Understanding opportunity is what it takes to run a successful global macro fund. Kathleen Kelley, founder and chief investment officer of Queen Anne’s Gate Capital Management in New York, understands that concept better than most.
Her first opportunity came when she was an economist at the Federal Reserve Bank of New York, a position she traded for a similar one at Tudor Investments. It was Paul Tudor Jones who suggested she move to the trading side and thus Kelley made the best trade of her career.
“It was Paul Jones who said to me, ‘You know, you should move over to the trading side,’ so I moved over and for the last six years that I was at Tudor, I ran a portfolio in macro. At that point, we could do anything except equity, so it was commodities, fixed income and FX,” said Kelley. “Paul was still very involved in the commodity markets, so I learned commodities by sitting outside of his office.”
Kelley’s next career trade took her to Vantis Capital in 2001, a long/short equity hedge fund, where she brought in more macro themes. She then moved to Kingdon Capital, which was long/short, but had sector allocation portfolio managers. Kelley was brought in to add a macro allocation, with a stronger focus on commodities as an instrument to implement the macro view.
Next came a personal year living in London with her three children, where she planned her biggest trade — launching her own global macro fund, Queen Anne’s Gate Capital Management.
We caught up with Kelley to get her views on the markets, starting a fund and her experience working with the proverbial “smartest guys in the room.”
FUTURES MAGAZINE: Introduce us to your new fund. What do you trade and how do you make your decisions?
Kathleen Kelley: We are a discretionary macro fund with a commodity focus. We take our macro view and implement it in the commodities phase because we do micro supply/demand analysis for each commodity so we can bring together macro and micro and then we have an investable idea. That’s the best situation for us.
We have a framework for evaluating these markets that has been developed over the last 20 years. We look at what happens with high prices and in commodity markets, but other markets as well. [Because] that tends to lead market prices to change their behavior so producers produce more of it, consumers consume less of it with record high prices and with record low prices you have the opposite. So we are constantly looking at the impact that three- to six-months out for high prices or low prices in certain markets will have. That’s how we look at the world. And we are looking for the inflection points that are almost always brought about by these strong directional moves in price.
We look to identify these inflection points in individual cycles in each market as well. The commodity markets especially are inefficient and so they overshoot. And when we see that overshooting we are looking to enter into a position. So we try to identify crowded trades. We’re somewhat contrarian when we start off with an idea. And then we have a three- to six-month time horizon. We then become trend positive, but we’ll usually start off being contrarian. We use a combination of options and futures to [put] ourselves into these contrarian positions.
We’re very research intensive and somewhat value investors in commodities, if you will. We’re looking for low-priced commodities to buy and high-priced [ones] to sell. We have smaller allocations to interest rates and FX, but usually more than 50% of risk will be in a commodities base. We’re really using commodities to express a macro view. We use a risk management process that Paul still uses at Tudor. A lot of the principles that guide how we operate here were those that I learned at Tudor.
We are largely contrarian and a lot of times we will be taking the opposite view of CTAs [commodity trading advisors] that are all one way. As long as we’ve done a deep dive on research and have a differentiated view than the consensus in the market, that’s when we’re going to start to enter into a position. So we’re going to be negatively correlated with CTAs because we are somewhat contrarian to their position at the beginning. [Also], we are normally negatively correlated with the commodity indices because [of our] contrarian [philosophy]. We are not long-only. So in general we have low or negative correlation with most of the indices.
FM: Walk us through a typical trade, if there is such a thing, from inception to pulling the trigger.
KK: In the beginning of this year people got very bullish on the platinum market and started to think [that] prices were going to go much higher. And the market was very long so the first thing that we look at is why everybody is long this market and what are the underlying assumptions they believe.
And then we go back to our supply-demand analysis or economic analysis, depending on the market. We ask the questions: ‘What do we think? Do we agree with these underlying markets’ assumptions or do we disagree?’ In the case of platinum, we disagreed with the market consensus. We thought from a supply and demand basis that the market was too optimistic and was expecting this big move higher in prices. And everyone was positioned that way. For us that is an investable thesis because everybody is all one way and we have a differentiated view backed up by our supply-demand analysis. So we’ll start to go short there.
We’ll usually enter into it through options and add to it in futures. At the beginning, because we are trying to catch this inflection point, we are just going to have our premium at risk in these low-delta options. Then as the market starts to behave the way we think it is, we’re adding to it with futures. And so, our differentiated view was from the fact that we thought that Europe, which on the macro view was still very weak, and that automotive demand from there would still be weak, and that’s the biggest source of demand for the platinum market.
On the supply side, we thought that South African producers were actually getting a fairly good price on the basket of commodities that they mine. We thought that they would continue to produce because they had started to get a better basket in local currency terms. And as this has played out over the last couple of months, the move in the [U.S.] dollar has helped that basket go even higher, so that their local currency has weakened. The basket that the miners are getting is the highest it’s been in five years, so we think that they [will] continue to produce, [which] means [more] supply that the market is looking for. And we think that demand continues to be bad, which [means even] less demand. We need it to be a surplus market not a deficit [one], which is what the rest of the market is looking for. So we expect platinum prices will continue to go lower from here.
That is something that we’ve had on since February. We were a little bit early. The market started to turn in March and we’ve had that on since then.
FM: Tell us about your risk management process.
KK: We’re a small team of five people. But three of those people are intimately involved in the risk management process. Every night we go through our portfolio. We have stops and targets and we look at each individual position. We look on a portfolio basis also and at what our risk is overall. After that we go through the portfolio and look at it in terms of where we are in our P&L, from our year-to-date and from our peak.
We [determine] how much we want to risk given where we are. We have certain parameters that are set up where we view risk and every night we check to see where we are relative to those parameters. If we are outside [them], then we’ll de-risk some of the positions in the portfolio. So we have a very systematized approach to risk management where you take the over-thinking out of it. We have rules where we add risk, and we have rules where we take risk out of the portfolio. And that is very similar to what I learned at Tudor, except not as systematic; but now we’ve taken it and given it our parameters so we know exactly when we’re cutting back and when we are adding.
FM: What would be your dream market? And conversely, is there a nightmare market?
KK: There isn’t a dream market. There’s always a cycle some place, so we don’t need a bull market or a bear market. We find opportunities in everything. The tough markets are the ones where there is no follow-through because by the time we have an investable idea we’ve spent so much time on it. Going through the data and the analysis that if we got the inflection point right but there was no follow-through, that’s tough. Like the crude market this year, which seems to be about to go down then it comes screaming back, then starts to go down, then comes screaming back and ends up being a great big sideways range. Or the gold market for the last month-and-a-half. That’s tough.
FM: Tell us about some of the more difficult markets you’ve seen and traded.
KK: Well, 1998 was pretty interesting. You know, we tend to view commodities and most of the markets we trade as cyclical. So there’s always a cycle someplace that we’re looking to identify and figure out the inflection point in that cycle. We’ve seen a lot of those over the years and some were bigger than others. That whole increase in volatility in macro markets over 2007, 2008 and 2009 — those were interesting and challenging times.
Watching 1998 evolve was pretty fascinating. There was Europe and the introduction of the euro. We also went through the Asia crisis and [saw] what that meant for commodities markets, given that was the marginal source of demand. [Some] different things have changed dramatically over that time. One, that there was this passive investor in the commodity markets that was long-biased that made it harder to use fundamentals to analyze individual commodity markets — but now that flow seems to have stalled and slightly reversed. That’s probably the biggest change.
FM: You watched the trading go from open outcry to almost exclusively electronic. How did that affect the markets?
KK: It just brought our commissions down a lot and forced the creation of a more specialized market maker or broker. But for us, we’re not really high-volume, so that hasn’t been as big a thing.
FM: Do you think the high-frequency traders are having much effect on the markets?
KK: No, not really. I mean, people complain about them when they’re losing money and say that it’s all high-frequency traders’ fault. But I don’t see it as much of an economic phase; it’s more of an equity thing. But volatility has definitely gone up a lot. The trends are not as long as they used to be. There are some things you can partially blame on [HFT], but it’s hard to say if it’s that or just the access to information we all have or faster response times brought about by technology. I’m not sure.
FM: Well, something else you’ve seen change completely over the years is the access to information. How has the information flow changed things for the professional trader?
KK: I think it’s a way to differentiate yourself because we all have the same information, so it comes down to the framework. I actually think for us that it’s a good thing because we have a very different framework for evaluating the market. So I think that comes through even more clearly.
FM: You started your firm in what may be one of the toughest times ever to launch a fund. Tell us what it’s been like and your vision for the firm.
KK: It’s not that different from what I’ve done all along, though. I was lucky enough to work for probably the two nicest guys in the hedge fund business (Paul Tudor Jones and Mark Kingdon), and they are arguably the two most intellectually curious also. I have a strong idea of what I want this to look like and a great model for it, too. This is the chance to do something on my own and have it be based on what I’d seen before for some pretty impressive firms.
FM: When it comes to an investor’s portfolio, who is the ideal investor for you? Where do you fit in, say, a typical high-net-worth portfolio? What do you complement or set off?
KK: The irony is that, even for a corporate investor that has high commodity exposure, we’re a pretty good fit. Even though we have a lot of our risk in commodities because we tend to be agnostic to direction, we also tend to be negatively correlated with commodities. We have a different approach. For people who are looking for something slightly different in their portfolios, we make a lot of sense too. But probably the biggest telling point is our risk management because the process we use is put in place so we try to avoid double-digit drawdowns. [Therefore], we’re not going to see the big commodity blow-up that so many have lived through.
FM: What advice would you give to traders just starting out, and also those looking to start their own funds?
KM: Find markets that you really think you have an edge in and that you understand better than anyone else and stick to those markets. Don’t try to be a credit trader and an equities trader and a commodities trader. You need to find the area where you have an edge and stick to that. We don’t trade any equities because we have no edge whatsoever. Even though I understand the commodities markets really well, I wouldn’t trade the commodities equities at all because I don’t have an edge in evaluating management teams.
For a fund, you have to find experienced people that have spent their careers in the position that you want to fill. It’s a very difficult thing to find those people because you have to find those who are entrepreneurial enough to want to go to a start-up. Finding the right people is definitely one of the big struggles but [it gives you] a lot more flexibility. Obviously there are all sorts of reasons to [start a fund] but the hiring and the human resources really [are] the most difficult [part].
FM: What do we need to do to get more women in the business, especially women traders and portfolio managers?
KK: We need to see more women in the business. And the way for that to happen is that people should invest in women-owned firms because unless your daughter turns on the TV and sees somebody doing it who looks like them, they’re probably not going to do it. Unless they have a mentor, like Paul, like I had. So, we should be investing in more women-owned firms and we should make sure that our daughters and nieces and friends all take math and science courses because that’s what you need to do this job.