28th June 2016

To be clear, not everyone had an uncomfortable Brexit. What is being referred to now (and no doubt in case studies at Harvard in years to come) as “Black Friday”, was in fact quite a Good Friday for investors in Arminius’ global macro hedge fund.

So how did we manage to not lose money through Brexit? By obeying our models.

By mid May 2016, it was obvious to us that markets globally were “fully priced”. Irrespective of global location, markets had run very hard into what is seasonally a high point in the year and often a time when people simply pack up shop for the European summer. We are not simply slaves to the oft-quoted “sell in May and go away” tenet, however our models for equities in most of the developed country markets were statistically expensive. By our metrics, one standard error above fair value of our models equated to the extreme probability of an approximately 10% retracement in the price level. This means that by May, the S&P500’s fair value was closer to 1990 than where it was trading at ~2100 points. The FTSE250 trading at ~17000 was worth around 15,300. The ASX200 trading at ~5400 was worth about 5100. Commodities, led by the energy basket, had gone up by almost 25% in six months across energy, precious metals, iron ore and most softs. Interest rates were being cut globally and Australia was one of the few developed countries to have a base rate above 1%, let alone positive.

Once the statistical signals had been received and global credit spreads were taken into account it became obvious that by the end of May almost all of the “smart money” had departed the equities markets for long term bonds. That included us. Aggressive smart money was also beginning to accumulate positions shorting equities in the US. That included us, to a lesser degree of exposure.

The one thing that very few investors saw coming was the Brexit result. Alongside the continued “expensiveness” of global equities and commodities, falling global bond yields, was the increasing compression of the so-called predictive ability of the “betting markets” for the Brexit. We watched incredulously as the “Remain” vote was predicted, 3 weeks prior to polling, to be up near 80% likelihood. In the next few weeks, we watched the predictive markets compress this from 80%, down to 74% then to 72% then to 60% or so. In the days leading up to the poll some (not all) predictive markets were in fact predicting (correctly, as it turned out) that “Leave” would win the day. However, the predictive markets were not conclusive in the days before the polls, unlike, say the Iowa Electronic Markets are always conclusive (eg. Obama’s victory over Mitt Romney) many weeks before the ultimate outcome. I might add here that UK betting houses cleared a lot more in “wagers” than were wagered on the Iowa Electronic Markets in the Obama vs Romney election, but with spectacularly poor predictive capacity in the end. The Wisdom of the Crowds logic follows that the more money that is “wagered”, the more accurate the prediction will be. Now that doesn’t seem to have been the case here, does it?

As the results from the Brexit poll became clear, what became clearest of all was the phenomenal degree to which the financial markets (with the exception of the vol in GBP options markets) got it wrong. Our job is to make money on the way up, then not lose it when the market comes down. Global financial markets were already quite fully priced even as the English polling booths opened. We had taken profits in the market from mid May and found solace in cash, some long term bonds, short equity positions and the USD.

Arminius’ global macro hedge fund made money on the Brexit vote, even though we do not make bets on political events. We invest our clients’ money on the basis of quantitative statistics about the market, and our quantitative models told us in mid-May that risk in global markets was too high. Therefore we shifted 95% of our fund to the safe haven of cash & bonds, which is where it will remain until at least 01 July. As a result, we have avoided the market falls which followed the Brexit vote, and the Fund made profits on some market neutral short positions in the US equities market.

Full disclosure: I did make AUD$100 on a bet with an American colleague that the English would vote to leave. Cold hard cash, baby.

For a more detailed interpretation of our perspective of the Brexit fallout, please consider our article “THE WORST IS YET TO COME FOR YOU, ENGLANDER” which will be released on our website Wednesday, 29th June.

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