Citi Global Markets Challenge 2019
Last year we competed in the Citi Global Markets Competition (writing here), and this year Billson Porter was back again. Like last year, the quality of the competition and professionalism of everyone involved blew us away.
This year we did much better than last year (we said we'd be back with vengeance) and had a much more comprehensive and cohesive story with what the global markets where up to at the start of April. We were lucky enough to be selected to represent Monash university and go to the national finals with our ideas and positions. Whilst we are in May now (sorry for the long time with no posts, we have been working hard at uni and in our respective jobs) we thought we should have a look at what we did. Commentary will be italics.
For those who do not know or remember what the competition is, we were asked to build a global portfolio across 5 asset classes (cash, bonds, equities, currencies and commodities), worth $500m USD, and at least 5% in each asset class and in the finals you can chose derivatives for three hedging strategies.
We had two main themes throughout the entirety of the rounds. One was asymmetry, looking for when the probability of a favorable payoff was high; and secondly 'pervasive uncertainty' in the market.
Our first major position was a large short on the Euro vs the USD at the time of the competition we believed that as we are currently at the end of QE, along with the relative strength of its' money supply relative to the euro that we would see a strengthening USD, this is what we also saw in 2013. The long USD also allowed us to allocate extra cash to other ideas.
A month on and we would have delivered a miniscule return. We still think this will pay off. The Italian economy, along with Brexit concerns is still a worry. Add in a return of Trump's tariffs comments, this position should pay off the rest of 2019.
In commodities, we had what we think is another asymmetric opportunity within iron ore and steel futures. As productivity around the world gets better and monetary policy is normalising, nearly all reasonably abundant resources have a downwards price trend due to mining methods becoming cheaper. Since iron ore is an industrial metal, we know that it is highly linked with global economic growth, at the time we thought a short on this is consistent with a slowing global economy. Steel was priced the opposite at the time with growth concerns. We thought therefore that iron ore could be asymmetrically hedged with a small long position on steel as it is currently priced too pessimistically as opposed to the positively priced iron ore.
This has also paid off in the last month. This position was almost like a classic oil spread trade but not quite. We had one judge say to us that they would be looking into doing it themselves. That level of feedback felt amazing.
Our equities position was pretty boring but consistent with a slowing world economy, FUD and monetary normalisation. We went long the world index and added extra weight to global infrastructure & utilities. One area in which we thought had a huge downside was corporate credit, not only are there an increasing amount triple B rated debt, but credit spreads are at an all time low, along with a large amount of 'cov-lite' loans. The issue was that to go short on this high yield debt proved to be extremely expensive, as we would have had to cover any coupon payments on the bonds and as a result that gives us an expected loss of roughly 5% on the trade. However, we believe we found a way to gain exposure to this high yield market without having to pay the premiums of going short on a bond. By shorting highly indebted, low quick ratio companies in the consumer cyclical sector we could make use of the distressed equity valuation method. This method suggests that distressed equities perform more like call options on their corporate structure than traditional valuation methods. As a result we think we have the wind in our back as we have an opportunity to bet against high yield debt by selling the most expensive call options on the market.
Unfortunately I do not have the pricing data, nor the time at week 11 at university to recreate the index we made and work out if we had made money. I suspect not. On page 26 of the presentation (the link to it is below) there is a link to the index we made. If anyone wants to have a look and tell me the results I would be more than pleased to update this.
For fixed income, we had a mix of slowing developed economies and growing emerging economy sovereign bonds. Initially, our fixed income positions did seem very inconsistent with our theme of monetary normalisation, until you account for our FX positions which has hedged a lot of our raw EM exposure. We thought at the time that the steep yield curve and high yields meant that before any additional capital gains, we had an expected return of roughly 8%. On top of this, we were already starting to see economic slowdowns in countries such as India, which have a lot more monetary policy headroom relative to inflation and growth compared to nearly all developed markets. Additionally, with our developed markets position, we think that this is a great opportunity to ride these bonds as their market participants mentality change from hawkish to dovish. We find our AU and CAD positions especially attractive given their fragile housing markets and UIP pricing shift.
Thus all up the portfolio we went into the national finals was:
Long EM bonds, with fx swaps (35%)
Long certain DM bonds (30%)
Hedging with interest rate swaps
Long utilities and infrastructure (15%)
Short high yield bonds through our distressed equities index, hedged with a long futures position on the SPY and a variance swap (-15%)
Spread trade with iron ore and steel (-5%)
Long USD and short EUR in currency, with cheap options hedge (-50%)
Our main takeaway this year was that we needed to work on how to sell a portfolio. It's all well and good to have to good ideas, but no one will listen to you if your presentation does not look professional. Last year we were told that we had too many ideas and concepts, this year we pared that down, I would say that again, we need to pare it down and even more basic with how we can play the major global themes.
A big thanks to Citi for creating & hosting this event.
WJD & Jay
To see our full presentation link is through here.