The Derivative - 5 Asia/China Focused Hedge Funds, 1 Podcast!

Episode Date: July 2, 2020

We recently wrapped up our virtual conference: “Capitalizing on China’s Growth: Opening the Door for Investors and Managers” where we had some great one-on-one interviews with hedge fund managers operating in Asia and live in mainland China markets, including futures. We pulled the best nuggets from each individual manager and mashed them into the ultimate pod on different strategy nuances across AI models, fixed income trading, stock picking A Shares, systematic trading of China futures markets, and more. Hear from the pros with boots on the ground in Hong Kong, Shanghai, and the rest of Asia – as they unpack tips and tricks for these unique markets. Podcast Chapters: 2:37: Stephan Zhou – Partner, Shanghai Mingshi Investment Management 18:21: Desmond How – Head of Fixed Income, GaoTeng 48:15: Michelle Leung – Chief Executive Officer, Xingtai 1:11:02:  Alison Zhao – Head of Business Development, AP Capital Management 1:29:07: Brent Belote – CEO & Portfolio Manager, Cayler Capital & if the mashup wasn’t enough, you can listen to the whole interview with each manager here:   Mingshi Investment Mangement  Gaoteng   Xingtai   AP Capital Mangement   JinZhiShang Strategy 21 (Cayler Capital) If you’re an accredited investor and you’re interested in having a one-on-one or group session Q&A with one of the managers below, register for OPIM Connect: Cap Intro Event. Register here. And last but not least, don't forget to subscribe to The Derivative, and follow us on Twitter, or LinkedIn, and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Thanks for listening to The Derivative. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations nor reference past or potential profits, and listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk

of substantial losses. As such, they are not suitable for all investors. Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Hi everyone, your host Jeff Malek here, with a quick note on this pod being a little different format. We co-hosted a virtual investment conference a few weeks ago focused on the opportunities in China, with the conference participants able to view different interviews with various China and Asia-focused hedge fund managers. There was a lot of super interesting stuff in those interviews, but we didn't know if you wanted six new pods dropped immediately all focused on China, and putting them all together was way too long for a single pod. So instead, we're doing a bit of a mashup on the pod today where we grab parts of each manager interview that we did and put them all in this pod.

So up next are the best pieces of talks with Stephen Zhao, partner at Shanghai Mingxi, Desmond Howe, head of fixed income at Gauteng, Michelle Leung, CEO of Zingtai, Allison Zhao from AP Capital Management, and Brent Belote, the head of Kahler Capital. Enjoy. Today we're joined by Stephen Zhao of Shanghai Mingxi Investment Management, a quantitative hedge fund based out of China. And the Mingxi team focuses specifically on Chinese A shares and the benefit that that brings to their strategy. And Stephen and his team have joined us for some of our events here in Chicago in the past.

And our team at RCM has joined them in China a few times. So great to see you again, Stephen. Yeah, great to see you as well. Tell us a little bit about your personal background. How did you end up ending up at Mingxi? Okay. Mingxi was founded by two academics, basically Professor Robert Stamberg and Professor Yuan, and they both from Wotan, and they both teaching there, and Professor Yuan was a PhD from Wotan as well. And actually I'm a, I have a common friend, a college friend with Professor Yuan. We, we, we were known each other

during that time. And after graduation, I was doing commodities and for like more than 10 years. And in 2009, Professor Yuan, when he decided not to teach anymore in the US and he had a talk with Professor Robert Stammer. They decided to come to China and they started the pawn shop and he sort of talked to me and I said, fine. I have no idea at that time, but I generally think it should not be a bad idea. So that's how we started. And I started with me some 2010 but softly I probably spend them maybe 50% of the time and that fully John means in the 2015 I spent 100% time and I'm basically now in charge of all the operations and the finance as well part of the marketing so let's dig into the strategy

a little bit. So you mentioned a few pieces in the beginning, but just give us the overall 30,000 foot, we call it an elevator pitch here in the US, but give us the quick elevator pitch on the main strategy. Okay, as I said, we are now offering actually four different strategies, and the three I already mentioned,

which is like an intraday strategy basically we're predicting three minutes up to four hours return the stock and so far we are carrying a shop around three and also we are doing a three to five day strategy by the name you can see our turnover rate at around 20 to 30 percent a day. And that carries a similar shot. And also we're doing 20-day strategy. And that's often lower shots, but it's still 1.8. And it's been running for like last five years. Now we're having...

Like long-short strategies? It's like this. It's not really a long shot. In China, the shorting inventory is just not available. And so basically what we do is we have a three-strategy, but the application of this three-strategy always have two. One we call the market neutral. Like you said, we do it long and short.

But in shorting, because of the lack of shorting inventory, we do it with shorting index future, or sometimes we just using the swap, index swap, and rather than shorting single net. So in China, there's no long term per se, long short per se, but only long versus shorting index futures. And this is what we do for onshore.

And another application is the same strategy. We call it index enhancement. It's 100% purely long. Basically, the target is to outperform the index. Basically, we want to generate an offer. As always, we're doing it for long side only because we just can't trust single names in China. It's practically not practical in China. And these are the two applications.

But in offshore, we're also doing a combination of intraday and 325 days because we're doing the strategy we call Optima. Basically, it's optimized signal of 325 days and intradays. So basically, we're offering two oh sorry offering force and so the to put it in US terms you know the classic long short equity market neutral hedge fund might go long Microsoft and short IBM and capture that's not what we do yeah you would go long Microsoft and short the S&P yeah exactly exactly exactly but that was not the case for our offshore partners because we have we have doing our SME since last year and we launched

our fund this March. Before that the master fund we do around 30 to 40% on shorting longshot basically because you know for the international PBs they do have a fairly okay shorting inventory availability. So for us, we're able to have around 30 to 40% on shorting single names. So that you can say it's like a 40% long short and another 40% like a long and versus investment choice. Got it. And then the names you're picking long or short is all driven by AI?

Yeah. Yes. And for our high-sharp strategy, basically, we are using machine learning and deep learning algorithms to combine those factors together. It's like basically if I want to say what kind of people I like, I need to give some factors. Like I want to like tall or I want to be the eyes is big or blah, blah, blah. I need to give factors. But if I'm giving only 10 factors, we used to do linear combinations, giving like a 10% weight or 20% weight on certain factors. Then we have a score. Then we see which one got a high score, and that will be the one. But now, since 2016, we

are adopting this machine learning and deep learning algorithms. It enables us to combine a much larger number of factors. Actually, it makes it more accurate. Actually, now if I'm describing people, I can see

okay I like the hair to be how long and I wanted the angle of the chain and I can give the 10,000 factors which the older lineal. How many factors are going into the model? It depends basically. I will say on average one of the signals maybe carry around 500 up to 3000. Sometimes even go higher, even 5000, then we combine those signals together. And of course, by using nonlinear AI combinations. And the AI would combine them in a nonlinear way, which we don't understand. So far it's black box, but the output is quite

robust. And so it's black box, so it's just assigning a score or it's saying these are the top 10 stocks you want to be in and these are the bottom 10 stocks? Okay. Let's talk a little bit about our strategy development. Basically, we have six teams researching those so-called factors, basically like the unique features of the share market. And each team may be more focused on finance, so there will be more intuitions. They will handwritten those factors.

That team may be more into AI. They're basically using machine learning itself to create factors. Then we have a bank. Then we have a group called the AI teams. They will just combine for those each and every teams, combine for them of those factors into one signal. Those signals we can call this as those single signal is itself is tradable so just say we have a six different signals from six teams then our i our ic then we'll decide how to combine them and they will combine them in a linear way and giving the weight actually and then we make a mass signals mass signal will basically basically give a score by the by the ranking of the returns of the shares.

Let's say the Y, if we want the Y to be say, I want to outperform S&P for China access and then the machine will basically pick the possibility of the best return of the stocks compared to S&P for China access. And the number one is multi, for example. Number two is Ping An. And then up to like a down to like a number 2,000, number 3,000. Then it comes to our like an optimizer on this like a risk

because we want to control the volatilities. So after optimizations, then we'll have a basket of the shares. So the EMS then will, the OMS will be sending those orders to the EMS, and the EMS will execute. And so, can you give a couple simplistic examples of some of the factors? Let's say all flaws. Let's say some of the factors people might understand better is like all the flaws. If you see the active buying is towards one direction and then you will see if the price is also moving up in the last three days, then

you will see you are trying to make a straight day like a price and volume factors. If the buying order is increasing on daily and the price is all moving up, you might end up saying, okay, the fourth day, you're more likely to getting a positive day for the fourth day. And this you can call a feature. Basically, this is like a summary of the intuitions written by a human. Also, there's a summary of features which you can't understand because it's interreligious. There's a lot of ifs in there.

The computer will say if the daily volatility of certain shares is so much and the volume is decreasing and the pace of like 10% every day, and if the price is going up, then what? And it's more complicated. And the computer will give a score, say, okay, factor A, probably I will give it like a square. Factor A will be square. And factor B may be multiplied by factor C, and it will become really complicated.

So it's really hard to explain. But a lot of people would assume factors means like market cap and a bunch of these balance sheet factors or things like that. So we don't use that sort of data that much that we call a fundamental or accounting variables we were using our less than 10% in our model we're using 70% on price and volume because in the high turnover rate strategy those fundamental data it doesn't it doesn't work that much but yes of course in the low turnover strategy which 20 days we're using almost 30% for account

accounting variable and so you mentioned that the alpha perhaps only being around for a few years let's talk a little bit more about that is that as the Chinese China a shares market evolves and becomes more you know as more professionals get in there, you think it'll be kind of these ARB opportunities will fade away? Exactly. Definitely, I would say, because look at this. If we're talking about all performing the, if we're talking about the 50 or 80% ARB, like last forever, nobody will believe that, basically.

That's just crazy and and of course it depends on a few things now so far we're able to maintain like three plus shot and we're talking about with eight percent volatilities we're talking about we can realize maybe a outperformance of like uh up to 30 50% because we need to outperform the cost of the hedging tools and which the shop might get polluted. But I mean the long run definitely is towards the decay for sure. But because of the structure in China is so unique. Like two years ago, the participation rate

of retailer sector is around 86%, but last year was 85. And this year we don't have the data yet, but I assume, according to our understanding from the exchange as well as some of the PBs, on-shore PBs, it'd be more or less the same. So the retailer set doesn't decrease. So that's basically we guess, we can only gas. That's the soil of our offer.

And it will just remain for some time, of course. And I don't think it will last forever. As I said, I don't believe it will last forever. But yeah, I think it will be, it will take some time. It will take some time. Plus the other way is, our R&D is keep going on, and we are actually trying to catch up to so-called the international, like, okay, give an example. Like I said, at our Two Sigma, we are trying to catch up from all the angles, and we do

talk to a lot of people, and we do a lot of recruiting as well. And we have people working for us from all those big firms. And they were working with other big firms. Now there are a lot of people joining us and we're trying to develop to deliver to more strategies, as well as we trying to improve into models, algorithms, like a trading impact, and our internal system as well. So there's a lot of room to improve as well. I think that will, I mean, fight against the decay. So I believe one day,

the alpha will be stabilized at a we call a reasonable levels not really giving people a yield of like 15 20 or 30 percent a year that's just unreal right that was what's happening the last couple years and so the trigger for your guys assessment of the opportunity lowering will be that retail participation rate. Like if that falls to, I will personally assume that yes, I will personally assume that.

And if the more institutionalized, for example, if the participation rate of the quantum media to less than around 10% of last year, some of the, some particular time may be higher, but on average is like 10%. If in Chinese market, maybe higher, but on average, it was like 10%. If in Chinese market, if we are talking about like, okay, 60% or 70% trading from quant,

then I think the offer opportunity will be definitely much less. Let's wrap up. We'd like to ask all the guests a couple of favorites. So do you have a favorite investing book? I want to be very frank with you. I don't read investment books. How about a non-investment book? Okay.

If you're talking about novel, I like one called The Siege. It's basically by a Chinese famous writer. It's just talking about a people's city, how much people from outside want to get in and how much the people inside want to get out. I think that's interesting, confident about human nature. It's always confident.

I can call that my favorite book. You have watched the Star Wars movies ever? Yeah, I do. I think I watched every one of them. Nice. So favorite Star Wars character? I don't remember exactly. I think those people or creature you call from Naboo. With those like jumping in the air? Gungans. Gungans. Oh Gungans. Okay I forgot his name. Maybe one of the characters called Jar Jar. Yeah, Jar Jar, thanks.

Also the name of one of our PB managers. So... All right. Well, thanks so much, Stephen. This has been fun. Thank you very much. And we'll hope to see you once the pandemic unravels here, either in Chicago or in Shanghai.

Oh, can't wait. All right. Thank you. Thank you. Today, we're joined by Desmond Hao, head of fixed income for Gaocheng, a top tier asset management firm with an extensive domestic and overseas experience.

Desmond has over 23 years of experience in the investment management space and fixed income and is with us virtually from Hong Kong. So Desmond, thanks again for joining us today. Thanks, Jeff, for having me here. So let's get into the strategy a little bit. So tell me about your strategy that you run of how it works. What's the general idea behind it yeah so um so the three funds that i run um maybe i'll just uh uh you know briefly talk about the the two other funds uh the first is the uh uh the penguin asian high you fund that is a mutual fund that's listed in Ireland. It's a usage fund.

It's the strategy, we employ a barbell strategy to balance the income and capital gains approach to our total return. That one, I think because we are pretty cautious about the credit cycle over here. In fact, I was among the first proponent that we were already in the bear cycle since the fourth quarter of 2017. You know, a barometer for our credit cycle is spreads and default rates. So at that time, probably we've seen the best in is actually uh hastening the uh the

default rates uh uh to to go to maybe to pick at around uh you know the typical 11 to 13 percent but uh but i think this round probably you know we because of the extent of the uh impact you know it's not just on a few industries, but many, many businesses will be suffering. I think the default rate could go as high as 20% globally. So we are actually cautious into this, but we launched this Asian High Yield Fund on the pretext of an observation that we made last year.

We saw there's a reach for yield given that the global rates are going to have gone to zero, like the developed markets, especially now that even US rates are zero. And now there's a reach for you theme out there. And I think the high yield would suit really well in this environment that's lack of yield. So we launched it, but at the same time, we are cautious about the default rate. So the strategy is a barbell.

As I said, a big portion of it, we go to quality high yield high quality high yield where we go for the income and and there are also some uh you know babies thrown out of the bath water so there will be capital gains opportunities selectively we go for uh some of the distress small distress names uh and to get capital gains. So this strategy is a balanced strategy between income and capital gain. Now the second strategy... What type of yield are you trying to get there for high yield for the investors? So actually Asia is in a sweet spot right. You know as of today, high yield average yield is like 8.9% according to Barclays. And compare this with like the US high yield, which is 6.3% and Europe 5.6%.

So, I mean, definitely, you know, Asian high yield looks really attractive, right? Vis-a-vis the counterparts, right? So for this portfolio, you know, we try to also try to go closer to this Barclays or JP Morgan's benchmark of right now it's 8% to 9%. This is the yield. But I think carry is only one part of the game. The other part, we're looking for alpha, playing for spread compression in some of the oversold credits. And then what countries are we talking?

So this is all of Asia or China specific? Which countries? Well, we do a portfolio construction based on what's available in the universe. I think the two good benchmarks have been JP Morgan, Jackie, and then the book place, the Bloomberg book place, Asia Asia high indices, right? So the spans more than 10 countries, you know, the bigger part of the indices are China,

I think 50% or more are from China. So China is a very important part of our investment portfolio. The second largest will be probably Indonesia and third will be India. These are the three main focuses for Asian high yield. Great. Then let's get into the... That's the Penguin High Yield? Yes, Penguin High Yield, Asian high yield fund.

What's number two uh is the short uh actually greater china uh short-dated uh high you fund which we launched last september that one actually is pure uh pure carry so what we do is uh this is uh you know uh talking to investors who says who wants to have the best of both for high income and low vol. You know, as I said, there's no free lunch. Actually, you know, everybody wants that, right? Actually, we did some back testing. going into a portfolio of short dated, maybe two years duration type of sector focused portfolio. We back tested the portfolio during the fourth quarter 2018 sell-off.

Retracement is just barely a 4% with a 9% carry. So sharp ratio is pretty pretty pretty good and in fact uh this uh during this march sell-off uh you know this portfolio averaging like single b you know actually sold off just barely eight percent compared to some of the triple b's up out there that sold down like 15 so i think it outperformed and it was designed to do it for that uh you know you know negating a market risk from the short dated nature of the portfolio but at the same time we tried we tried to uh go for some of the uh you know uh safer sectors in the high you know for our our favorite is actually the Chinese property sector. So a good 70%

of our allocation is to the Chinese property that gives us this carry about 9% to 10%. And that carries based on the rate differential between what the US and China? Or you're saying just absolute

yield, right? It's a coupon. These days the most No, it's just absolute yield, right? It's a coupon. You know, these days, you know, the most attractive proposition, I think, out there for high yield is definitely Chinese property. And I can talk about that later. I guess you have some questions, but I can tell you today that, you know, that has been my favorite sector uh you know over the last

14 years uh of issuance history so the first us dollar property bonds was issued in 2000 2006 and up to today um there are like uh you know uh thousands of issues already but uh lo and behold, there are only two cases of default incidences. What does that look like? Is it like a US REIT or something? So you're getting rents? Is it commercial? What's the backbone of the property? So the bonds are issued by Chinese developers, but using an offshore entity.

So they set up an SPV outside of China. So in theory, the rating agencies may have been rating them as senior, but in theory, they are actually subordinated, right? Because they are further away from the assets. That's why the market has been demanding a premium, a risk premium over their rating. So right now, single B property companies average about nine handle uh and that's like almost uh 200 basis point uh of uh cheap to any of of this uh of this rating peers and and i guess the the a good reason is that uh of the nature of this spv and and and

and and also the uh why this sector has been cheap is because of supply. So the past five to seven years, a lot of supply has been coming out from this sector. But back to my point, right? Just quickly, is the government limiting supply? So then they have to go offshore to get the funding they need? Yeah, you're right on that because uh the government right now you know uh actually especially after the hong kong incidents recognize this you know that uh price stability

is really paramount right uh to to keep uh uh uh people happy uh right and uh and and avoid social tensions right so uh for that you know the uh the government would uh uh rather not uh just uh developers uh trying to beat up land prices and and hence would uh escalate uh you know price appreciation of the units they're selling. So I think they control the land prices by suppressing developers from issuing bonds onshore. Some developers tried to get around it by issuing offshore bonds as well, which actually, two years ago, the NDRC recognized this loophole and actually kind of slam on the doors have been requiring this the developers to get approvals from them before they can issue so last year last actually last last july they came up with a new rule saying that only if the developers shows that they are using

the use of proceeds from offshore issuance for refinancing, otherwise they can do offshore issuance. So I expect supply to be curtailed going forward because of this new NDRC law about offshore issuance. And that's why I actually... The capital gains play as well as an income play? Yeah, yeah, yeah. A lot of capital gains play. Because again, I was trying to tell you that last 14 years, there are only two default incidences,

which is very low by any standards globally, right? You know, in any sectors, right? To two out of thousands in 14 years, this is like, you know, the pricing of, you know, 9%, you know, 9% yield actually implied cumulative default rate of about 35 to 40 percent which is really high right because the actual default rate is so low so you know i think this sector is well suited for long-term investment i like it and so number three let's go on fund number three Number three is the one that I am the most excited about. This is my flagship fund.

We call it Gauteng Emerging Market Long Short Fixed Income Alpha. It's a mouthful. It was deliberate because I want to be succinct about what I want to do. So the scope of investment is wide, right?

It's a global emerging market, which I have been investing over my 20 over years of my career. Run through those countries real quick. So that's basically everything that's not the G10? Yeah. So it's really, you know, it's a wide breadth. It spans 80 countries and tens of thousands of issuers. But we can actually break it down into three regions. First, Asia. Asia would represent a third of the universe. And then Latin America would represent a third of the universe and then latin america

would be another third and and the last third is uh is a it's a combination of eastern europe and africa uh and middle east so uh these are the we can bring it down to these three regions. And in Asia, obviously China is a big component, followed by Indonesia. And in Eastern Europe, it's Turkey and Russia. Africa, we have also some South Africa is a big component and some maybe peripherals like Egypt and in Latin America, for sure, it's Brazil and Mexico. Yeah, these are the two. So it's not frontier markets of like Nigeria or some super new countries. So the good thing about this asset class, there's a lot of inefficiencies that we can exploit.

So that includes some of the frontier markets. Although they are a small component, they are probably like a couple of percent of the of the of the indices but these are the ones that nobody spend enough time to look at these credits and and actually can have sometimes have some super normal profits if you can get the trade right. So Nigeria, as you mentioned, is one of them. We also have, for example, Argentina. It's the perennial defaulter. I was on a podcast the other day. I think they're up to nine times

in the past hundred years or something. I didn't live long enough to see the nine times, but in my personal career already, you know, three times. And I think this is the fourth. And if you have invested $100 20 years ago in this country,

right now it's probably worth seven cents. Wow. Because of the restructuring, the deep haircuts that the restructuring entailed. And now it's worth... I remember a couple of years ago when they issued a century bond, I was like, you know, almost fell i was like you know almost fell off the chair

i was fell off the chair so you know what it shows one thing uh there are new investors right always new investors coming into the market and they didn't see then they didn't have the chance to see uh or experience uh what uh argentina went through and uh second thing may be that market is forgetful, right? So, you know, there's pressure for deployed cash and, you know, some yields may be attractive enough for investors to come in

at the spur of the moment. Back to the strategy. So, global emerging market, long short fixed income alpha. So again, it's a fixed income strategy, but it's a hedge fund. So long short, you know, I see myself as a good beta manager because over the 24 years of investment, I've made money over the 23 years.

But importantly is this strategy itself, only 30% is coming from beta, but a good 70% is coming from alpha. So I see myself as a better alpha manager. Having 24 years investing in this space uh be able able to uh extract uh you know alpha consistently uh you know uh for for from from the emerging market as i said the emerging market you know uh there's a lot of inefficiency i can exploit you know because the uh while the rating trajectory as a whole is uh

is up has has uh has been uh has been uh going upward right because i remember when i and when i was at pgim right and uh pg um the the index average rating was like maybe low BBB or something like that. And now it's really like BBB, so investment grade. So as a whole, the emerging market is converging to the developed world, right? But if you look at intra-regions, the trajectory may be very different. So Latin America could be on a downward trajectory while Asia is on an upward trajectory. And we can exploit the difference of these two regions by taking either the long or short sides of the trade. So that's one advantage of this strategy.

But you're still doing single names within those countries or you're doing sovereign debt? Yeah. So the strategy is pretty widely encompassing, meaning that I can invest in sovereigns, I can invest in banks, I can invest in corporates. And in fact, if you look at the universe, it's about $3 trillion in value. A billion is in sovereigns, a billion is in quasi sovereigns and a billion is corporate, right?

So there really is a big and deep market that we can exploit, yeah. And how do you get the short exposure? Is that via credit default spots or how are you getting the short exposure? Is that via credit default spots? How are you getting the short? So I differentiate my shorts. I break it down into two

types. One is alpha short and one is beta short. As I mentioned earlier, I try to get 70% of my total return from alpha. That's my mainstay of the strategy. And alpha shorts, what we do is we are playing for spread decompression play.

We have spread decompression play thing. We think that a certain credit, you know, is either on a downward rating trajectory. So we play for credit migration, play for downgrade, or we play for default because we see this company may be fraudulent or given the financial condition is bad,

they are not able to raise capital to refinance. So we will short those credits by borrowing bonds. So we borrow in the repo market. So we do a reverse repo on the bonds and we will short the bonds. So I think there are not many people out there who have the guts to short bonds even at 12% type of yield because shorting bonds is expensive, maybe expensive. There are two costs associated with shorting. One is the coupon. The coupon is not paid by the issuer, but it's going to be paid by me

when I short the bonds and and the other part is the borrow cost so we have to borrow the the bonds to to to short the bonds and uh you know and and if it's at 12 borrowing cost and uh i mean plus the uh coupon that means uh you know i'll lose one percent a month type of, you know, I'm a payer. So you must have a lot of funds lining up to loan the bonds to you, right? Yeah. These days, the repo market is more efficient than in the past, especially the past five years where we saw Chinese money going after Chinese bonds and they are using the repo facility to get leverage.

That means sourcing bonds now has become much easier for me. In the past, a lot of bonds are being bought and kept. There's no need to repo out the bonds. So I would have some difficulties in finding borrows. But now I think it's really widely available, which means that this strategy actually makes it more operational. The book isn't neutral. It's not equally long and short,

is what you're saying with the alpha and beta portions. So you might... Yeah, that's a good question. Yes. As I said, I think I'm a good beta manager. My win rates have been about 70%. Out of 10 months, I made money seven times because I get the direction right, whether it's long or short. So beta would represent 30% of my total return. But, you know, because I have the latitude to play beta, but I don't really bank on my beta for total return,

I could, this strategy is not market neutral, meaning it's not like one for one. It's not. So I can dial up risk when I like, you know, if I like the market, you market, if the market is especially, I think recognizing which part of the credit cycle we are in is very important, is paramount. That affects my investment decision,

whether to go into the year, into the month, whether to go long into uh into the year into the month uh you know whether it's go long or short right so uh if i recognize we are already in the bear cycle meaning means that i cannot be too uh you know positive beta uh uh or my beta cannot be too too positively high uh as as in this year uh actually you know i i set a risk budget that's much lower than my strategic risk budget because i've been cautious about uh taking long risk so uh there are months you know the the good the beauty about this strategy is also is uh i can technically adjust my risk budget according to the sentiments of the market. So a month where we think that there's a pent-up demand for credit risk, I will allocate more risk budget into it and go long.

And if, you know, like, for example, in February this year, I sense that the market is too complacent about the possibility of a pandemic. Right now, you know, you think that pandemic is really thrown around at the word, but as early as January, we were already cautious about this pandemic, meaning it's going to affect the rest of the world. So we doubt back our risk from net positive in January to net negative in February. So we are actually very tactical in our risk budgeting, which, as I said, would give a pretty good win rates for investors. I like it. And then that's all discretionarily based or is there systematic overlays that are informing you on when to tilt or dial back one way or the other? Yeah. So the risk budgeting is the first step of my investment process right and i uh you know i i look at uh i scan the world right uh whether it's

uh it's equity market uh rates market vaults market i scan the world uh and also and and also different parts of the world as well you know whether it's asia or or us or europe and uh you know the the factors that i look at uh that may decide uh on on how i set the budget right uh for example vix is a it's a good uh uh indicator for me about risk taking uh and vix you gotta be a bit more contrarian so when volatility is low you want to be more cautious and because of complacency and when voltages are high and then you need to have an expectation of whether this volatility is going to be higher or maybe we have hit the peak and that's where you can decide that's time to actually go long so i think vix has been a good indicator for me and and the other good indicator has been rates as i mentioned you know global rates uh you know negative rates uh

favors reach for yield trades so that uh you know when i see see negative rates, well, one thing I'll be more cautious about the risk environment. But actually, on the medium to longer term, actually, it has been a strong indicator that investors want to take on more risk. All right. Well, Desmond, this has been great. It's been a lot of fun. Thank you for joining us. And we'll make sure to visit next time we're in Hong Kong or if you get over to Chicago at all. I'll try. You know, actually, I spent five years in the States, right? Actually, Chicago is one of my favorite cities. The architecture is wonderful. And not forgetting jazz i love jazz

yeah we agree and then we ask all our guests i'm not sure if you're a star wars fan have you seen the star wars movies of course uh but i'm not really a fan but my favorite character must be uh yoda yoda i like his i like yeah i like his quote uh uh do or do not. There is no trying. Stay for investment. You don't try. You just have to do it. Perfect for an investment manager. Just get it done.

And for this session, we have Michelle Leung, founder and CEO of Zingtai Capital Management. Michelle's extensive background includes Ivy League schooling, regular contributions to Bloomberg and CNBC, and students at big investment firms around the globe. So thanks so much, Michelle, for joining us today. I'm born and raised Hong Kong. Okay, great. And I finished high school here and did my first year of university in China, in Peking University, Beida.

I then completed my bachelor's at the London School of Economics. And my first work experience was actually at the United Nations for three years. So I did something completely different. And after three years at the United Nations, I went to So I did something completely different. And after three years at the United Nations, I went to Harvard Business School and completed my MBA, class of 96 from HBS. And after that, I joined Goldman Sachs and I was in Goldman Sachs and investment banking for a number of years before I started my operating and private equity and investing career. So I started life as a COO of a listed Chinese consumer business.

The company is under the Hutchinson Wampoa Group, and it was listed in the year of 2000. I was there for five years in an operating role. And after that, I was part of a team that started a private equity firm, Lunar Capital. And Lunar Capital invests in privately owned Chinese consumer businesses. And it was whilst my time at Lunar Capital

that the idea of starting Shingtai Capital came about. I started Shingtai Capital over five years ago. And I would now have a five-year track record and we run a long only strategy investing in chinese growth equities i'm the founder and i have a partner who's a cio and his name is bing chao zhao and he's from china from zhejiang province so the whole thesis of what we do is um sh, Shingtai Capital, we're a value driven investor in growth. So what we try to do is capture the highest growth in the stocks that we pick whilst paying a lot of attention to valuations we pay for that growth and being

very focused on the margin of safety. Uh, we, we like to do all most of the research ourselves. So we really take more of a private equity-like approach to investing in public equities. We do our own challenge checks. We put a lot of focus on frequent and in-depth management dialogue. And so we use what we learn from management

and what we see on the ground through channel checks to build our financial models that yields our investment thesis. So the fact that we're on the ground in Shanghai is a really critical part to what we do. And then help me understand coming from the US, it seems that all of China is a growth stock compared with, right, compared with U.S. growth and value. So how do you delineate what are the boundaries for growth versus value in Chinese equities? Right. So if you look at the MSCI China, we have very little overlap with MSCI China. I think our top 10 positions represents like 0.6% of MSCI China. So

the MSCI China has all kinds of exposure, has exposure into consumer and growth stocks, which include technology, healthcare, e-commerce, et cetera. But it also has exposure into financials, commodities, energy companies, etc. We are only looking at the growth and consumer end of the MSCI China. So if you will, we take a very broad interpretation of what we think is consumer driven and what we consider growth. growth, but we would not invest in a state owned enterprise industrial or a large bank or commodities company. So we try and stay away from the state owned enterprises. We try and stay away from the large industrials and financials and commodity companies. Everything else is really in our universe. And so are there some, what are some of the names that would be included in that universe

that people would know? So to that universe would be definitely the names that you would know well, which is Alibaba and Tencent. We in general are not invested in a lot of the consensus names, but those names would be in our universe. So the way we look at growth is we try to capture growth where we think that growth in the next few decades in China will be driven by Chinese consumption. So what we try to look at is,

we try to look at what the underlying driver of growth is in a company. And if we deem it to be driven by consumption, we will consider that stock to be in our universe. It's very interesting because a lot of people don't realize that even though China is the second largest economy in the world and will be soon the largest consumer market in the world, it is a very young economy in terms of the consumer economy. I mean, it is just 30 years old. Most of the stocks we cover were listed, some of the early ones listed around between the year 2000 and

2005, but a lot of them were listed from 2005 to today. So a lot of stocks we cover are quite newly listed. And overall, the way the consumer economy has evolved is that China did a great job building the consumer infrastructure in the early days. So we have great infrastructure in terms of an e-commerce backbone, in terms of distribution channels to distribute products. And what we're seeing now is a lot more product coming online that are filtering through these these um through filtering through the infrastructure right so that's a very classic example so that that brand actually is one of the earliest consumer companies in china that was it was founded in the 70s and that brand's gone through evolution over time so you know everyone growing up in china in the 70s and 80s

knew this brand bossy dung because because that was the main brand in terms of if you wanted to buy a down jacket. And that brand has, the stock actually lost a lot of market value in around 2010 because it had issues dealing with inventory channels being overfilled. They built too much capacity for the growth that they actually saw at that point. So they thought growth would be unfettered

in the early 2000s. They built this huge infrastructure of distribution channels and stores and they overbuilt and faced stuffed inventories and all kinds of issues. So the stock actually lost 90% of its market value around between 2010 and 2012, but then went through a restructuring.

And after that restructuring is when we invested. So we saw that there was going to be a recovery coming online and we invested at a very cheap multiple, around 10 times, because we thought that growth would recover to 30% plus per annum in terms of earnings growth. So that's a very good case study for us in terms of how we capture recovery growth. But Bozidong is a big consumer brand in China and it was a very staple type of consumer

brand in terms of just a regular down jacket. And it's actually evolved into quite a premium consumption type of positioning. So they now have multiple types of price points. They're quite fashion conscious. It's a very different company than it was over the last 20 years. Yeah, the model and you're showing off her sleeveless down jacket in your deck doesn't look very, that looks pretty fashionable. No, so what people associate with the old Bozzy Down was just a regular plain down jacket. And now they do ski wear, they do fashion items, and they have many different price points.

So how deep will you dive into that company? So you're betting on the recovery just of that company? Or was it in the broader upmarket as well? In that case, it was just in the company. So the way we like to capture growth is we like to capture two types of growth. We like secular growth, which is blue sky scenario, newly listed company or sector where they're just seeing five, 10 years of limited competition and and very strong growth we also like to focus on so alibaba when it was first listed as an example of secular growth we also like to focus on recovery growth because a lot of consumer companies in china have gone through cycles we've seen over

the last 10 years where they were once a high flyer but then like bozzy dung lost 90 of their market value trading at very cheap multiples um and we like to be we like to capture value dislocation so we really like companies like bozzy dung where we can invest it 10 times and we can see very strong recovery coming back online uh before the. So another thing we like to do is we like to invest quite early. If you look at sort of our top positions and positions have generated the most alpha for us over the last five years, in general, it's in stocks where we were very early. And what we mean by early is when we invested,

there was limited or no sell side research coverage and where we're one of the few or earlier institutional investors so in brosley obviously brosley was a huge it was a large cap company lost 90% of the market value when we invested at 10 times when it was a small cap company no one was talking about brosley done because everyone had written brosley off because they'd lost so much market value we what we did in the case of Bozidong is we went in, we had in-depth discussions with management, and we did our own channel checks. We talked to their distribution channels, and our hypothesis was that we saw same-store-cell recovery in multiple provinces,

and we projected that they would have a very strong recovery. The market didn't agree with us. In the case of Bozidong, we invested in 2016 at 10 times and the stock was flatline for 24 months. So, you know, it didn't lose value, but we invested 10 times, it was a flatline. After 18 months to two year periods, the market then recognized that growth was very strong and had gone through this huge recovery.

And the stocks after that went through, you know, a 200% growth between 2018 and today. Great. And so that's it. Yeah. So just what does it look like now for your exit? So how do you monetize that? Is there, do you have formulas for that? Or it's just, again, checks and feels for when it might turn over?

Right. So we're fundamentals, bottoms up investor. We rank everything in terms of risk reward. So we usually take profit when the risk reward no longer makes sense for us or it's past our projections where we think it's fully valued and we think that it doesn't make sense anymore, or if we see other stocks in the portfolio or pipeline that represent better risk reward, we will then trim the existing position to replace it with other stocks that represent better value for us. So in the case of Bozidong, our thesis is that the stock is still attractively valued. It's at 15 times earnings today. We still see very strong growth over the next two years. So we're still holding a high conviction position in Bozidong. But we have other examples where we invested, the stock saw very strong

growth. We invested in another stock. It's a hot pot food condiment stock. It's called Yihai. That stock was one of our best performing stocks in our portfolio over the past five years. We made like 12x on that stock. We invested at 10, 11 times earnings in 2017. And we sold the stock in 2019, two years later, because at that point, the stock was valued at 30 times, 35 times earnings. And we felt the risk reward no longer made sense. And we had other positions in the book and other ideas in the pipeline that were more attractive. And that's like a uh ramen noodle kind of thing it's actually um hot pot is a cuisine that is very popular in china it's 25 percent of the dining industry in china so it's a it's a huge hot and it's basically a but this was it

do it from home take it home this is the the. This is the key condiment. It's like the ketchup to hamburgers. Oh, got it. It's what this guy is. So this is like the key component, the key condiment that you need to eat the hot pot cuisine. Because a hot pot is just a boiling pot of water where you boil food. So the whole condiment, the sauce, is a main ingredient. I love these kind of stories right like people are you read papers and read news articles about someone caught 10 cent and this and that

when there's real money to be made in the boring stuff like like hot pot condiments right that's that's great and so it seems to me you're saying like you're you're trying to capture these growth stocks but at value prices a lot of a lot. Correct. We're a value investing growth, which a lot of people say, well, everyone wants to be that. Everyone wants to do that. Right. You might wait 30 years to get the right opportunity or whatnot. Yeah. So, you know, we look for value dislocations. So dislocations will either come in stocks like Bozidong that have gone through correction and are about to recover, or they will come in opportunities where the market is either overlooked, ignored, or misunderstood a stock.

So for example, in the case of Yi Hai, the market overlooks and misunderstood this stock because it was, it was, it was IPO shortly before we bought the stock. The IPO was not successful and the stock corrected right after IPO. And that's when we invested. But the market was. successful and the stock corrected right after IPO. And that's when we invested. I was just going to say, how much pain will you take on if you're right? If you got in early and it's still going down, will you take it? That's a very good question. Yeah. That's a very good question. That's the tricky part about the recovery growth stocks that we invest in so timing is really critical um we will

usually wait for anywhere from three to five quarters of recovery before we invest so we won't invest after one quarter of recovery um but you know oftentimes we're early so in the case of early not good stock didn't do anything for 18 to 24 months after we invested and in some cases like you say we invest and we're facing this falling knife situation where the stock keeps correcting um we've had those situations early on in our in our five-year track record we had a few of those cases in the first two years of our track record um and in some cases if we hit a stop loss and we felt that we had no information edge and understanding why the stock kept correcting, we would consider trimming the stock in half or taking some risk off the table. So we actually manage the portfolio.

We're a long-owning manager, fundamental, long-term driven. We like to hold stock for three plus years. All our models are done on a three-year basis. The turnover, the portfolio in terms of name turnover is low. It's around 30%. Volume turnover is higher. It's 50% plus because we actively manage the exposure we're in. So China, like you said, is a great growth story. But at the same time, it's a very volatile market. So the growth dynamics and the competitive dynamics within each sector, within each company can change very rapidly. So you can't afford to not be very focused on constant information updates.

So the portfolios positions in our book, we talk to the companies every month. And then I'm reading all this news on like Luckin Coffee. Is that how I say it? So how do you avoid those landmines, so to speak? How do you avoid those traps? Right. So a couple of things.

So obviously corporate governance is a big issue and we're very focused on it um we tend to only invest in companies where we have some assessment of management track record so we either know management or we know how management has guided and performed in the past or we have reference checked them versus other peer companies or other people we know in our network. So we would rarely invest in a company where we don't feel comfortable with management's credibility and management's track record. So that's the first thing. The second thing is that we never invest in companies that don't have positive earnings and don't have some kind of history of earnings so that's the second but we don't invest in companies that are newly listed and overnight have this huge market cap but don't actually deliver earnings that's not that's not in our focus area we like

to understand the driver of earnings and sales and be able to verify it. So in a case like the company you mentioned, because of the rapid growth, because of the network of reps that they're relying on to, to, to drive sales, it would be very difficult to diligence, you know, where the growth is and how, how, how that growth actually happens. So that would be something we would stay away from. Good to hear. I think US investors read that, right, in the papers,

and they say, like, this is why I don't want to invest over there. You can't tell these things apart. You're going to run into these. Well, I don't think that's the case. I don't think that's the case. Because if you look at, you know, what we look at in companies is clearly we look for high growth. Clearly we look for, you clearly we look for you know comparison market positioning but we also focus on a couple other things you know we like companies that are

in net cash with limited uh leverage on their books we like companies with a historical track record of earnings uh we like companies where we have active and accessible management where we the manager is willing to talk to us every month so if a company doesn't fit into that type of profile we will likely pass on on investing in the company yeah and i think some investors would say well how do i trust those numbers so i guess you know what's how do you guys trust the numbers because you're doing channel checks and you're seeing the actual the brand and the feeling it correct correct so if we're looking at an infant milk formula company we will go to channels we'll go to stores we'll go to hyper

markets we'll go online and we'll see if what the shelf space is like does the sales and the branding look like they're generating sales they are and we'll talk to peer companies we'll reference check with peer companies to see what the competitive position of the company actually is. One more question on the RIT. So in your deck, you kind of talk about strong downside protection, which you just mentioned, but you also just mentioned, but there's no hedge, there's no overlay that's just based purely on the skill and picking the companies? Correct. So all the alpha we generated is just from stock picking. We have not, we have no, it's a pure, it's a straightforward long-owning strategy. But the downside protection is based on also not chasing high performers.

So we're not in high beta names. We're not in highly valued names. So, you know, we're not in the consensus names that would trade according to the market beta. So quite, and we're in names that are very cheap, right? Average PEs are 13 times. So in a down market, we often see that we are not tracking the beta and we are capturing, you know, less than half of the, of the downdraft. That's great. So let's finish it up here.

We finished up asking you some of your favorite things which is our standard so okay we'll just go through these quick favorite investing book favorite investing book i guess intelligent investor as a value investor yeah yeah i'll take it um favorite restaurant in hong kong where do I gotta go when I come visit Wow Okay that's a tough one I have so many I would say A good classic is China Club China Club okay

Are you a podcast Consumer as well as now a contributor Do you have a favorite podcast I'm not a big Podcast consumer But I like the I like the um i like the mckinsey podcasts okay i haven't read that one or read it listen to it sorry um how about your favorite place you've lived in all the uh different areas you've been i would say hong kong okay hong kong

who's who's second place? Where were you when you were in the U.S.? In New York? I was in New York. I love New York as well. New York or London, all right. And then finally, I don't know if you're a Star Wars fan or have watched the movies,

but favorite Star Wars character? Not a Star Wars fan. Not at all? Princess Leia, have you heard of her? Yes, Princess Leia, yeah. All right, we'll give you Princess Leia. Have you heard of her? Well, yes. Princess Leia. Yep. All right. We'll give you Princess Leia. Well, thanks so much, Michelle. This has been fun and informative and looking forward to talking again soon. Today, we'll be joined by Allison Zhao, who is the head of business development for AP Capital Management. We are going to be talking with Allison a little bit today about their Absolute Return Fund.

The principal investment objective of AP Capital's Absolute Return Fund is to consistently achieve a net positive return with little directional exposure and low correlation to the equity markets. The fund also targets a low risk and volatility profile versus other industry competitors. Allison, thank you for joining us today. We're happy to have you on The Derivative. So as head of business development at AP Capital, can you give us a little bit background on your path and what led you to AP Capital? Oh, yeah, sure. So as you mentioned before, I actually started off at the finance department of Citgo Chicago, where I was reporting to the mayor's office, you office, soliciting revenue numbers and analyzing financial reports for different industries and etc. And then later after working in the state of Chicago, I joined Wells Fargo on the FICC derivatives trading floor.

So I was rotating on both trading and sales. Later I joined a Swiss boutique investment bank where I focused on cross asset structure, product, sales and trading. So, but then, you know, my past experience were all on the sell side. It's more client driven, it's more product driven I would say. And then the funder of AP Capital, Patrick Hsu, one day reached out to me and said, hey I actually appreciate your background in the investment banking side and also you have already have the foundation on the financial instruments, derivatives and etc. Would you like to join us to help us expand our business etc. I think the most important reason, well there are several key reasons why I joined JEP. First of all is definitely the culture. We have a very, very flat culture. Patrick, as the founder, he tried to decentralize,

have a very decentralized company structure. So where we, every one of us have a say, have the autonomy and et cetera. And the second of all is definitely for the challenge and responsibilities. I myself will be covering the, basically the external relationship part for the company, either relationship with ETF issuers, with exchanges, with allocators, with media, and et cetera. That's tremendous responsibility. And I'm super excited for the challenge. And that's the reason I joined AP Capital. And so far, I'll be having a ball. Let's get more granular into the strategy in terms of focusing on the Absolute Return Fund. Yeah, sure.

So we first started doing AHRB, namely the arbitrage between Hong Kong and China onshore markets. And then later on, we realized that, you know, there's not one opportunity. It's all very opportunity driven because of the policies in mainland China and et cetera. So we shifted to commodity futures trading in 2015. And we're also trading ETF options. And then in 2016, we have we onboarded Goldman as our prime broker. Then obviously we have more accessibilities because we have this partnership with them. And we also opened our Shenzhen office in 2016. So our new strategy developed in that time is actually basket trading and futures arbitrage.

And we also got some new investors from family offices and high net worth individuals. So at that time, it's still mostly China markets, like China ETFs, China futures, or you're starting to move global as well? Back then, it was still pretty focused on AH. Okay. Yeah. But the seeds of expanding to multiple markets globally,

it's already embedded in that period of time. And then in 2017 is where we started to trade ADR and also the pair of tradings. And also we became became a exchange Hong Kong exchange member that year and which started prepared us to be a ETF market maker in the next year so in 2009 2018 we started to trade ETF mark was started to do ETF market making in Hong Kong locally. And the top ETFs you may probably heard of, you know, the CSI 300, the ticker is 3188 or 2822 or 2823.

So those are the most liquid and commonly traded ETFs. You're not giving out your telephone number here, are you? So that's the ticker for the csi 300 etf is that right uh yes yes okay all right those are the most liquid ones the top ones in hong kong um and in 2000 2019 actually the end of 2018 we started we realized that you know CME is actually launching Bitcoin futures and that's got our attention we because we figured that you know Maybe this crypto trading things will be more in more and more institutionalized It's not like a game anymore. It's becomes a seriously becoming a new asset class. So that got our attention

and so at the beginning of 2018, especially in the beginning of 2019, we started to trade crypto strategies. And how we trade cryptos is that we don't really hold any directional positions as well, just like our main strategy, right? We are actually doing cross market arbitrage or spot and future arbitrage of future calendars, present, et cetera. So the methodology of trading crypto is more or less the same as our main strategy. It's just to a different asset class.

Do you track internally over this five or six year period where the returns and risk management has been great, where the alpha is coming from based on different sub strategies, like in different years, I'm imagining there's greater risk in market neutral or calendar spreads or ETF arbitrage versus others. Do you guys track, you know, where the risks lie and where the alpha is coming from year over year? I know that's very like detailed, but can you touch on that perhaps? For sure. I think it's a very good question, first of all, and it really depends on the market conditions. Maybe I can take this year, 2020, the first five months as example, maybe.

So we have four main strategies in our fund. First of all is index ARP. Secondly is ETF market making. Thirdly is Paris trading. And the last one is actually market making. Thirdly is pairs trading. And the last one is actually crypto trading. So those are the main categories of our strategies. Of course, we have some other strategies, but these four are the main ones. The core, right?

Yes. So, yes, the core four. And so in the first five months of 2020, what we're seeing that is providing us the alpha is actually the all-you ETFs and cryptos. There, as everybody knows, right, there was the all-you price went crazy and there's a lot of volatility there. So we're actually trading a lot of all you ETFs and also futures.

So we're trying to make some profit there. Just curious, sorry to cut you off. When you were trading oil futures, are you trading on the IME in China? Are you trading Brent oil? Are you trading WTI? What China are you trading on you know you trading Brent oil you trading WTI like what oil are you trading we're trading all of them okay yeah yeah we're trading we're training definitely international products like I E all you and also crude all you and Brent and wwti so yeah yeah and also brand and WWTI. Got it. Okay. Yeah. And also cryptos because the big movement,

it's basically crypto. It's a reflection of the volatilities in the, in the stock markets or in the currency markets on the gold markets, et cetera. So, and, you know, one thing special about cryptos is that it has different regulations in different markets. So even just for the same kind of currency, you can have drastically different volatilities or prices in different markets.

And since we paid a lot of effort to expand our horizons to those different markets before 2020, so now we're able to capture that movement in different markets. You had touched on very briefly about AP Capital's edge. If you could elaborate more in terms, I think one differentiator, if you will, that sets you apart from your peers is the IT infrastructure and the internal platform. Can you provide a little bit more color there? Sure, for sure. I think there are three aspects that differentiate ourselves from others. First of all, I think it's the market accessibility.

By that, I mean, let's just be honest. There's a lot of HFT tycoons there's a lot of hft trading houses like jane street or imc you know or flow or october they have great it or infrastructures that we as a smaller hedge fund we cannot compete with but our unique edge is really the market coverage and the market accessibility, because those big firms, they don't actually go there to compete with us. Maybe it's the cost and return is not appealing to them, but for us, certainly, I think it's pretty attractive. And also we have spent tremendous efforts in those emerging markets and try to understand the local policies, local economies and the local brokerage relationships and etc. market for many years to to uh on board as our part of our trading team so you could see that

it's a one plus one uh larger than two effect um and that's certainly one of our uh big edge is the market accessibility and the market expertise um the second one as you mentioned is our it uh we got that 100 internally developed and the beauty of this is that we can not only integrate the risk management system into the IT system, into the trading system, but also we're able to have very tailor-made trading functions or connectivities with brokers or exchanges. And that certainly gives us more flexibility and more tailor-made solutions for fellow traders. And that's second.

The third one is actually the trading team. And all of the traders are experienced traders. We seldom hire junior traders, fresh graduates. We want the traders be very, very focused and specialized in their area. So that's, and in, in return, what, what we can get in return is that, you know, the traders are pretty happy because they're trading what they're good at.

And also, we can very obviously see that our traders have better intuitions when trading in that market. For example, a big breaking news happens and what's that major reaction is what's valuable what do you find as a benefit or maybe the difference between trading asia um versus trading the u.s and like what should investors know on how the the market landscape differs um from an investment standpoint granted they're hiring you to figure you know those individual nuances out yeah sure um i think one the the biggest differentiator between those two markets is that u.s is the most liquid the most developed financial markets um you have a lot of tremendous liquidity there and usually people need to trade in very, very big size for us to actually capture some average charge opportunities and et cetera. Whereas in Asia, it's more policy or opportunities driven.

Cycles can be shorter than the U.S. markets. The U.S. market. Like, for example, taking Chinese onshore market as an example, the cycles are short and things can be pretty political-driven. So you need to stay tuned with the government policies. And, you know, maybe sometimes even you have to read the official government documents to anticipate what kind of new strategies will be launched during type of period or what kind of new products will be launched so that's very I think that's a very unique thing of trading in the Chinese markets.

And also, but we are seeing that one thing that also difference is that the growth in Asian markets is actually pretty rapid. There's countless new product launch, new ETFs, new thematic products, 5G or Big Bay Area or Vietnam or Vietnam, new economy, China new economy, etc. So there's a lot of new product launch and with the major ETFs trading with very, very high liquidity and also you have this new ideas coming in to make the whole overall market more energetic or adventurous.

So I think there's a lot of growth potentials in Asian markets, overall speaking. So help me understand, like, you've seen massive movement up and down in some of the Chinese commodities year to date and, you know, volatility, but you've seen several markets move, you know, 30, 40% year to date with what's going on with the political turmoil and Corona. inputs for you guys is it more um fundamental or technical like how are you you had mentioned just in passing about you know looking at reports and government data and stuff that leads me to believe that you have you know a fundamental

approach is that is that the right assumption? Is it a combination, fundamental and technical? I think it's more of the, previously I mentioned the policies and the new launches and et cetera. It's more on the overall expansion or the overall strategies or the environment and et cetera. But then for our strategies we actually trade we actually have very short holding periods um usually it's around one to

three days so we can imagine we trade the entry out pretty fast and for the commodities you know there's a a lot of swings in the past days and what we're trading is more on the future side, the commodity future side, where we're actually trading a lot of future spreads, the rolls. And there's a lot of futures we're trading at discounts. And we're able to capture that, you know, the differences and make money in the roll markets. So that's actually how we treat it.

We try to shorten or hold in periods so that to make sure the volatility in our own P&L profile, it's stable. But then also, yeah, stay tuned of the overall economics or policies. It's definitely beneficial. Yeah. So a couple of questions here, Allison.

Your favorite investing book? My favorite investing book? Random Walker on the Wall Street. Favorite place to vacation? Sure. Canada. Canada. Vancouver.

I didn't see that coming. Because my husband is Canadian, so. What do you miss the most about Chicago? Is it the Chicago Bowl? Deep dish pizza. Deep dish pizza. Today, we've got a young star in the energy trading space, Brent Belote, founder of Kaler Capital. Brent joined us a while back on the pod to talk through U.S. oil prices going negative for the first time ever,

and excited to hear his thoughts on how he's approaching the Chinese oil futures markets. So, thanks for being back on with us today, Brent. Thanks, Jeff. It's been good. And so, give us a little background on you, how you got into energy space and where you grew up and everything. Yeah, I grew up in the Bay Area in Petaluma, a small town. I went to school down in LA at USC and got into the energy markets. I did grad school at NYU, did my MBA in quantitative finance and econ, and then got recruited to JP Morgan, where I worked on the oil desk for 10 years. So at first, I was in charge of North American oil

fundamentals, running kind of supply demand balances on anything in North American crude, looking at crude grades, pretty much anything that moved oil around the North American area we tracked. And then switched over and worked on oil product derivatives, focusing on gasoline and heating oil for the last two years of my career at JPMorgan. And in that regard, I spent a lot of time looking at refinery economics, jet fuel hedging strategies, pretty much anything that moved now, gasoline and heating oil in demand. Now let's talk a little bit about the main strategy that you run in the U.S. and what that looks like.

So Kaler Capital Systematic Energy Diversified is the primary strategy that we run here in the States. It takes all the fundamental data points that I aggregated and built up at JP Morgan. And we apply a systematic approach to fundamental data. So we look at all the supply and demand micro markets of, of the world. We're looking at basically six primary ones, WTI, Brent, WTI, Brent differential, gasoline cracks, heating oil cracks, and then a option model as well on WTI. And we look at the underlying fundamentals of those markets, looking at supply demand. So on the supply side, I'm looking at shale forecast, shale current production, and the movement of oil around the world as well. So imports, exports out of the

Gulf Coast, pipeline flows around Cushing, Oklahoma, refinery economics, how much gasoline, heating oil, et cetera, is being created around the world, and shipping movements as well, primarily around the Middle East. So you take in all these fundamental factors, create a supply-demand picture through those data points, through that model, and then discretionarily make the decisions or the model itself kicks out the buys and sells? when we will execute or enter exit trades. And yes, the inputs are all fundamental database. It tells us where along the curve we should be. She would be in the front of the market. She would be farther out and dynamically adjust for kind of increases and

decreases in volatility. So obviously, you know, we had a great March, April, but it was very volatile, even if it was positive volatility. So right now the model is investing in December futures contracts, nothing in the firm of the month to try to tamper the volatility and really stay out of the noise of the macro environment. Let's talk China. So yeah. Interested in your strategy. So now once you learned about the opportunity in China, were you saying, cool, I'll just port this same model over? Or what did that look like? No, so it was kind of an interesting transition. So the way the model works here in the States is it inputs all the fundamental data. And obviously, getting fundamental data in China is probably a

non-starter, especially with all the, you know, I trade 13 products kind of across a macro. So my question, and when I started looking at the data was, is, can I run the last leg of the algorithm that I run here in the States and see if it has relevance across China markets. And that data looks at spot prices and the term structure that has is currently going on between there. So, you know, when I ran the data, it really kind of popped and I was actually surprised at how well the term model algorithm that I run as kind of the last hurdle for entering into positions worked for China. And it was a, it's been working fantastic since we started launching, since we launched in early March. And so we run 13 markets, kind of a gamut of financial ag and glass, no energy, ironically,

but the metals have done fantastic. So it's interesting to see how this model has performed across different asset classes. So you're taking the same energy market inputs, and then are you just saying you just took the curve model and put it on yeah so like i said so i took the last the last portion of it which is um looking at term structure so it looks at different the spreads between different different parts of the curve and analyzes those versus first for best ones yeah left the other fundamental factors behind yep and so what does that look have you thought of stage two of actually getting some of that fundamental data and running? Yeah, I've looked at it. The biggest issue that I'm running into is timely data, number one, and then number two, trying to audit it or have an idea of what I'm actually looking at.

It's tough. It's tough to dig through it. Yeah, it's tough. It's tough to dig through it. Yeah, it's tough. So I think that it is possible, but I think it would involve probably a full-time Chinese analyst or someone over there to scope the data and make sure that it's actually, you know, to scrape it and dig in and make sure that I'm not just, to be honest, running fake numbers and trying to take positions on it. Yeah. And so how have you found the trading? As liquid as you thought? Less liquid? More liquid? More liquid than I thought. Very surprised. I think they did something really smart with that, where the futures contracts are very small for a lot of the markets. And I think it's smart to start that way. Whether you click a button for 1,000 and you click a button for 10, it's pretty much the same thing

and it doesn't price people out. So it's been encouraging to see the number of contracts that have actually been trading. And the algorithms that are run look and they only trade the most liquid futures contract to avoid this. So we tried to stay out of the fray and not end up with a situation where the bid ask is so wide that we're causing issues

with it. So. And what, so let's name, go through those markets again. So it's, what are the 14? Sorry to put you on the spot. Yeah. Yeah. Yeah. Five of them. Yeah, the 10-year gold, Chinese 10-year gold, silver, cotton, polypropylene, hot rolled coils, rebar, soybeans. I just love the names of some of these, right? Did you ever think three years ago you'd be trading hot rolled coil? No, no, or rebar for that matter. No. But years ago, you'd be trading hot royal coil. No, no, or rebar for that matter. No, it was, yeah, like I said, it was interesting to see where, you know, my first way I ran this was I took each individual model, each individual market, and I ran the, you know,

kind of my inputs for this algorithm on it. And I looked at them on an individual basis. So these 13 were the ones where it really worked. And there were some that it didn't. And I was surprised them on an individual basis. So these 13 were the ones where it really worked. And there were some that it didn't. And I was surprised that for the energy space, it didn't. I think the reason it didn't for the energy space in China was just purely liquidity and lack of data. So I don't think it went back far enough. And I think the liquidity factor meant that, you know, the curve, you know, if you're looking at the term structure of the curve if only the front two months really update or change change in the back of the curve is static for four or five days is that really static or

did it they just not update the data so I think it was more a function of just kind of stale data and I think if you if you dug into it and as they get more liquid you'll find that it'll probably add markets. These 13 kind of have the most, the fullest curves of the markets over there? Yeah, exactly. Exactly. I tried to stay in the front six months and they had to be a certain threshold of liquidity and they had to have a certain term structure and bend them. And so just give some example trades.

So you'll go long the June rebar and short the D sub rebar? No, no spread. So it's only directional. So these markets are only directional. So we'll be long or short a given number of contracts in each of the 30 markets. But not always in the front month. You might go into the back months?

We will only go in the most liquid contract based on open interest okay which is typically the one of the first two typically yeah yeah some of them trade in it's it's kind of fascinating because some of them trade in not almost quarterly increments where you know gold will be like a june september december and some will be six months rollouts to the next liquid contract. Like copper goes from June to December, I believe pretty much every time. So it's been interesting to see how the roles occur and where they are. Well, thanks so much for joining us. We're gonna do a couple quick fire favorites questions to close out. investing book that's a good one um or i'll give you any book uh investing

i'll i'll go with uh jesse livermore um i think it's about a plunge reminiscent of a stock yeah i really enjoyed that one it kind of made me think about how um you know how and when you should be buying and trying to spot that. And then, uh, the, um, Nassim Taleb wrote, um, one is dynamic, dynamic option hedging. It's a very technical book, but, um, it's been very prescient and very nice. And I've used it a lot in a number of different, um, a number of different markets. It's more about, it's more about option pricing and option models, but it's been, been fascinating. been fascinating favorite uh national park near you there grand teton or yellowstone i like grand teton it's just close it's easy there's great lakes there um yellowstone's beautiful it's a little crowded um and it's it's a little far so yeah i grand teton for sure for me. Got it. And then favorite Star Wars character?

That's a good one. I am a Star Wars fan. The new ones, I haven't really appreciated the new ones. So I'll stick with Luke Skywalker. Just be a very vanilla win. you've been listening to the derivative links from this episode will be in the episode description of this channel follow us on twitter at rcm alt and visit our website to read our blog or subscribe to our newsletter at rcmalt.com if you liked our show introduce a friend and show our website to read our blog or subscribe to our newsletter at rcmalt.com. If you liked our show, introduce a friend and show them how to subscribe. And be sure to leave comments. We'd love to hear from you.