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qCIO

Global Macro Hedge Fund Strategy


September 2011
Q M S Advisors
. .

This material does not constitute investment advice and should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy.

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qCIO: Capitalizing on Market Inefficiencies

Long-Term Returns from Short-Term Dislocations

In the long run, markets tend to behave like weighing machines, which value assets rationally on the basis of what they are actually worth. In the short term, however, he knew them to be more like voting machines, which reflect the often erratic desires and fears of fickle publics and willful national governments. Benjamin Graham

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qCIO: Exploiting Temporary Mispricings

qCIO seeks to exploit these constantly evolving economic conditions and the temporary mispricings that result among individual geographies and asset classes, opportunistically adjusting our investment views in response to the changing patterns of risk and reward in the markets. qCIO does this through close quantitative analysis of global pricing trends, business cycles, volatility levels and other macro-economic signals.

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qCIO: A Market Neutral Global Macro Fund

Bespoke Tactical Macro Investing

qCIOs returns are driven not by the directional movement of any one market but by exploiting shortterm mispricings among the markets themselves. Additionally, qCIOs derived alpha tends to be highly efficient due to the targeted balance of risk and return it achieves across markets. qCIO: a customizable strategy with a consistent return per unit of risk.
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Q.M.S Advisors

Quantitative Global Macro Hedge Fund Strategy


September 2011

This material does not constitute investment advice and should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy.

Table of Contents

Portfolio Objectives Asset Classes and Market Coverage Model Overview and Investment Process
Overview of Signals Across Investment Strategies Derivation of Relative Return and Risk Expectations Blending: Aggregation and Apportioning of Views Portfolio Construction

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Portfolio Objective
Quantitative Global Macro Strategy Focused On Maximizing Risk-adjusted Returns
Example: Excess Return over Cash Volatility Sharpe Ratio

Objective 10 - 20% 5 - 10% 2.0

Relative Tactical positions are formulated on an Absolute Return basis To maximize risk-adjusted total return Long or short positions may be taken in any asset classes The portfolio may be implicitly leveraged Trades are implemented with futures, forwards or option contracts Stock-index futures, forwards or options on nine equity markets 10-year government bond futures, forwards or options in seven countries Currency futures, forwards or options on seven currencies
Historical simulation does not guarantee future performance of any individually managed account or fund.

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Coverage
Asset Classes and Markets

A set of Models covering multiple Asset Classes and Markets Markets currently included in the modeling process

9 stock markets: US, Japan, UK, Eurozone, Switzerland, Australia, Canada, Hong Kong and emerging markets 7 bond markets: US, Japan, UK, Germany, Australia, Canada, Switzerland 7 currency markets: USD, EUR, JPY, GBP, CHF, CAD,AUD

A system built around five independent set of models, with nonoverlapping signals and return drivers
Risk Premia: Intra-country Stock-Bond Bond-Cash Relative Value: Inter-country Stock VS Stock Bond VS Bond Currency

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Model Overview
Global Macro Strategy: Approach
An quantitative global macro investment strategy built around five independent sets of models with non-overlapping signals and return drivers
Risk Premia Arbitrage Intra-country Systems Market Spreads Inter-country Systems
FX

Stock VS Stock Bond VS Bond

Cash VS Bond

Bond VS Stock
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Investment Process
Investment Procedure Outline

Within each sub-system Signals Pairwise Views Derive direction and confidence of investment views for all pairs

Across all sub-systems Blending

Portfolio Implementation Portfolio Construction Portfolio construction: Tactical trades implemented via futures contracts

Identification of common signals for all pairs

Derive expected returns for all assets through Bayesian blending

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Signals

Pairwise Views

Blending

Portfolio Constru.

Investment Process
Investment Procedure Outline
All recommended strategies of the qCIO Model are based on expected excess returns derived from blending investment views of five independent sub-systems designed for different asset classes and markets; the weights of the views are determined by their relative statistical confidence as well as their dynamic correlations. Foreign Exch. sub-system Bond-Bond sub-system Stock-Stock sub-system Expected Excess Returns and Risks qCIOs Blending Model

Cash-Bond sub-system Bond-Stock sub-system

Strategies Q.M.S Advisors


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Signals

Pairwise Views

Blending

Portfolio Constru.

Common Signals And Returns


Diversification Across Signals Of Different Nature

Across Asset Classes


Example (bond versus cash): 7 markets 7 iterations of the model

US Bonds vs. US cash, Japanese Bonds vs Japanese Cash, etc.

At each iteration, the dependent variable is defined as the excess return of bonds over cash, hedged into CHF The explanatory variables correspond to the signal associated with the country under consideration A dynamic constant is included, corresponding to a risk premium

Within Asset Classes


Example (equity versus equity): 9 markets: Consider each possible pair 36 iterations

Japan vs. US, EU vs. US, EU vs. JP, UK vs. Japan, etc.

The dependent variable is the excess returns of the two stock markets considered (relative to cash), hedged into CHF The explanatory variables correspond to the difference in signals between 2 markets

Example: Yield Gap for Japan vs. US = YG(USA)-YG(Japan)

No constant (premium) is included as there is no rationale as to why stock markets should outperform one another
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Signals

Pairwise Views

Blending

Portfolio Constru.

Investment Process
Typology of Signals

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Pairwise Views

Signals

Pairwise Views

Blending

Portfolio Constru.

Sequential Derivation of Direction and Confidence of Investment Views for Each Sub-System

Each pair of assets is considered in turn The expected excess return of the pair of assets is the dependent variable Hindsight biases are minimized by assuming that all signals work equally and moderately well at inception The relative importance of each signal is determined by Bayesian adaptive regression according to its consistency to performance Direction and confidence of investment views are both expressed as expected relative return and standard error

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Signals

Pairwise Views

Blending

Portfolio Constru.

FX Signals Contribution By Type


Signals Ranking By Current Relative Explanatory Power
FX Sub-System: Current Signal Ranks (1 = Best) USD JPY EUR Risk-adjusted Carry 5 6 2 Yield Trend 7 1 6 Flows 1 4 7 Growth 7 1 5 GDP Revisions 2 4 7 Technicals 1.5 4.5 4.5 Composite 4 4 5 FX Sub-System: Last Week's Signal Ranks USD JPY Risk-adjusted Carry 5 6 Yield Trend 7 1 Flows 1 3 Growth 6 1 GDP Revisions 2 4 Technicals 2 3 Composite 4 2 FX Sub-System: Signals' Weights USD Risk-adjusted Carry 22% Yield Trend 15% Flows 5% Growth 4% GDP Revisions 2% Technicals 53% JPY 11% 12% 8% 7% 8% 53% EUR 2 6 4 5 7 5 5 EUR 14% 12% 8% 5% 6% 55% GBP 4 5 3 4 5 6 6 GBP 4 5 2 2 5 4 4 GBP 12% 8% 10% 4% 7% 58% CHF 7 2 6 6 1 7 6 CHF 7 2 7 7 1 1 1 CHF 11% 12% 7% 6% 7% 56% CAD 3 3 2 3 6 3 2 CAD 3 3 5 4 6 6 6 CAD 15% 9% 10% 6% 7% 52% AUD 1 4 5 2 3 1.5 1 AUD 1 4 6 3 3 7 6 AUD 20% 11% 10% 6% 4% 49%
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Signals

Pairwise Views

Blending

Portfolio Constru.

Cash-Bond Signals Contrib. By Type


Signals Ranking By Current Relative Explanatory Power
Bond-Cash Sub-System: Signals on scale from -5 to +5 US Jap Eur Value -3.4 -1.3 -4.7 Growth +3.4 +3.4 +2.0 Risk -2.7 -1.2 -2.4 Yield Dynamics +2.3 +0.6 +4.0 Composite Bond-Cash +2.6 +3.2 +2.4 UK -4.0 +2.9 -2.5 +3.9 +3.7 Aus -2.3 +2.8 -4.1 +3.7 +4.1 Aus -1.7 -0.7 -1.6 +4.8 +1.5 Aus 0% 48% 3% 50% Can -3.8 +2.5 -3.1 +3.0 +2.7 Can +0.6 -0.5 -0.4 +4.6 +1.0 Can 54% 36% 0% 10% Swi -3.3 -0.4 -3.4 +4.1 +3.3 Swi -1.5 -1.4 -1.2 +2.7 +0.6 Swi 10% 48% 0% 42%

Bond-Cash Sub-System: Signals' change from last month US Jap Eur UK Value -2.3 +2.1 -2.0 -0.2 Growth -0.4 -0.2 -0.9 -0.6 Risk -0.5 +0.2 -1.1 -0.7 Yield Dynamics +4.6 +0.6 +4.9 +6.0 Composite Bond-Cash +0.3 +0.9 +0.2 +1.2 Bond-Cash Sub-System: Signals' weights US Jap Value 55% 40% Growth 31% 24% Risk 0% 9% Yield Dynamics 15% 27% Eur 43% 38% 0% 19% UK 23% 57% 0% 20%

Positive (negative) signals recommend long (short) duration

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Signals

Pairwise Views

Blending

Portfolio Constru.

Bond-Bond Signals Contrib. By Type


Signals Ranking By Current Relative Explanatory Power
Bond-Bond Sub-System: Current Signal Ranks (1 = Best) US Jap Eur UK Yield Dynamics 1 6 5 2 Value 3 1 6 7 Composite Bond-Bond 2 1 6 5 Aus 4 4 4 Can 3 2 3 Swi 7 5 7

Bond-Bond Sub-System: Last Month's Signal Ranks US Jap Eur Yield Dynamics 1 6 5 Value 6 1 3 Composite Bond-Bond 1 6 4

UK 2 4 2

Aus 4 5 5

Can 3 2 3

Swi 7 7 7

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Signals

Pairwise Views

Blending

Portfolio Constru.

Bond-Stock Signals Contrib. By Type


Signals Ranking By Current Relative Explanatory Power
Stock-Bond Sub-System: Signals on scale from -5 to +5 US Jap Eur UK Value +2.0 +3.7 +2.8 +2.2 Business Cycles +3.4 +2.7 +3.0 +2.7 Composite Stock-Bond -0.9 +1.2 +0.9 -0.1 Stock-Bond Sub-System: Signals' Change from Last Month US Jap Eur UK Value +1.1 -0.0 +1.3 +1.0 Business Cycles +0.1 +0.1 -0.0 -0.0 Composite Stock-Bond +1.1 -0.4 +1.8 +0.8 Aus +3.0 +3.7 -1.1 Can +1.1 +3.1 -0.7 Swi +2.9 +3.7 -3.4

Aus +2.3 +0.1 -0.1

Can +1.7 -0.0 +0.8

Swi +0.9 +0.0 -0.5

Stock-Bond Sub-System: Signals' Confidence Level (1 = "Normal") US Jap Eur UK Aus Value 2.4 0.3 1.1 2.7 0.3 Business Cycles 0.0 0.0 0.0 0.0 0.0

Can 1.0 0.0

Swi 0.5 0.0

Positive (negative) signals recommend to overweight (underweight) Stocks against Bonds

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Signals

Pairwise Views

Blending

Portfolio Constru.

Stock-Stock Signals Contrib. By Type


Signals Ranking By Current Relative Explanatory Power
Stock-Stock Sub-System: Current Signal Ranks (1 = Best) US Jap Eur UK Value 6 8 1 2 Momentum 4 9 5 2 Implied Volatility 6 9 2 1 Energy Prices 9 3 7 6 Business Cycles 5 7 6 8 Composite Stock-Stock 5 9 4 2 Stock-Stock Sub-System: Last Month's Signal Ranks US Jap Eur Value 6 8 2 Momentum 3.5 9 5 Implied Volatility 6 9 2 Energy Prices 9 3 7 Business Cycles 4 7 6 Composite Stock-Stock 4 9 3 Aus 9 2 5 4 4 6 Can 7 6 8 5 8 7 Swi 4 7 7 8 3 8 HK 3 2 4 1 1 1 EMF 5 8 3 2 3 3

UK 1 1 1 6 8 2

Aus 9 2 5 4 5 7

Can 7 6 8 5 8 7

Swi 4 7.5 6 8 3 8

HK 3 3.5 5 1 1 1

EMF 5 7.5 3 2 3 3

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Signals

Pairwise Views

Blending

Portfolio Constru.

Pairwise Views
Expected Excess Returns over USD Cash
20% 15% 10% 5% 0% -5% -10% United States Japan Eurozone United Kingdom Australia Canada SwitzerlandHong Kong Emerging Markets

Returns over USD Cash

Stocks

Bonds

FX vs USD

* All bond markets and all stock market except Hong Kong and Emerging Markets are currency-hedged into US dollars

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Signals

Pairwise Views

Blending

Portfolio Constru.

Pairwise Views
Process

qCIO is based on the sequential analysis of all expected returns and standard error of all asset pairs for each sub-system qCIO is designed so as to ensure an optimal and robust dynamic modeling of all pairs of assets considered by utilizing advanced Bayesian methodologies

For each of the five sub-systems, we obtain:


The expected excess return for every pair of assets The expected risk for every pair of assets The evolution of the weights for each signal

In total 92 pairs of assets are systematically dynamically modeled and analyzed

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Signals

Pairwise Views

Blending

Portfolio Constru.

Blending
Aggregation and Apportioning of Views
Currency System USD vs JPY USD vs EUR EUR vs JPY etc.

Stock-Bond System US Stocks vs Bonds Japan Stocks vs Bonds Eurozone Stocks vs Bonds etc

Blending
Expected Returns and Standard Errors

Stock-Stock System US vs Japan US vs Eurozone Japan vs Eurozone etc.

Bond-Bond System US vs Japan US vs Eurozone Japan vs Eurozone etc.

Bond-Cash System US Bonds vs Cash Japan Bonds vs Cash Euro Bonds vs Cash etc.

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Signals

Pairwise Views

Blending

Portfolio Constru.

Blending
Aggregation and Apportioning of Views

Bayesian blending mechanism to obtain expected returns based on:


Prior expectations: Excess returns are set to 0 in the absence of views, their covariance is estimated historically using exponential decay Views: Expected excess returns obtained from the Bayesian regression Confidence of the views

The expected returns can be interpreted as a weighted average of the equilibrium prior and the tactical views. The weights are determined by the relative confidence that we have in the views and the risk of the assets Expression of the pairwise views:
1% eS 1 - 1 0 E ( RStocks ) 0 1 - 1 E ( R Bonds ) = 0.5% + eb 1 0 0 E (Cash) 0.75% ec
Stocks outperform bonds by 1% Bonds outperform cash by 0.5% Stocks will generate a 0.75% return

P
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E(ret) = V + e

S=diag(cov(e))
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Signals

Pairwise Views

Blending

Portfolio Constru.

Blending
Aggregation and Apportioning of Views

The conditional expected returns of each asset class is expressed as: E(R) = [ ( t W )-1 + PT S-1 P ] -1 . [ ( t W )-1 P + PT S-1 V ] With:

P the vector of equilibrium returns (set to 0) W the covariance of returns (based on historical data) P the matrix of views S the covariance of the views t a calibration factor (set to 0.02, no consensus on its value in the literature)

Limiting cases:

P=0: No views BL returns= Equilibrium returns (0) Inv(S): No forecast error BL returns = Views

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Signals

Pairwise Views

Blending

Portfolio Constru.

Blending: Systems Interdependence


Excess Returns Are Derived From Every Sub-Systems

The expected excess return of each asset is influenced by views in all five sub-systems. Some of these influences are not surprising:

The expected returns of stocks are heavily influenced by views in the stockstock and stock-bond sub-systems The expected returns of bonds are heavily influenced by views in the bondbond and bond-cash sub-systems The expected returns of currencies are heavily influenced by views in the FX sub-system

But because of correlation among assets, a sub-system can influence the expected return of assets that are not directly involved in its own views. For example:

The stock-stock sub-system is contributing to higher expected returns for all currencies against the US dollar. This is because the stock-stock sub-system expects the US stock market to out-perform European stock markets in currency-hedged terms, and this is associated with a weaker dollar.

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Signals

Pairwise Views

Blending

Portfolio Constru.

Blending: Systems Interdependence


Excess Returns Are Derived From Every Sub-Systems
Sub-Systems' contributions to expected excess returns of stock markets over cash, % p.a. US Jap Eur UK Aus Can Swi -0.3% -1.5% -1.2% 0.4% 1.2% 0.4% -2.0% FX Sub-System 1.7% 0.5% 2.1% 2.0% 2.0% 1.6% 1.7% Bond-Cash Sub-System 1.1% -0.1% -0.5% -0.3% 0.4% 0.7% -0.3% Bond-Bond Sub-System -1.0% -0.1% -0.4% -0.5% -0.8% -0.8% -1.6% Stock-Bond Sub-System 1.0% -7.5% 1.5% 2.9% -0.1% -0.2% -0.2% Stock-Stock Sub-System Expected Stock Excess Return 2.5% -8.6% 1.5% 4.4% 2.8% 1.7% -2.4% * All stock markets except HK & EMF are currency-hedged into US dollars Sub-Systems' contributions to expected excess returns of bond markets over cash, % p.a. US Jap Eur UK Aus Can Swi FX Sub-System 0.1% 1.4% 0.1% 0.5% 0.0% -0.1% -0.1% Bond-Cash Sub-System 1.8% 1.6% 1.8% 2.0% 2.0% 1.9% 1.4% Bond-Bond Sub-System 1.2% 1.2% -0.5% -0.1% 0.2% 0.9% -1.1% Stock-Bond Sub-System 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% Stock-Stock Sub-System 0.5% 0.4% 0.6% 0.8% 0.4% 0.5% 0.3% Expected Bond Excess Return 3.6% 4.6% 1.9% 3.1% 2.6% 3.1% 0.6% * All bond markets are currency-hedged into US dollars Sub-Systems' contributions to expected excess returns of currencies over USD, % p.a. JPY EUR GBP AUD CAD FX Sub-System 15.9% 7.4% 5.4% 6.5% -2.1% Bond-Cash Sub-System 0.2% -0.1% -0.1% 0.0% 0.1% Bond-Bond Sub-System 0.4% 0.1% 0.5% 0.2% 0.1% Stock-Bond Sub-System 0.1% 0.1% 0.0% 0.0% 0.0% Stock-Stock Sub-System 0.6% 0.0% -0.2% -0.1% 0.2% 17.2% 7.6% 5.6% 6.6% -1.7% Expected Currency Excess Return CHF 11.5% 0.2% 0.5% 0.1% 0.2% 12.5%
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HK -0.7% 2.7% 0.3% -1.0% 8.2% 9.6%

EMF -0.3% 1.7% 0.5% -0.7% 4.7% 5.8%

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Signals

Pairwise Views

Blending

Portfolio Constru.

Portfolio Construction

Model Tradeoff between return and risk is made The objective function is to maximize single-period expected return subject to tracking error target Flexible control of turnover can be achieved by means of a transaction penalty parameter (factor is highest in the first half of the month), and other methods Round-trip transaction costs assumptions are 12 bp, 4 bp, and 8 bp for stocks, bonds and FX Portfolios with different objectives and constraints are constructed using the same set of expected return, ensuring information consistency
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Q.M.S Advisors

Signals

Pairwise Views

Blending

Portfolio Constru.

Portfolio Backtests
Unrestricted Global Macro Program
qCIO targeting 3.5% Tracking Error
Unrestricted Bets United States Japan Eurozone United Kingdom Australia Canada Switzerland Hong Kong Emerging Markets Net Stocks -0.6% -1.1% 3.2% 2.0% -2.0% -1.7% -2.0% 0.8% 1.3% -0.1% Bonds 11.5% -1.7% -2.3% -5.0% 1.8% 2.2% 1.6% FX -6.1% 13.2% -27.1% 3.1% 11.2% -15.5% 21.2% Bets vs Benchmark Stocks 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Bonds 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% FX 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

8.0% Confidence Very high High Average Low Very low

0.0%

Expected Information Ratio Current 2.32 Five-year average 1.96

The unrestricted program is the most accurate reflection of the models views. Where a benchmark is present, no short-selling or leverage is permitted.
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Q.M.S Advisors

Signals

Pairwise Views

Blending

Portfolio Constru.

Portfolio Backtests
Unrestricted Global Macro Program
4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Monthly Alpha - Unrestricted Global Macro Program


Past 15 years Annual Alpha = Tracking Error = Information Ratio = 3.64% 3.20% 1.14

The unrestricted program is the most accurate reflection of the models views. Where a benchmark is present, no short-selling or leverage is permitted.
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Q.M.S Advisors