Bill Lipschutz talks to Profit & Loss about how the FX market has changed since he founded Hathersage Capital Management, and why the barriers to entry for currency-focused hedge funds are going up, not down.
Profit & Loss: What products do you trade and what types of strategies do you deploy? How would you describe your trading philosophy?
Bill Lipschutz: Hathersage trades G10 currency pairs and plain vanilla options on those pairs. Our strategies embrace one or the other of two basic approaches. They are either: tactical, momentum driven or strategic, macro fundamental. We are 100% discretionary, highly focused and uniquely experienced.
Philosophically speaking, we aim to know everything there is to know about the sector and the specifics of the instruments employed. We stay close to the market around the clock, looking for opportunities to apply our decades of experience to both short-term price dislocations and long-term changes in valuation.
P&L: What about your approach do you think differentiates you from other currency-focused hedge funds in the market?
BL: We employ a unique portfolio construction technique utilising positive convexity to initially express trade ideas. Further, we use this concept to optimally manage the risk/reward of our portfolios over the life of those ideas.
P&L: Going through the P&L archives, it became apparent that some of the complaints made at the end of the ‘90s were similar to the ones made frequently today ("liquidity isn't like it used to be back in the day") – at a fundamental level, how different/similar is the way that the FX market moves and operates today compared to when you founded Hathersage in 1991?
BL: I would say it’s quite different from when I started Hathersage. Today’s market favours the strategic over the transactional.
For one thing, liquidity is low. There are many fewer market makers than there have ever been in the floating rate era, flow of information is highly restricted, and there are fewer experienced sector participants – both on the buy side and on the sell side.
Regarding options market dynamics, there has been a fundamental supply/demand reversal over the last 30 years. In the early days of FX options – mid1980s through mid-1990s – demand drove prices as end users were overwhelmingly buyers looking for hedges or cheap directional leverage. By the early 2000s, supply had become the driver as systematic vol selling to enhance portfolio yield across most asset classes became the norm.
Finally, there is now virtually immediate dissemination of information. There is no “time edge” that existed for some traders in the past.
P&L: As a discretionary trading firm, how do you deploy technology to help generate trade ideas?
BL: We make great use of information filters to sort and assess the importance of the wide array of relationship and transactional data available. We also do a lot of what we call “driver analysis”, i.e., what are the catalysts that move markets and to what extent.
P&L: The amount of data and information available to trading firms has increased exponentially over the past few years - has this made it easier or harder to find unique trade ideas?
BL: The uniqueness of a trade idea is unimportant except to the largest pools of assets, as crowding affects exit liquidity. It is the quality of the idea that is paramount. Finding those quality ideas sometimes leads to the consensus view – at least for a while.
P&L: Arguably the barriers to entry for someone wanting to set up an FX hedge fund have come down – technology, operations, data, etc, can all largely be bought or outsourced. But have the barriers to success gone up or down?
BL: The barriers to entry today are higher, not lower. Technology, operations, data can be bought or outsourced, but at what cost?
First, there is the issue of credit. Banks and prime brokers are more judicious and strategic about which customers they extend credit to than in the past. In general they require significant threshold volumes be maintained.
Second, as we learned in the wake of the GFC, counterparty risk is two-way. Every hedge fund needs to maintain a relationship with at least two PBs, lest one encounters difficulty. This fact effectively doubles the minimum level of business that a fund must maintain in order to operate.
Third, it is now absolutely necessary to be considered institutionally appropriate in today’s asset gathering environment. This means establishing and maintaining an infrastructure to effectively engage with both the real money investment community and the consultant community.
Fourth, regulatory reporting requirements are greater than ever before. The increase in both volume and frequency of such interaction simply requires more manager attention and greater resource allocation.