don’t have to worry so much about liquidity issues?

AL

Yes, we are actively involved in emerging market currencies as well as some small frontier markets such as Serbia, Nigeria, Uruguay, etc. Liquid core emerging currencies are suitable for both systematic and discretionary strategies. Non-core and frontier currencies are not good candidates for systematic strategies; instead, they require traditional analysis of fundamentals and political economy. These currencies tend to be heavily managed and controlled by their central banks, leading empirical analysis to erroneous conclusions about price behavior, correlations and sensitivities to macro variables. Our investment universe covers more than 30 currencies, increasing our ability as we seek to generate diversified currency income.

FXTM

When developing a strategy, do you give a higher priority to building entry signals, exit signals or money management rules?

AL

All three receive equal attention, but may be developed in different forms depending on the nature of the strategy. Systematic strategies by design are built around an equal balance of entry and exit signals, both informed on the same set of variables, but capturing the changing direction of those variables. As per discretionary strategies and trade ideas, the “rationale” for the strategy leads to an “entry signal”, which therefore receives more thought process. Instead, exit signals tend to coincide with stop-out or take-profit rules decided ex-ante, and are grounded on risk management considerations.

FXTM

Do you think that every strategy loses its accuracy sooner or later, or do you believe in long lasting market rules? Have you ever found a strategy that became profitable again after a long negative phase?

AL

Yes, I believe every systematic strategy is susceptible to gradually lose its profitability, and there are many reasons for this.

First, there are non-market related reasons to expect strategies to lose their “edge”. We live in an age where information is abundant, free and instantly distributed around the world; making it only a matter of “when” not “if” a knowledge advantage will be eroded. Any static trading rule, basic or complex, that demonstrates superior profitability will eventually be replicated by other market participants.

As per financial markets, over any reasonably long period of time new economic and market conditions emerge, which are meaningfully different from anything experienced in real-life or back-test. Changes in monetary policy regimes and policy reaction functions dramatically alter currencies’ sensitivity to economic variables. Assumptions no longer hold, and correlations breakdown. Over the past three years, many central banks have been aggressive like never before in managing ranges, trends and volatilities in their own currencies. For example, exchange rates in Brazil, Chile and Colombia used to hold very stable correlations to external factors such as commodity prices. That has no longer been the case over the past 2-3 years. In developed markets we can look at the extreme experience of the Swiss National Bank, who has set and defended a floor on the Euro/Swiss exchange rate at all costs since September 2011.

Another example can be found in global interest rate markets having all converged towards the zero bound, creating an environment of suppressed volatility in yields, which are a major driver of currencies. The scale of this phenomenon is simply unprecedented, and the information content in relative interest rate differentials for currency trading has in many cases disappeared.

FXTM

Do you use any form of optimization? If so, how do you make sure it doesn’t create curve fitting and confirms robustness of the model?

AL

No, we don’t. In my opinion, any optimization technique is a data mining exercise by definition. This makes me very skeptical. I think rigorous and extensive analysis of data is an indispensable building block of any investment strategy; but it is equally important to have an ongoing qualitative understanding of the fundamental regimes behind those data. For example, looking at historical data for emerging market currencies and macro variables requires a deep understanding of changing monetary policy regimes, mandates and reaction functions. These create what we call “correlation breakdowns” in the historical patterns. Optimization techniques tend to overlook these idiosyncrasies, frequently leading to erroneous conclusions.

In the past, I investigated several optimization techniques aimed at combining different systematic investment strategies into an overall portfolio. I worked with such as mean-variance optimization, minimum variance, equal risk contributions, etc. Even for a liquid asset class like FX, properly factoring in transaction costs and slippage risk erodes large parts of any performance improvement achieved over a naïve equally weighted allocation across strategies. Overall, I find that on an out-of-sample basis, net of transaction costs, a naïve equally weighted allocation represents a challenging benchmark to beat.

FXTM

Do you favor any particular time frame in your strategies? What is your average trade duration and trading frequency?

AL

With the exception of intraday trading strategies, which we are not involved in, we do not have a pre-set template for trade duration and investment horizons. On the contrary, I believe “horizon diversification” is a crucial component of an overall diversification strategy. Horizon diversification, combined with “themes/signals diversification” and “currency diversification”, may help mitigate portfolio volatility. Keeping this framework in mind, while our views can extend several years into the future, the expression and implementation of those views can occur both strategically and more tactically, depending on market conditions. As a result, most of our trades’ fluctuate between a few days (say one week) and a few months (3-6 months) for the more strategic trades that exhibit strong trends and allow more staying power (for example trades with no negative carry, both in options and forward space).

FXTM

 What should an inexperienced trader watch when choosing a time frame?

AL

The time frame should be consistent with the rationale for the trade; to the extent the two can be associated with one another. For example, if a bullish trade idea on a currency is built around the expectations of improving economic data, one should keep in mind which data releases tend to provide the most powerful catalyst for currency moves, and chose the time frame for the trade around relevant release dates. Similarly, it is wise avoiding time periods with concentrated political or economic event risk, for which there is no conviction or view.

FXTM

How many execution brokers do you use? How do you split execution between electronic and voice?

AL

We use more than fifteen execution brokers and the majority of execution is done by voice. There is a small percentage of execution done electronically, primarily for major currencies.

FXTM

Which historical data do you use when developing your strategies? How important is that?

AL

On average, G10 currencies offer good quality economic and financial markets data going back to the early 1990s. Prior to 1992, given the existence of the Exchange Rate Mechanism among European currencies--data on exchange and interest rates contain information that is not representative of today’s free-floating markets. For emerging markets, it really is case specific. When carrying historical analysis and back-tests, we focus on periods when currencies have free-floating regimes or, at a minimum, managed within large crawling bands, allowing for enough volatility and trading ranges to be analyzed.

FXTM

Which software do you use in the research, risk and reconciliation functions?

AL

For research we use a variety of tools. First level statistical analysis and data visualization/charts is done via Microsoft Excel. For more complex and rigorous econometric analysis we use EViews and Matlab. We also make extensive use of dealers’ online software and platforms, particularly for options analytics and back-testing. Bloomberg and Haver Analytics are the main source of databases and news feeds. Risk analysis with the research process is carried out using the software mentioned above. Separately, the Risk Department uses RiskMetrics to carry out their separate and independent assessment of risk exposures.

FXTM

How does liquidity impact the efficiency of your strategies? Have you already explored to what AUM limit the strategies would allow you to grow to?

AL

Given the deep liquidity of foreign exchange and our investment/trading style, I do not see AUM limits for what we do. That said, we have small and diversified positions in some frontier markets which would incur larger transaction costs at much larger AUM levels. But we are nowhere close to this being a subject worth exploring.

FXTM

What is the biggest strength of your team?

AL

Passion for what we do, and striving for excellence in how we do it. Those are the main driving forces. As per our team structure, I believe a high degree of separation and specialization in skill sets and competencies, all brought together by a collaborative approach (more details discussed in question 6).

FXTM

Can you give us your feeling about the move of the EurUsd in the next 6/12 months?

AL

I believe we are in the early stages of a medium term US dollar bull market, which will play out against a large number of currencies. Currently the Euro is supported by an ongoing removal of tail risk and tight monetary policy, while the US dollar is held back by the Fed quantitative easing policy. I doubt the Fed will begin its exit strategy this year, which should allow the Euro to remain supported, say in a range between 1.25 and 1.37 over the next 6 months. After that, going into 2014, I believe more stars will be clearly aligned for sustained US dollar outperformance, with a good chance the Euro to break 1.20.

FXTM

What’s the best advice you would give to traders who want to enter the FX fund management industry?

AL

To have a flexible and open-minded investment process, with the predisposition to rotate into and out of different investment styles, such as systematic vs. discretionary, fundamental vs. technical, momentum vs. mean reversion, carry vs. value, etc. More than other asset classes, currency markets are very regime-dependent; they tend behave according to different “regimes” through time, often lasting several years. Flexibility and adaptability to multiple investment styles is a key ingredient to long-term success in currency markets.