Higher volatility creates strong investment opportunities for active managers. Turning these into alpha needs a consistent, diversified approach to allocation. Paul R Lucek (pictured), CEO & co-CIO, Ridgedale Advisors, explains…
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Higher volatility creates strong investment opportunities for active managers. Turning these into alpha needs a consistent, diversified approach to allocation. Paul R Lucek, CEO & co-CIO, Ridgedale Advisors, explains…
How does the macro-economic environment affect your investment process and what was the impact of the shift from quantitative easing to quantitative tightening?
Our investment process utilises allocations across multiple systematic quantitative trading programs. At the top level, we simultaneously allocate using a barbell strategy between convergent and divergent strategies. Convergent strategies based on non-price fundamental quantitative data typically work well in risk-on, rational, low to medium volatility environments. Divergent strategies generate trades based upon price series using trend identification techniques and typically work better in risk-off periods when volatility is high. Over the past 36 months we have seen the markets shift back and forth between risk-on and risk-off events with a steady increase in volatility as participants have adjusted their portfolios during the shift of QE to QT, and our models have responded very well in this environment.
What are the key factors that help you deliver consistency to clients?
The risks that hurt most portfolio allocations are caused by lack of true diversification. As an example, the classic 60/40 stock/bond allocation suffered dismally in 2022. What were thought to be diversified alternatives in 2008 turned out to be comprised of highly correlated strategies that performed poorly at the same time. We believe a truly diversified portfolio has to be built from active trading strategies that maintain low correlations to each other even in very stressful market environments. By constructing diversified systematic trading strategies that stay diversified throughout market turbulence we can deliver consistent returns.
Can you explain how periods of volatility impact the potential for alpha generation?
Higher market volatility brings a greater degree of opportunity for our trading strategies, especially within the divergent half of our portfolio. We have published academic pieces showing that higher volatility in markets leads to increased correlations across markets and then to increased auto-correlation within markets. This increased auto-correlation drives the performance of trend programs and can generate strong alpha, sometimes called crisis alpha.
Is rising correlation in markets a challenge you face? If so how do you mitigate this?
We expect that correlations across markets are not fixed statistics, and in fact the rising correlation that occurs during crisis events drives some of our strongest periods of performance. By building our systematic portfolios to take advantage of changes in market correlations, we have greatly reduced any risk from this factor, and instead turned it into an opportunity for alpha generation.
What is your outlook for growth going forward? Where do you see the most potential?
We believe the high level of volatility in other markets will continue and eventually spread to equity markets. Equity markets have driven the perception of low volatility through muted VIX and S&P implied option volatility. Our analysis has shown the daily US$ volatility of all the markets in our universe (commodities, currencies, fixed income and equities) is the highest it has ever been over four decades except for the peak months of 2008. This level of high volatility across markets will drive returns in our quantitative approach.
Paul R Lucek, CEO & co-CIO, Ridgedale Advisors – Paul leads portfolio management and development of new investment and risk management strategies and co-leads the investment Committee. Prior to joining Ridgedale, Paul served as CEO and CIO of SSARIS until 2016, and prior to that as Director of Research. Before joining SSARIS in 2004, Paul developed quantitative algorithms for trading stock index futures and used this expertise to launch SITE Capital Management LLC in 1996, a CTA and CPO that focused on systematic equity derivatives and options strategies. Paul was previously part of the Human Genome Project at Columbia University as a candidate in the MD/PhD program and received a BA and MA from Harvard University.
