To err is human, which is why we have quants, as anyone from the University of Chicago will readily attest.
When it comes to currency funds, however, and specifically absolute return currency funds, a little id goes a long way, at least according to Axel Merk (left).
The president and chief investment officer of Palo Alto, Calif.-based Merk Investments notes that quant strategies are great, until policymakers “change the rules.” It’s a risk that plays particular havoc in the currency space.
Which is the reason he’s introduced an active, human element into the Merk Absolute Return Currency Fund (MABFX).
It’s done in a systematic manner, Merk is quick to note, and all of the fund’s risk layers are still quant driven, “it’s just that the models have been demoted.”
“We used to take a common sense look at the models and if we all felt okay with them we’d go with it,” he translates. “Now, if someone has an idea we feel will perform better than the model given what the risk profile would otherwise be, we will do it.”
By adding the human judgment dynamic, the absolute return currency fund is now “far more tactical.”
“We used to trade monthly, now it’s weekly and even intraday. We have markets that now flip on a dime, depending on whether it’s risk on or risk off. We said to ourselves, ‘why wait two weeks to react?’”
He further explains that the fund projects the choices made with the firm’s Hard Currency Fund (MERKX) on a trade-weighted basis into the absolute return fund, which are then unconstrained.
“We make a projection from directional to non-directional.”
So is the new strategy delivering?
The fund has a 1-year performance of 10.63% as of June 30 with a standard deviation of 6.49%. Surprisingly, its disappointing annualized 3-year return of -0.59%, and an annualized return of -1.02 % since inception in 2009, might actually strengthen Merk’s case, as the strategy update was deployed after the fund lost over 8% in 2011.
“We loved the concept of a quant-driven absolute return currency fund with its relatively low volatility and correlation. But absolute return strategies aren’t any good if there aren’t any returns.”
The currency space, he concludes, appears to be well suited for such active management, as “non-profit-maximizing participants,” such as corporate hedgers, central banks or travelers can create exploitable market inefficiencies.