Have access to capital, and don’t lose what you’ve accessed opine the fund managers of the Concorde-VM Absolute Return Fund Ferenc Faragó and Tamás Makara, otherwise known by their blog alias as Vakmajom and Veermedve. Markets are better informed than journalists, which is why the two fund managers base their investment decisions on pricing trends. They manage the Fund as if they were looking after their parents’ money.
According to a known theory, assets picked randomly by a monkey can generate returns matching those of funds selected by trained analysts. But surely many of our readers do not know the origins of the name Vakmajom [Blind Monkey] and who the Vakmajom Team is. The below interview was originally published by privatbankar.hu.
Ferenc Farago: It’s an old story, with little relevance. I was regular contributor to a forum on the stock market, and I had to pick a name. Why my choice fell on this I can’t quite remember, perhaps it was a bit of a joke about the fact that a random technique can generate better results than people professionally devoting themselves to the business of fund management… But I never meant it really seriously, that one should treat stock markets as the casino.
On the contrary, it is sensible to consider what one should invest in. A well planned investment strategy can generate better returns then buying the index, say the S&P 500 for 20 or 50 years. And, going back to the name of the fund, it is called VM, rather than Vakmajom. At the time I was writing under the Vakmajom alias Tamás used to contribute to the forum as Veermedve, later we established VM and VM Co.
So the name just stuck?
Tamas Makara: Yes, it used to sound funny.
For a long time you operated in complete anonymity, in fact the press conference that was held to launch the VM Fund, aptly, in the Zoo, neither of you were introduced, your real names were a mystery.
FF: Yes originally, when we were approached [by Concorde to manage the Fund] we suspected it will come with obligations that go beyond the strictly speaking management of moneys. We considered it and decided that we’ll not look for publicity. This is the second time we give an interview, and we are only doing it to not to break the series. (A four piece interview series introduces the fund managers of Concorde’s four absolute return funds – the editor.) There are people who enjoy publicity, we don’t.
But you post something on the Vakmajom blog with almost daily regularity.
FF: That’s’ different, it’s a different form of communication, there I am in charge.
TM: It is also different in that it is usually about markets, and not about our personalities. Pushing yourself in the foreground is not a good position psychologically, once you state your view – makes revising it much more difficult.
FF: It’s also a bit of a superstition, a personality trait. There are people who will happily share what they are doing and it has no impact on their activity, I’m not like that. It is at times necessary to accept certain public engagements, but I certainly don’t seek these, because in these situations I get asked questions which imply that I know something – why else would they be asking me. I believe this assumption is wrong, I mean, if one assumes that one is in possession of special abilities, it reduces one’s intellectual flexibility.
Tamas Makara and Ferenc Farago
A healthy disposition is that one has confidence, but is also mindful of the limits of his own abilities – and so has to be able to adjust prior views, should they turn out to be wrong. The disposition, which is also implied by an interview situation, that one knows something, which is why one is asked for an interview, has detrimental effects on daily decision making. This kind of confidence in one’s own abilities reduces the capacity to adjust. This is why we don’t like giving interviews.
If your assumption is that you know nothing, than how do you invest? Do you assign probabilities to various possible scenarios?
FF: Tamas’ and my views are the same in this regards, we are trend followers, we do not intend to guess what will, or should happen – instead we assess which outcome has a higher probability based on past analogies, i.e. looking at the behaviour of assets in similar situations in the past which outcome had materialised with greater frequency. This approach does not give much space to individual conviction about which way the world or a particular asset is, or should be going, although subjective opinions can’t be filtered out completely. But our main focus is on predicting the higher probability outcome based on past analogies.
This is the main tenet of our approach, and it is not based on mere theory. As a conservative investor I always prioritised retention of capital over earning a profit. You can only play this game if you have access to capital, and you manage not to lose it. To protect capital one has to ensure that the damage of a wrong decision is limited. You have to apply risk management, and your risk management can only be defined in relation to the price of an individual asset. This then implies that it is the progression of price that needs to be followed, implying a technical approach to investment. This idea of risk management lies behind the fact that if you use the stop loss mechanism, you have to accept asset price as the primary indicator, and if this is so, you can’t argue with the market. The market dictates.
Stop loss orders?
The use of stop loss order is an order placed with a broker to automatically sell a stock if it reaches a pre-determined price, thereby avoiding significant losses. The order is activated automatically when the asset reaches the pre-determined price, with or without limit price. So for example is someone buys OTP shares for HUF 4100 and is expecting the price to go up, but would not like to lose more than HUF 200 per share, than they can give a stop loss order at HUF 3900; when the shares hit the specified price the brokers will automatically initiate disposal of the stocks.
TM: To illustrate it in another way; let’s assume that someone buys a share for 100, because he thinks it is undervalued and is worth 200. And then he is holding it until either the price of the share goes up, since on a fundamental basis he believes it should be worth 200, or his opinion changes. In this case there is a possibility, that by the time our hypothetical investor receives such news that convince him that his stock should not be valued at 200, but less, the stock is only worth 1, that is one hundredth of the initial price paid.
If we buy something for 100 and following our purchase the price does not behave the way we expected, we need to rethink our investment thesis. Our normal disposition; that we don’t assume to know anything is multi-dimensional; we know for sure that we don’t want to lose much, and this is of primary importance. Even very unlikely, low probability events happen at times – no one thinks they’ll crash when they sit in the car, or that a gape in the road will open beneath them!
The other issue is that when we take a fundamental approach, because we do at times – it is very easy to get trapped in the pitfall that one builds up an investment thesis, and believes certain things to be facts, but in reality there are very few things that we may know are facts. One may have read things, or heard things, or has a belief, but to deem these as facts is very dangerous. It is very easy to commit this mistake, especially if one reads the papers and has an economic background.
FF: Well, not all of us have an economic background. Tamas is an economist by training, but I’ve studied humanities, Latin and Ancient Greek, so I’m intact.
TM: It is very easy to believe things that have not been verified, which are not true. One must be alert not to believe that he can understand a system as complex as the economy. It is possible to examine certain hypotheses, but these are not certain. So if the market proves us wrong we need to review our thinking, at least that’s our approach.
You mentioned that pricing is key, which is the view of technical analysts; you also mentioned the fundamental approach. How can you combine the two?
TM: We use both approaches; at times we have fundamental views about something at times not. We also constantly examine price charts, and at times this gives us certain views. We have a basic rule though; no matter how convinced we are of a certain position from a fundamental perspective, we only take the position if this view is supported by pricing behaviour. And if it isn’t we wait, until the pricing moves in such way that a sensible entry point is presented. Then we take the position and manage the risk by a sensibly placed stop order. And as part of the rule, we only take positions in sufficiently liquid assets. If you use stop orders and trade on a technical basis, you must choose assets that you can exit without significant extra cost, and immediately!
No matter how much we like an illiquid corporate bond, if the evolution of pricing is not transparent, or we do not believe that we can exit as and when we wish to at market price, we don’t buy it, we don’t expend further thoughts on it either.
So any fundamental idea must satisfy technical criteria before you invest, how about the reverse, do you judge your technical ideas from a fundamental aspect?
TM: No, we do not hold up the reverse. What sometimes happens is that although the price behaves well from a technical aspect we do not invest as we deem the particular investment too high risk, so although it would have been okay from a technical perspective it failed to pass a fundamental filter. Or sometimes we do make the investment, but take a much smaller position then we would have on the basis of the technical aspects. However it is also possible that an asset behaves really well from a technical perspective, and although we don’t from a fundamental perspective understand why, we buy it.
Very often the market knows news before we do – there are better informed players then us. You have to believe the pricing. We really like it if there is activity on the market that we don’t understand. By the time the price reaches the point where it was heading to, usually everyone knows why it’s there, however, it would be too late to take a position at this stage.
FF: At times one can’t understand why the price of a certain asset behaves so that it is a sell or a buy, as there is no new information. Most price movements are like this, they happen without one knowing why – this is the best, riding on a price change that is yet unexplained, as not very many dare to buy into the changing asset at this stage. The most valuable part of any change in pricing is when investors don’t yet believe there is momentum.
An example, which often happens in the case of the HUF, is that the exchange rate starts creeping up, but nobody acknowledges it, the press does not even mention it until it knows why. The minute they understand it, it’s news. So, it would be an oversight not to participate in price movements until we knew the fundamental reasons. Another – fictive – example: a listed company, say an insider has a shoe factory. It receives a huge order from say the Chinese army. The first sign will not be a stock exchange announcement, but rather someone or some ones will start buying the stock like crazy. The shares double in price and a financial journalist asks why. What would the insider respond? If he hadn’t bought enough shares yet, they’ll say they have no knowledge of any significant new event. Once they bought sufficient amount of shares, and who knows where the share price is by this point, that’s when public announcements and press releases are made. Then everyone understands the fundamental reasons, but it’s too late. Of course this is an extreme and fictive example…
TM: …and let’s not go into the legal implications.
FF: Of course, in todays, better regulated markets this is not possible, but we saw similar examples in the past. And similar symptoms are still present, if not in such an extreme form. This is why we think that the evolution of price is the primary source of information, because it is the cumulative expression of the knowledge of all market participants.
So, in 2005 Concorde Asset Management approached you, what was the initial idea?
TM: Initially we were discussing some form of cooperation, and then we came up with this Fund, which at the time was a ground-breaking construction in the field of absolute return, derivative funds.
FF: The concept was shaped over long discussions, and then further adjusted after the Fund started operating. Just because we both had experience in managing our personal portfolios it hadn’t fully prepared us to investing a Fund. At least for me it was a surprising psychological burden – and I didn’t take it very well. Not the risk in itself, I had no problems with investing for myself, but the responsibility of managing someone else’s money. It took me two to three years to get used to it, and it is still an on-going process, but I’ve learned to handle responsibility.
This is beautifully illustrated by the NAV chart of the Fund, as in the first three years it moved completely in tandem with the benchmark.
FF: Yes, although we did trade a lot, but only took miniscule positions and very narrow stops. The Fund’s risk exposure was considerably less than what’s required to achieve its target returns. This was a learning curve!
TM: In our minds, we thought about the Fund as if it was our parents’ money, and we managed it as such. If a person’s savings are sufficient to maintain his lifestyle then his aim is not to make a 50% or 100% return but to have slightly higher returns than keeping the money in the bank or in a money market fund. You can’t take risks that would lose a pre-pension aged person 20 or 30% of his savings.
Our hope was that with sensible risk taking, we can achieve a slight outperformance. Obviously we’d like to produce a significant outperformance for the Fund, but this is a secondary aspect to avoiding any significant losses. The primary principle was held up even in the first three years of the Fund’s life; and more recently, say over the past five years, the Fund also achieved significant outperformance, although clearly our goal is to increase this. (The five year cumulative return of the fund was 15,08% on 24th July 2013.)
Then in 2008 your ‘apprentice years’ were up, and there was a global crisis. The Fund started to behave differently. In 2009 it achieved a positive 23% return, in 2010 positive 11.5%. What had changed?
TM: Already in 2008 we increased the risk exposure of the Fund, and we achieved a positive return in a relatively hostile environment. At that point our risk exposure was set correctly, except we didn’t anticipate the extent the markets will fall. We predicted many things correctly, made a few mistakes, but mainly we handled risk very well, so in the end the cost of mistakes was not significant and the investors came out with a net gain at the end of the year.
Then, in 2009 things started to fall into place, we read the market better; we had the right risk exposure – although, of course, in hind sight winning positions always seem to have been set too small and losing ones too large. However, hind sight is always 20/20.
Over the years the fund has grown a hundred fold in size from HUF 330m to HUF 33bn. Did the psychological pressure increase a hundred fold too?
FF: Not at all, we got used to that over the first two or three years.
TM: Whether you risk the savings of a hundred investor or a thousand, the responsibility is the same, the absolute figure does not matter. However, Fund size is significant from a liquidity perspective. The size of the Fund determines what assets are deemed sufficiently liquid, i.e. what assets can we trade in and the maximum position size we may take.
How about the more liquid Hungarian papers?
TM: From our perspective the “more liquid Hungarian paper” does not exist. Although the market for Hungarian government bonds is more liquid than the market for Hungarian equities, but the Fund is managed with a global perspective – and Hungary is just a tiny speck on the map. Of course, we need to account for the fact that this is a HUF denominated Fund and we need to maintain real value. For this reason we devote particular attention to the EURHUF rate. This does not mean that we actively trade this currency, but we can’t disregard the exchange rate, we need to ensure the protection of the investors’ assets from this aspect as well. This aside, Hungary has no specific significance.
Does this mean that you hedge the currency risk of any foreign investment against the HUF?
TM: Yes, we always hedge the exchange rate risk of foreign currencies, as we always handle separately our beliefs about the expected performance of a stock-market index, or a bond and our expectations about the currency it is denominated in. It is possible that we’d like to take positions in both a stock and the currency, but then we take these positions separately, with separate stop loss orders for each position. But this is not an issue when we take futures positions, so for instance, if we take a futures position in a US stock market index we don’t have the same currency risk we’d have if we bought the stocks directly.
Although there is not a liquid futures options market for Hungarian government bonds, but because most of the portfolio is held in government bonds, we can change the duration of these assets depending on our views. We always buy the bonds directly on this market.
The 2012 September Managers’ Report mentioned gold and S&P500 positions- do you list all your positions in the monthly report, or only the most significant ones?
TM: We always have considerably more trades than what we write about. And a significant proportion of our positions are very short lived, either because they were planned that way or because they were automatically liquidated due to the stop loss order. We don’t hold on to losing positions.
FF: I believe the Fund never held a losing position for more than two days. This is not necessarily always good, but it’s a fact.
TM: This is how we operate. Even eventually winning positions may have been taken at the fifth attempt only because previously we could have four times tried to take the position and failed due to the stop loss order kicking in. This way we lose so little, it does not even show up in the Fund’s price chart.
FF: If the managers’ report contained every detail it would look something like this; the Fund took 58 positions of which 52 were promptly stopped out, the Fund held the remainder for longer, however currently it only has a single position remaining, which it continues to hold. On the surface it may seem like we’re not doing much, as the Fund’s volatility is very low; however there are a great number of trades behind this, there are occasions when we trade the value of the entire portfolio in one day. As trading on the futures markets are relatively cheap, we don’t lose much on fees and commissions – what’s really expensive is if we get something wrong! Equally we may hold winning positions for months.
Our Hungarian readers follow the EUR HUF rate, OTP, other significant local players, the BUX. Do you have any views on these?
TM: We prefer not to talk about these. We prefer global themes if you’d like to discuss current matters.
US elections? The position of the Euro zone?
TM: In the US, I believe, the main question is not around monetary policy but fiscal policy, and whether there will be any fiscal tightening. So we follow very closely how the markets react to any news in this area. While the decision makers still vacillate between tightening or simply the lack of further stimulus, there have been some encouraging signs from the consumer side – new car sales were up, and there are positive developments on the real estate market too, and the markets have, from a technical aspect, confirmed theses as well. The price of a number of assets shows that the market has come to accept this. This may potentially be very important.
In Europe, although it is in a different position, the impact of forcing fiscal tightening will be decisive. However, in Europe changes in the monetary system do have significance. This is why Europe could sustain most of the increase that took place after the announcements in early autumn. However, all this is secondary to the evolution of fiscal policy globally.
The world just now is a bit similar to Japan, not in what our prospects are in 20 years’ time, but in that when there is a fiscal stimulus there is some sign of growth, but when there is tightening, for example due to high levels of deficit, the growth is stunted. Although a lot of people currently expect high inflation and raised interest rates, these will not be maintained long term.
FF: We always think about what will happen, but if we want to make money, this is not enough. The really interesting situations are when a wide spread consensus picture of the future is formed – say for example that there will be fiscal tightening in the US next year. This expectation is priced in by the markets and is reflected in lower asset prices. In case the fiscal tightening does not happen, or if the deficit is raised even further than this provides a great opportunity, as asset prices will have to go up, when everyone comes to realise that a different scenario is materialising than what’s priced in the market.
Our job is not merely to think about what’s expected, but to think about what will happen when reality pans out differently from what’s priced in the markets. For instance markets were expecting the collapse of the Euro zone and this was priced in by the market. The mere fact that nothing happened was sufficient to push up the value of the Euro.
What’s the division of labour between you? What happens if you disagree? Is there any grating between you?
TM: We constantly discuss the market. We understand each other well, as we have had daily discussions on the markets since 1998 – occasionally we missed a weekend. However, you can’t always call an investment committee meeting for every single investment, if the investment is within the normal risk exposure than either of us can take the decision independently, and tell the other later- in this case we don’t have a joint decision making process. Of course, the risk that may be associated with an individual decision is tiny. In situations where the risk exposure would be higher, but we’d still want to invest as we believe it to be an important opportunity, we take decisions jointly, and determine the maximum risk exposure.
FF: But most importantly there is two of us, as managing the Fund is a great responsibility, it is better having it spread. It allows us to go on holiday once in a while; it also ensures a certain level of control. The responsibility falling on the individual is big, that’s why there is the two of us.
TM: Coming back to my point when I say the risk associated with an individual portfolio decision must be tiny; by tiny I mean 0.1% or possibly 0.2%. This is the maximum loss to the portfolio that may result of an individual decision, should it turn out wrong. When I say larger risk exposures, for joint decisions, it usually means about 0.5% to 1%, this is the maximum loss to the assets of the portfolio, and it is ensured by setting the stop loss order correctly.
What was your best and worst investment?
FF: I have a “here is one I made earlier” response to this; I don’t have one and I don’t wish to have one. Although, of course I’d quite like to have a best investment but then I’d necessarily need to have a worst one too, and that I really wouldn’t like. In my very early years I did have some spectacular investments, good and bad – in my very first year I had some amazing trades. But I mainly remember the opportunities I missed – like investing in certain technology stocks at the time of the technology boom.
TM: Out of tens of thousands of positions one can’t even remember. There is not a particular single investment which would stand out. I never lost so much on a trade that it would have been significant. Our best investment was that in 2008 the Fund was positive! If we hadn’t been so vigilant about setting the stop loss orders, we could have lost a lot! Our method saved the Fund from any significant loss.
The managers’ short bios:
Ferenc Farago was born in 1967, and studied Classics, in Budapest. He has been involved with the capital markets since 1996. Since its launch in 2005, he is co-manager of the Concorde-VM Absolute Return Fund. He is a director of VM and VM Befektetési Alapkezelő Zrt. [a Hungarian regulated asset manager]. He runs a blog at vakmajom.hu
Tamas Makara was born in 1969, and graduated from the Budapest Economic University, where he later gained a Ph.D. Since its launch in 2005, he is co-manager of the Concorde-VM Absolute Return Fund. He is a director of VM and VM Befektetési Alapkezelő Zrt. [a Hungarian regulated asset manager]. He is an associate professor of the Investments and Corporate Finance department of Corvinus University, Budapest, and mainly lectures on quantitative financial subjects.