2016 Year in Review

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While there were many things to be negative about in 2016, this year saw the birth of my first child which was an experience that has exceeded all my expectations and then some. While there is less time for reading, blogging, etc the trade off is gladly made. As one can imagine, my free time is scarce so while I will try to continue writing on this blog, updating the book list, twitter, etc my output might be somewhat limited.

This year certainly had many people questioning the future of hedge funds. It was not a good year for anyone employed in financial markets and the hedge fund sector in particular. Even if performance was positive, many big funds that I know are either stressed about the future or are in the process of cost cutting/layoffs. There is one thing for certain,  career opportunities in hedge funds will probably be limited.

In my opinion, this may have been inevitable as hedge funds were designed as portfolio supplements to High Net Worth individuals actively seeking outsize returns and volatility. Hedge Funds as an institutional product, with low volatility and correlation, may be a stretch. Sure some will survive and perhaps thrive with institutional clients but not in the whole.

As for trading, I focused specifically on volatility markets this year with very minimal exposure to single stock or special situations. If any it was likely done through derivatives. I don’t feel as I have any specific edge and the stress to reward ratio in individual names didn’t make much sense.

Volatility was fairly muted throughout the year with the obvious exception of Brexit and the Election but both events were extremely short lived. It seems the market is taking out the “known unknown” premium, leaving only completely unpredictable event premium and hence an overall low VIX. The good news is that unpredictable events seem to still happen 2 or 3 times a year but one really needs to be prepared to take advantage of these situations.

There were two other very interesting dynamics in the volatility market in 2016.

  1. Skew in SPX was extremely high through the year compared to recent past. So while VIX and ATM options were fairly low, the tail hedges remained comparatively expensive. SPXSkew20170111.jpg
  2. Typically Realized Volatility is calculated on a Close to Close basis. Both the election and Brexit events occurred after market hours and manifested itself in overseas markets, NOT in the SPX. So Relative Value vol traders, SPX versus FTSE or NKY vol witnessed some very dramatic movements. However a US-centric vol trader glancing at a realized vol chart would think nothing happened at all in 2016.

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    NKY vs SPX 30 Day Historical Volatility

Performance:

I continued the forward test of an equity derivatives strategy from last year and expanded to another alternative of the original model. In mid May I allocated actual capital as shown in red below:

2016performance

As a reminder, the purpose of this strategy is to capture mean reversion and the volatility risk premium, to identify max risk and eliminate tail risk, and finally reduce turnover so it requires far less screen time. Luckily it accomplished these goals in 2016. However it should be pointed out that the volatility regime this year can best be described as mean-reverting. And although the strategy muddled through a strong, low vol uptrend, the main risk as defined by large sell offs never really materialized.

Finally, I would like to reiterate a tweet I made earlier this year that I would like to focus more on meeting people face to face or over the phone as opposed to producing or consuming information. The marginal return is diminishing in my humble opinion and real value is derived from relationships. I met with college students, global macro PMs, independent traders, people who left the business, Insurance PMs and Risk Managers, and a host of others and my goal is to continue to do so in 2017. If you are in the NYC area please feel free to reach out!

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