Fully capitalize on alpha generation
Mechanical and statistical rules
For clarity the following hierarchy is maintained within the fund.
Level 1 Program The Program level
Level 2 Portfolio Dedicated and separately managed portfolios within the Program
Level 3 Strategies Defined strategies
Level 4 Trades Individual Trade Ideas
Level 5 Transactions
Examples
Macro – Opportunistic – FX – AUDNZD – MOFX-AUDNZD1
Fixed Income Relative Value – Futures Rich Cheap – JGB FFBO-JGB 1
Three complimentary levels of risk control apply to the Program and each of the Program’s books. These risk controls apply at a primary portfolio level and at secondary sub-portfolio levels covering the Programs exposure to investment strategies, asset classes and countries.
The Program’s portfolios are subject to strict drawdown limits. If a sub-portfolio (country, asset class or investment strategy) breaches a monthly or annual drawdown the risk of the sub-portfolio is automatically reduced by 50%. If the Program portfolio breeches a monthly drawdown limit the risk of the entire Program is reduced by 50%. If the Program breeches the annual drawdown the Program will neutralize all risk.
Portfolios are subject to drawdown triggers from the portfolios high water marks. The drawdown triggers and responses are listed below. All breaches require review by the trading and risk committee.
Trigger Level
Trigger Point
Position Reduction
Unit Risk Reduction
Time Out
Level One
-5.0%
50%
-50%
Level two
-10%
100%
-50%
1 month
Level three
-20%
100%
100%
indefinite
The Program Manager uses an VaR Target of 3.20% of NAV (based on a 99% 1 day confidence basis) to maintain risk control. VaR is determined using Risk Metrics ® historical simulation method. The VaR Limit of the Program is 2 times the VaR target. If a VaR limit is exceeded the Manager is required to reduce the risk to comply with the limits.
As a final control the Program Manager used a Total Capital at Risk measure of exposure. This is a more conservative method than Value-at-Risk. All positions have stops and liquidity costs. TCaR is a real-time estimate of the Programs exposure should all positions be stopped out simultaneously and all options valued at zero. This number is added to a measure of potential worst case slippage, this is called the Liquidity Premium.
Risk % Program NAV
Monthly Drawdown
Annual Drawdown
VaR Limit
TCaR Limit
ASSET CLASS EXPOSURE
5%
10%
1.6% Target 3.2% Limit
10%
COUNTRY EXPOSURE
5%
10%
1.6% Target 3.2% Limit
10%
TOTAL PORTFOLIO
10%
20%
3.2% Target 6.4% Limit
20%
Each trade within the Program’s portfolios is subject to a pre-set maximum dollar loss limit. This limit is determined on a fixed fractional basis with the following calculation.
Example 1
Nominal Capital Allocation 100M
Annual drawdown Pct 20%
Annual Drawdown 20M
YTD PNL 10M
Risk Capital = Annual Drawdown + YTD PnL 30M
No. trades (this varies with each strategy) 10
Dollar loss limit = Risk Capital / No. Trades 3M or 3% of NAV
Example 2
Nominal Capital Allocation 100M
Annual drawdown Pct 20%
Annual Drawdown 20M
YTD PNL -10M
Risk Capital = Annual Drawdown + YTD PnL 10M
No. trades (this varies with each strategy) 10
Dollar loss limit = Risk Capital / No. Trades 1M or 1% of NAV
The size of a position is a function of the dollar loss limit, the time horizon of the trade and the underlying volatility of the instrument or spread. The volatility of the instrument and the time horison of the trade determine the stop and the dollar loss limit determines the position size.
Example
Long AUDUSD Medium term trade
Dollar Loss limit = 1M
1m implied Volatility = 10%
Stop @ 3 standard deviations = 1.89%
Position size = 1M/1.89% = USD 52.7M
3.3.2 Trade Stops
Every trade has a stop including option positions. Once a trade has moved into a predetermined profit scenario, stop-loss levels are moved to breakeven as soon as possible and subsequently readjusted when the profit increases.
Concentration
4.1.1 Currency Risk
4.1.2 Fixed Income RIsk
Duration
Convexity
4.1.3 Equity Risk
Sector Concentration
Factor Concentration
4.1.4 Commodity Risk
4.2 Country Exposure
5.1 Instrument Liquidity
8.1 Infrastructure / Devops
8.2 AI Risk
8.2.1 Data Risk
8.2.2 Model Risk
8.2.3 Model Risk
The Program manager has an independent risk management group that reports to the COO and CIO. This unit ensures that the Program’s risk management guidelines are not breached. The Risk Management Group has the authority to veto or hedge any trade. The group uses RiskMetrics Group® RiskManager application and internally developed systems to measure:
VaR (Parametric, Monte Carlo and Historical)
TCaR
Performance under various what-if stress tests
Country, Asset Class and Investment Strategy Exposures and Risk Statistics
The Trade Control Group also reports to the COO and CIO. This group has the following responsibilities:
Trade Flow: To ensure that all trades are entered into appropriate systems in a timely basis
Profit and Loss (P/L) Calculations: Live and End of Day independent P/L calculations
Reconciliation: Reconciliation with Program administrator’s P/L calculations and counterparty notices.
In addition to continuous review the Manager has the following periodic reviews:
Weekly meetings with the Risk Management Team and the Investment Management Group are conducted where all positions and risks are reviewed
Periodic Meetings can be called by the Investment Management Group or the Risk Management Group anytime.
Systematic Events
Discretionary Events
AC Examples
KC SM Martingale into JGB position - EOD Breech
KC SS Adding onto losing trade - back office mark-to-market failure
KC CS TH MA Trade - excluded