How We Capture Volatility

December 3, 2020

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At RGN, we are committed to providing a two-sided convexity profile for both fixed income and equities, which we have been able to do successfully as you can see from these two charts:

The key factor is shown in the left chart: the more fixed income falls *or* rises during a day, the better we do. The second chart shows that we do better in large declines (especially) and large rallies for equities in a month. During those months, volatility generally spreads into the fixed income and FX markets (which we do trade in Smart Alpha) as well. Because we don’t trade equities for Smart Alpha, the convexity is only apparent on a monthly time frame (our Diversified Program shows daily convexity for equities too).

The reason for this is that our strategy employs extremely short duration momentum trades that continuously grow (within risk boundaries) as the position goes in our favor. Thus, the largest moves produce big profits.

You can see the importance of our intraday directional and short-term momentum trades in the chart below:

Our machine learning strategies are also able to initiate short term momentum trades. Within a day, the fund has the ability to go from flat to fully invested short in the US and also in Europe.

So, the larger the market move is, the better we tend to do.

You can see this occur on the following slide. Note how the orange position (short US 10Y Note Futures) gets progressively larger on 17-March, and then eventually takes profit.

In addition, if the market goes straight in one direction, our medium-term trades tend to add even more exposure as a trend is established. That’s what happened in February, as the US fixed income market trended sharply higher.

However, there is one more special thing to our program that makes it relatively unique.

In addition to the momentum trades, we also have a large set of mean reversion strategies. It turns out that the largest movements in markets typically occur not straight in one line, but more like a ball bouncing down (or up) a flight of stairs.

The mean reversion trades allow us to capture not only the main direction (the direction of the ‘stairs’) but the bounces as well. Thus, we can actually capture more than 100% of the start to finish move in a month. You can see this occurring in the chart above, where the blue long position in US 10Y futures is established after the decline, on 18-March.

Another factor is that we have spent decades identifying the best momentum moves to follow. Rather than following every move in whatever direction, we only follow the highest probability moves. In this way we are very different from being “long straddles” or buying variance swaps.

As you can see, we have been extremely consistent at doing this during the largest declines *and* rallies for fixed income and equities. While many strategies (hedge funds and Macro/CTA) claim this ability, the evidence we present below shows that this is not the case. You can see just how successful we have been in these large moves compared to all hedge fund styles and also macro/CTA. The one situation we are profitable in, but not so much as the other styles, is the “stocks up a lot” case. That’s because volatility tends to be lowest when stocks rally strongly, and higher in the other three cases (stocks down a lot, bonds down a lot, bonds up a lot).

In all of these charts that follow, our returns are in light blue, and CTA Macro is in light green.

The summary slide showing all four situations reinforces the idea that we provide *two sided* tail risk protection for stocks and bonds, far more effectively than hedge funds or CTAs.