Nicolas Mirjolet - Traditional vs. Alternative Markets in CTA Investing

00:00:08 [Nicolas Mirjolet]
And in our view, there is a case actually to be made that is more optimal to reduce a portfolio's bond allocation in favor of trend following instead of its equity allocation.
00:00:18 [Vincent Weber]
Hello, everyone, and welcome to another episode of Resonanz Spotlight, the podcast where we explore investment strategies, uncover the story behind them, and meet the experts who create them. I'm your host, Vincent, and in today's episode, we are going to take a closer look at CTA strategies. One significant development in the CTA space over the past few years has been the rise of alternative markets. CTAs, which traditionally focus on trading global futures markets, have increasingly expanded their investment universe to include a wide range of liquid instruments, from Odyssey power swaps to exotic currencies. This shift presents investors with an important decision. Should they fully embrace the alternative market approach and concentrate their allocation there, Or are there more nuanced trade-offs and considerations they should weigh before making the choice?
To help us unpack this complex topic, I'm joined by Nicolas Mirjolet, CEO and Co-Head of Research at Quantica Capital. Nicolas is a leading expert in systematic trend following and brings a wealth of experience in managing CTA strategies. Together, we'll explore the key differences between these approaches, discuss the benefits and challenges of each, and offer insights on how investors can strategically allocate to maximize their portfolio's potential. So whether you are an institutional investor looking to diversify or simply interested in understanding the nuances of CTA strategies, this episode is for you. So without further delay, let's welcome Nicolas to the show. Nicolas, it's good to have you here today.
00:01:58 [Nicolas Mirjolet]
Thank you for having me on the podcast. It's a pleasure to be here.
00:02:01 [Vincent Weber]
Great, Nicolas. So, Nicolas, could you start by sharing a bit about your early career, what initially drew you to quant investment and how did your journey in this field begin?
00:02:13 [Nicolas Mirjolet]
Yeah, sure. I mean, in short, it was a bit by coincidence. Initially, I would say I studied engineering in France and did a master of science in electrical engineering at the Swiss Federal Institute of Technology here in Zurich, where I'm based today. I had done an internship as well in the innovation department of a big German automobile brand. And I was actually planning to start my career in that sector back then. And towards the end of my master's program, a bit by coincidence, I came to meet a group of PhDs that were researching optimized asset and liability management solutions for pension funds using algos that are more typically used in controlled systems engineering. And the idea of connecting engineering with finance really caught my attention. And my curiosity.
So I applied to work on a project with the team to learn more about it. And the group eventually launched a quant advisory business, which I decided to join. And this is really how I got to start my career in quant finance and not in the automobile sector.
00:03:21 [Vincent Weber]
So, Nico, can you share some key milestones during your career that have significantly shaped your approach to investing?
00:03:30 [Nicolas Mirjolet]
Yeah, sure. So if I look back, I can probably say that. There were maybe one big milestone and one key turning point. The big milestone was certainly to be given the opportunity back then working for the family office. So as the family office's quantum risk management unit to spin out and set up our own systematic asset management business. And on the other hand, to as well receive a substantial seed capital to start managing a strategy that we had. previously developed internally, which was a short-term systematic equity long-short strategy. And so when it came to our approach to investing, we're really starting in the field, it was naturally heavily influenced by our engineering background.
00:04:21 [Vincent Weber]
What are the biggest challenges you faced during this journey, especially from an investment point of view and how have you overcome them?
00:04:31 [Nicolas Mirjolet]
I think looking back at the past 15 years, the biggest challenge by far above all is just running an independent asset management business and to compete in a field with managers that are for some far larger than we are. So if you like challenges, I can only recommend that one. I think more seriously. It helps to maybe to be a bit more specific because that can state it that way. It's maybe abstract or a bit generic. But in my view, when you run an independent business like Quantica, you are faced always with three distinct and also complementary challenges in a way. That is team, that is market, and it's capital raising. I think that challenge. gets easier to manage over time, the more experience you have. I think experience is very critical for that.
But that's something that you will always be confronted with. So we can quickly go through the three. On the team side, so one, you need to hire a competitive team that shares, one, your long-term vision. You need alignment on that, the philosophy and the values. The team needs to be aligned. It needs to be cohesive. And it needs to be motivated, ambitious. And obviously, there are many different companies in the market. So how do you build such a team? And for me, it starts really with the recruiting process. It's so important to spend the time on this and to spend more time than you would ideally like to usually. It takes a hell of a lot of time, but it's time well invested. And set the bar.
as high as possible, set clear expectations also with the candidates you are talking to about who you are, who you are not, what makes you unique, and who you want to be as a company. Number two, as an asset manager, you're dealing with markets all the time. And markets obviously can be very erratic. And I think managing drawdowns is something. That is a natural challenge you will have to face. And if you have been investing for a long enough time, if you have a track record, you manage a track record, anyone who has done that, no matter how successful the strategy is, there will always be a time when you will be confronted with a larger drawdown.
And I think in such moments, you will also, and this is completely natural, you will be challenged by some of your investors. You may even be challenged by people inside your team, right? So I think the robustness of the investment process makes absolutely all the difference in such situations. And what I mean with that is you need to focus on building robust processes and just not for on the investment side, but across the organization. And that means minimize complexity at all the times, rock solid conviction. And very clear understanding why you have designed your process the way you have done it.
Know when to make the process evolve, but also most importantly, resist the temptation to make changes simply as a reaction to shorter market moves that may push you towards doing things, but which ultimately in the long run are negative for the company and your investors. And number three, it's raising capital. And I think of all the challenges. that is in my view the most challenging of all i think identifying and harvesting persistent pricing efficiencies in the market as we do that's one thing building a competitive team is another but you really get to realize the level of challenge that raising capital entails when you have dealt with it yourself for a long enough time and I think for me, that's the absolute biggest challenge. And, good performance helps, but it's by no means sufficient.
Like you will not just raise capital because you have good performance. You need a clear and differentiated positioning. You need a clear investment process, a clear investment philosophy, differentiated investment philosophy. You need a rock solid sales and marketing process for sure. And then, you might have a great strategy, but if you don't have the right product that fits the needs of your investors. that you're talking to well you won't get too far with that so at the end of the of the day also you have to keep in mind that it's a very long-term process we're in a business where it's all about building trustful long-term relationships with investors and that naturally takes time so you have to take a long-term perspective on that but ultimately if i may summarize what i just say i
think there's a common denominator to all these challenges And to overcome them is to have a robust process in place across all the areas, key areas of your organization. And additionally to that, you need conviction in your long-term vision. You need conviction in your investment process. You need a good dose of resilience and persistence. And finally, I think at the end of the day, you also need a bit of luck.
00:09:57 [Vincent Weber]
Thank you, Nicolas. So let's come back to our main topic. talking about CTA strategy. Maybe for a start, for a listener who might not be as familiar, could you explain what CTA strategy entails, and particularly within the framework of Quantica's approach?
00:10:17 [Nicolas Mirjolet]
So there are many different types of CTA strategies, generally speaking, but I think the most common CTA strategy is trend following. Trend filling managers at their core rely on one well-documented market inefficiency, and that is the existence of persistence price trends that are recurring events across all types of market environments and across all asset classes.
00:10:42 [Vincent Weber]
Where do you see Quantica's unique edge and how does your strategy then differentiate from your peers?
00:10:54 [Nicolas Mirjolet]
Quantica is a trend follower, is a medium to long-term trend follower. We are fully operating on a fully systematic basis. And what sets us apart from, let's say, other CTA strategies or managers is our unique approach to measuring trends, which enables us to provide outlines of pure trend following exposure, but as well as differentiated exposure to trend following. So it can be very complementary, but at the same time, highly style consistent. That's key to us. To be more specifically, in our case, we measure trends based on what we call a multivariate relative risk adjusted framework. So rather than just looking for sustained up or down trends, as I just explained previously, we are looking for persistent price divergences between individual instruments and asset classes. So put differently, we look at markets on a relative basis.
And that's a subtle difference that leads to meaningful return differentiation.
00:11:59 [Vincent Weber]
One of the key topics in today's CTS investing is a trade-off between traditional and alternative market. So could you discuss both approach and the inherent trade-off and how investors should navigate these choices?
00:12:14 [Nicolas Mirjolet]
Yes, absolutely. So maybe it helps to clarify the difference first between traditional markets. CTAs and so-called alternative market CTAs. As I mentioned, traditional market CTAs have been around for more than 40 years. Alt-market CTAs have really started to emerge more lately around for the earliest, let's say around 2015, around that time. And the main difference between these two types of CTAs lies in the structure of the investment universe. While traditional market CTAs focus on the most liquid futures markets, alt market CTAs will predominantly trade less liquid, more niche or sometimes called esoteric markets, which are a lot harder to access and a lot more expensive to trade. The definition of an alternative market ultimately can be a bit subjective, but just to give a few examples of what we are talking about.
That can be, for instance, the emerging market rate for which there is no real liquid future available. That can be some regional gas, electricity or carbon markets, for instance. That's usually what alternative market CTAs encompass, while traditional market CTAs focus on 10-year US Treasuries, S&P 500 futures and the like.
00:13:35 [Vincent Weber]
Thank you. That's a very important insight. For institutional investors considering an allocation to CTA, what key advice would you offer? What should they be particularly aware of in terms of potential pitfalls and opportunities?
00:13:57 [Nicolas Mirjolet]
So first of all, of course, I would advise anyone who hasn't done it to evaluate the potential portfolio benefits of a trend following allocation. It's certainly a cost effective way to make your portfolio more resilient. basically to whatever microeconomic scenario may unfold into the future. So I can only recommend that, number one. But I'm probably a bit biased. Then there is one comment, actually, that we have heard from investors a few times. Those investors were going into CTAs, looking at CTAs for the first time. It's simply the sheer number of products out there that are available and the challenge of understanding the differences between them. And I think just a few inputs here.
To start with, it might be helpful to understand that there are different families of CTA strategies and bucketing managers into different clusters may be helpful. For instance, we talked about traditional markets versus alternative market CTAs. So, I mean, these are two very different approaches. Then within traditional market CTAs, it for sure should be distinguished between long-term and short-term focus strategies. Because each of these approaches will give you access to, well, certainly diversifying returns. They are all there for this, but they will have slightly different convexity characteristics, liquidity profiles, and obviously exposure to these different risk factors. And that's a question of investor preferences. So understanding actually what type of risk factor exposures are you interested in and also what kind of convexity those return. characteristics you are looking to get from that allocation.
And then there's another distinction to be made, an important one, is to distinguish between strategies operating on a management fee-only basis and those charging a performance fee. You really have these two types of families. I mean, it's a bit, yeah, a subtle topic. I mean, our view is clear that just don't stop at first for the cheapest solution, because I think here the question I would ask myself is, who are the fees you are paying to incentivizing in the end, right? Is it like business development or research and portfolio management? So I strongly believe that these two types of fee models will translate in different approaches, both to innovation. and also translate into different long-term performance expectations.
00:16:27 [Vincent Weber]
Nicolas, you share some very interesting framework to help us analyze and select CTA. Now, taking the portfolio perspective, how can CTA be effectively integrated into a broader diversified portfolio and what complementary benefits do they offer alongside your traditional asset classes?
00:16:49 [Nicolas Mirjolet]
As just previously mentioned, we believe that, or I mean, it is typically advised also by some large consultants in the market, an allocation of 5% to 10% to CTAs is usually recommended. So where does that number come from? I think it's just a number that allows to produce a meaningful impact on your overall portfolio return characteristics. That's what you want in the end. So I think it's five to 10% is a good way to start and is a sweet spot or is seen as a sweet, sweet spot. One question that we got a few times is, okay, assuming I decided to get into trends, where should I source the capital from to build my trend following exposure? If I look at my liquid portfolio and let's simplify, I just have equity bonds.
And I would like to add trend following. Where do I take that from? Do I take it from equities or from bonds? And in our view, there is a case actually to be made that is more optimal to reduce a portfolio's bond allocation in favor of trend following instead of its equity allocation. That would be our short answer to that. And more generally, actually, you can show that. And that's maybe at first counterintuitive, but we'll also be highlighting that the higher the interest rate level is. the more attractive an allocation to trend following relative to bonds becomes. I think that's related basically to correlation, market correlations and expected returns of these instruments when you combine them in a portfolio context.
00:18:26 [Vincent Weber]
Nicolas, thank you so much for sharing your insight and experience with us today. And it's been a pleasure having you on the show.
00:18:33 [Nicolas Mirjolet]
Thank you, Vincent. It was a great pleasure. Thank you.
00:18:36 [Vincent Weber]
And to our listeners, thank you for tuning in to another episode of Resonanz Spotlight. Stay tuned for more expert insight in our upcoming episodes. Until next time, I'm Vincent Weber and this is Resonanz Spotlight.