April 2023 Investment Newsletter
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April 2023 Investment Newsletter
Disclaimer: This page, including any links or posts, is not an offer or invitation to subscribe for shares in the fund. Please read the full disclaimer at the end of this page.
NOTE: This newsletter was written on 15th May 2023 and originally sent to investors of Orca Global Management on 18th May 2023. Sensitive information has been redacted.
1. April PnL
We finished the month flat in April. We had gains in our two new systematic strategies - BTC Momentum (+3.15%) and Delta-Neutral Arbitrage (+3.81%) - which were offset by a mark-to- market loss on our cash equivalent positions as options skew moved against us in our synthetic futures positions (we were long $ETH and short ETH synthetic futures). More on our new strategies below.
2. Orca v2
We want to take this newsletter to formally announce our stealth-introduction of Orca v2 back in mid-March. This is the amalgamation of all our post-FTX revamps: months of internal security protocol upgrades, credit + risk system battle-testing, and a consolidation of our overall portfolio + launch of new trading strategies that we have been working on (note: “Orca v2” is just our way of formalising all the improvements we have made to the original fund under the same mandates, and requires no action by our investors). Since the improvements to our overall security and risk management systems have been touched on in previous investor communication, we will focus on the updated trading strategies in this newsletter.
Currently, Orca is running three core strategies plus a few “reserve” strategies (not covered in the newsletter) that are available for us to diversify into depending on some factors such as liquidity and improvements in exchange safety. The core strategies are as follows:
We give brief overviews of each strategy below, but please note that we are purposely being vague in this section (particularly for the two systematic strategies) as we do not want to reveal anything mechanical.
(2i) Discretionary: Long Basket
Core to Orca’s vision since day 1, this is the strategy that we believe will be the outperformer in the next bull market. Currently, as a reflection of our market thesis, our allocation to this strategy is <1% but the basket components and weighing is updated on a weekly basis such that we are able to immediately increase allocation depending on our market view. The current sector breakdown can be seen in Figure 1.
This strategy is the long-term fundamental investing component of the fund where we try to capture idiosyncratic alpha in each of our holdings. To ensure concentrated exposure to our high conviction positions, we have limited our maximum position count to 10 coins, with each aligning with our long-term thesis of crypto.
The Long Basket strategy is essentially the product of all the bottom-up discretionary research performed by the fund, with careful considerations of sector exposures.
(2ii) Systematic: BTC Momentum
This is an absolute momentum strategy (as opposed to relative/cross-sectional, which is another momentum strategy currently undergoing R&D) that trades only BTC and we regard it as a smarter way to have BTC exposure compared to buy-and-hold.
Momentum strategies notoriously suffer from extreme negative skew resulting in huge drawdowns as we have seen from decades of CTA performance in traditional markets. However, compared to buy-and-hold $BTC, Orca’s momentum strategy backtest has shown potential to double the sharpe, reduce maximum drawdowns, reduce Value-at-Risk, and of course, increase returns, all with zero leverage.
This strategy is able to trade both positive and negative momentum, and our backtests showed that adding dynamically sized shorts positively skewed our overall returns (and therefore increased our sharpe). However, with the marginal benefits of trading the short side, and since momentum as a factor is effectively a bet on positively autocorrelated returns, we have decided to make this a long-only strategy.
Since its launch on 07th March 2023, this strategy has returned +12.29%. Due to the medium-term style of this strategy very few trades have been logged so far, and thus we reserve printing other metrics/statistics until the next update.
(2iii) Systematic: Delta-Neutral Arbitrage
This is a medium-frequency-trading strategy uncorrelated to the market that exploits positioning and price differences across centralised exchanges.
While the windows of opportunities for arbitrage may be limited, what we have discovered is that these imbalances are often structural and such regimes, and consequently regime changes, can be quantified. We believe that most strategies live right now in crypto markets are vanilla in arbitrage signal generation and hence, whilst making regular improvements/updates, we aim to juice this current algorithm as much as we can while these structural divergences exist.
This strategy was launched on 21st March 2023, and has returned 8.63% so far with a -0.03 correlation to BTC and an 8.79 sharpe ratio.
Orca v2 - Final Words and Orca MRC
As a fund with a long-term vision in crypto, we believe that the Long Basket is an essential strategy that must be maintained. However, with a high market beta, the returns of a long-term, long-only strategy is volatile and cyclical. Thus, we complimented it with two systematic strategies that each trades different time horizons: the impact to the portfolio is a reduction in the variance of returns, reduced volatility, diversification in market structure exposure, temporal diversification, and a vast improvement in our risk-adjusted returns.
This then brings on the question of capital allocation and rotation of funds into our core strategies. This is a complex problem and clearly a million-dollar question as it is essentially asking “when do I buy, and when do I sell?” It would be ideal to have a rules-based system to let us know when we are in a bull-market (→ max allocation to Long Basket) and when we are in a bear- market (→ max allocation to our systematic strategies). Unfortunately, crypto as an asset class is far too young to do any rigorous testing (which is why we always approach all backtest results with skepticism and take many weeks and months in scaling up strategies, as we have been doing since March) but we are working on a quantitative yet logic-based (i.e. ”intuitive”) signalling approach that we can adopt into our discretionary heuristics. Although still in R&D stages, from the results so far we are optimistic that this project, which we have named MRC (Market Regime Classification), will aid us tremendously in strategy allocation going forward. Interestingly, this project was actually born when trying to improve our momentum strategy:
Since the momentum strategy trades medium term opportunities, its out performance is also only clear after a medium~long- term period: this duration is hard to define but we estimated a ~2y period for the outperformance to be evident and statistically relevant. One concern that we thought may present itself to us and to investors on the back of this is whether Orca’s momentum signals may behave as a factor and consequentially if there may be issues exploiting the edge going forward. To address this, we added various robust parameters to the strategy, particularly a regime classification filter (on a different time scale to the momentum signals) which would allow the strategy to benefit more in positive autocorrelation regimes. This is the genesis of MRC and led us into a top-down portfolio allocation framework that adds a quantitative layer in helping us identify market-regimes.
3. Current Views
(3i) Crypto
We believe that the high for 2023 has yet to be printed, however, the crypto outlook is bleak in the short-term. The potential headwinds are numerous: US Government selling 40,000 seized BTC, Mt. Gox distributing 142,000 BTC, Voyager liquidating tokens to repay creditors, Jane Street + Jump scaling back market-making, etc. The timing and percentage of supply to be sold in the first three points are hard to gauge, but the last point, which is the most significant headwind in our view, has recently happened and the effect on the orderbooks was immediately (and painfully) obvious.
It may be the liquidity, or perhaps confirmation bias at play, but the past week or so, crypto seems to be trading very heavy, like the books are going to topple at the first whiff of negative headlines. With liquidity conditions at multi-year lows, we are prepared for exacerbated moves, particularly to the downside as many crypto participants accumulated positions in Q1 of this year.
Price action wise, $BTC entered the current range of 27~31k on the back of the March crypto bank failures (flow driven moves that we explained in-depth in the previous newsletter) and has been trading there for the past two months (Figure 4):
Medium-term momentum has clearly stalled so we would want to see a clean break + close out of this range to shake off any doubts before building out positions in our Long Basket.
On the topic of building out our long positions, some interesting statistics for the 2023 rally (Jan~Apr):
In the 104 days from 01st January 2023 to 14th April 2023 (the day of the yearly high), $BTC rallied 84.47%
If we remove the top 9 trading days, the overall return was -0.46%, meaning the entire 2023 January~April rally came from just 9 days
If we remove the top 15 trading days, the overall return is -20.00%
To us this reveals that this was a narrow rally i.e. not “broad momentum”, meaning not a “healthy” rally and not something that defines a longer term trend. But it also shows the importance of staying invested in a very flow driven asset class such as crypto. Timing moves is difficult, so its vital that we identify breakout momentum and buy coins that outperform the broader market, hence our ongoing discretionary Long Basket research + construction even when the allocation is 0.
(3ii) Macro
We are currently well and truly in the inflexion zone (Figure 5; see our February newsletter for an in-depth discussion about the inflexion zone):
These are vulnerable periods and never simple peaks + troughs as Figure 5 simplifies them to be: they are volatile market conditions that can last months. The current inflexion zone is faced with contradicting data, both in slow and fast economic data, that is adding complexity to short~medium term directional trading.
Despite various Financial Conditions Indexes showing a loose~neutral US economy, it is important to remember that we are still coming off a record hiking cycle. Take a look at Figure 6 - the hiking cycle preceding the GFC looks aggressive, yet the most recent hiking cycle was done at literally double the velocity when measured by average hikes per month:
The US market has just come off the most aggressive hiking cycle in decades, and while some banks have already collapsed, the worst effects of this are probably yet to be seen, particularly with FCIs still in loose territory. We therefore prefer to look past the different FCIs (Bloomberg, GS, Chicago Fed, etc.) and instead look at specific data points that, in our view, sits between Fed rates and the actual economy: what we mean by this is that we look for figures that are both directly impacted by Fed hikes and will also have a clear 1-to-1 effect on economic growth. One such series is the Senior Loan Officer Opinion Survey on Bank Lending Practices, where loan officers are essentially asked variations of the same question, “did you tighten lending standards?” Currently, whichever specific response we look at in the most recent survey, we are at levels not seen since the outlier of Covid and the GFC (Figure 7), and this survey has historically been a leading indicator for many statistics such as large ($50mm+) bankruptcies, SPX YoY EPS growth, etc.
So the effects of tighter money conditions are seeping through to loans, and we see it in the labour market too with the greatest ever monthly decline in the Atlanta Fed’s wage growth tracker.
With market positioning at extremes, VIX sitting at the bottom of a multi-year range, bank stocks lagging, and narrow SPX returns (opposite of broad market strength, measured by comparing the SPX equal-weighted index to the regular market cap weighted SPX), the data seems to suggest that it’s only a matter of time until the effects of the unprecedented hiking cycle kicks in painfully, and that the something-has-to-break view that bears have had for a while will transpire.
But when we look at charts, this narrative seems to have minimal effects on macro markets: bond markets are more focused on a return to monetary easing, the curve is steepening again, growth is outperforming value, and the NASDAQ keeps pushing new yearly highs.
So what’s going on?
The past year was a shock to equity valuations after they were propped up by low rates for over a decade. With the light of Fed cuts now showing at the end of the tunnel, the market is back to intently focusing on interest rates, as something that may save stocks (and other risk assets) again. The belief is probably that a swift return to the cure of low rates can quickly cancel out the current effects of tight lending standards, and may be enough to “get back to normal” before anything truly breaks. This would explain the outperformance of the growth sector (Figure 8) and stocks like $AAPL (which is now larger than the Russel 2000 by market cap).
A consequence of such a rally is that the biggest threat to risk markets now would be a longer than expected pause by the Fed, not only because post-hiking cycle pauses have historically been negative for stock markets, but because the belief that this is not the case is what is allowing duration-sensitive risk assets to do well this year.
Our view currently is that after a brief period of the spread between US yields and other DM yields compressing and USD coming off, as the tightening of global economies start to take affect and inflation concerns are replaced by recessionary ones in other markets, the US will again see relative outperformance to other major economies.
Further Disclaimer:
The following important information relates to the use of Orca Global Management’s substack publications. Orca Global Management is a fund registered in the Cayman Islands. This publication is directed only at persons who: a) Are expert investors who fall within the definition of Accredited Investor b) Are otherwise permitted to read this publication in compliance with the governing laws of their respective jurisdiction. It is not directed at or intended for retail clients nor general public dissemination. Any person considering an investment into Orca Global Management’s fund must ensure that they are suitably qualified, experienced and knowledgeable on such investments considering jurisdictional rules, regulations and restrictions, tax implications, residence or domicile and their financial circumstances. Past performance is not a guide to what may happen in the future. Prospective investors should be aware that the value of their investments could fall as well as rise. Any investment carries the risk of potential total loss of capital and investors may not get back the value of their original investment. Information on this publication may include data and opinions derived from third party sources. Orca Global Management does not accept liability for the accuracy or completeness of any such information or opinions which can be subject to change without notice. Furthermore, the information provided does not constitute an offer to buy or to sell cryptocurrencies or any other financial instrument, nor does it constitute investment, legal or tax advice. Details relating to the investment including the risk disclosures can be found in the Private Placement Memorandum. This brief statement cannot disclose all the risks and other significant aspects of the various markets traded by Orca Global Management.