February started with an unprecedented change in equity market volatility. The CBOE Volatility Index (VIX) experienced one of the largest single-day increases in its history. Although the VIX chart below illustrates the scale of the 2008 financial crisis move was much greater, February’s “gap move” wreaked havoc because it was preceded by a period of such unusually low volatility. In fact, volatility heading into February was at its lowest level in the past 18 years.
Warnings and concerns have abounded for months regarding this benevolent market environment. However, the E-mini S&P 500, FTSE 100 and Nikkei Index futures price charts from Q4 of 2017 through end of February 2018 (each representative of the three major sub-sectors Asia Pacific (APAC), Europe (EU) and North America (NA) traded by the program) illustrate the challenge of passing on or shorting the strong trend which pervaded until that first week of February. In response to the pre-February conditions, the model basket had been overweighting long-term over short-term signals. This, in turn, prevented it from capturing the full extent of the downside move in the equity markets in that first week. The risk management algorithms did start delevering the long trades, but with the abruptness and magnitude of the reversal, losses are (and were) unavoidable. Since early February, the system-picking algorithm (purposed to reduce tail loss) has increased the weighting to short-term models which, ostensibly, gives the portfolio the ability to capture short-term reversals or sudden increases in volatility going forward. Additionally, to improve the reaction time to downside volatility in the equity markets, we are adding a machine learning based intraday short only system to further protect the portfolio on the tails of the MSCI World (Total Return) Index.
To summarize actual results, there was no change in Eta Carinae’s positioning after January’s strong showing courtesy of long exposure across all the global equity index futures. Virtually all of Eta Carinae’s losses in APAC (-4.46% gross) came from the long-term trend and mean reversion systems. The majority of the losses in EU (-6.56% gross) came from long-term trend following systems, although the sole modest bright spot was a positive contribution from the short-term breakout systems. NA (-4.33% gross) performance mirrored the other geographic regions with the majority of the losses coming from the long-term trend following systems.
Eta Carinae targets a low downside correlation to the MSCI World (Total Return) Index while striving to obtain a majority of the upside capture. It is meant to be a tail protection program which has a net positive contribution to any portfolio. As witnessed this past month, the program may not always be able to capture sudden downside spikes in the equity market. However, if the bear market shows more persistence, the program should be able to provide tail protection.