When Christopher Foster expressed interest in working in futures after graduating from the University of Toronto, his dad, a portfolio manager, told him there was only one place in Toronto to find a job in that field — the Friedberg Mercantile Group (FMG).
Albert Friedberg ran the Toronto-based futures investment and brokerage firm and Foster pestered Friedberg until he gave him a chance.
Foster worked as a broker and then an associate portfolio manager, and he served on the investment committee for FMG from 1989 to 2000. But most importantly, he learned the business from Friedberg. “He was a passionate teacher,” Foster says.
While Friedberg took a global macro approach, one element of his trading that intrigued Foster was the study of sentiment. “You know how these [global macro] traders are,” Foster says, “they throw everything into the hopper and trades will come out. He was a fundamental trader, but he [also] looked at sentiment.”
While sentiment for Friedberg was just another factor to consider, Foster wanted to systematize the approach and went about building a strategy based on sentiment when he left FMG.
The industry was becoming more institutional and the era of managers producing huge profits with large drawdowns was ending. “[Friedberg] had a great long-term record, but the volatility was just mind numbing,” Foster says.
“I knew the appetite for those types of programs was waning. Investors were becoming much more sensitive to volatility,” he says. “I wanted to develop something that was much more systematic, had more [stringent] money management rules and used sentiment. That was the birth of the program in the late ‘90s.”
He would move on to Scotiabank in 2000 where he developed his sentiment strategy and pitched it to clients. One client, Chris Harrop, who would become a partner in the fund, liked the idea so much that that he helped set up an offshore fund to trade it. The two ran it as a separate offshore fund, Blackheath Offshore Limited, while Foster was still at Scotia. In 2008, they went off on their own, registering Blackheath in Canada in 2009 and in the United States in 2011.
The program trades 25 liquid U.S. futures markets on a medium-term basis and has produced a compound annual return of 16.97% since 2003. It was up 16.80% for 2011 through November. Blackheath manages $31 million in its sentiment strategy.
While Foster credits Friedberg with giving him his start, it was trading legend Bruce Kovner who shaped his philosophy. “He basically said, ‘Always be very alert when sentiment diverges from price action.’ I took that to heart,” Foster says.
He says it would be wrong to assume this is a contrarian approach. Basically he is looking for a divergence between market sentiment and price action. If price is going down and sentiment is not, that is a bearish divergence, which causes Blackheath to sell short. “Conversely, if a market is going up and sentiment is not rising, those are positive divergences and that prompts us to buy a market,” Foster says.
He explains, “If the market is going up and people aren’t getting more bullish, it tells you, 1) there is not a lot of hot money in the trade and 2) commercial participants are probably selling into the market. That is a pretty strong market. Those are the kind of inputs that will put us into a trade.”
That begs the question: How does Blackheath measure sentiment? Foster has three approaches. He looks at numerous regularly published surveys on market sentiment, he studies the Commodity Futures Trading Commission’s Commitments of Traders (COT) report and he looks at anecdotal information. That simply could be news headlines or a more complex study of the options put/call ratio.
On the COT data, Foster looks at what the various participants are doing compared to price action. “If I see a currency go up and the small spec and CTA participation is not increasing, that is bullish divergence.”
While the program is not contrarian in nature, it has produced non-correlated returns to traditional trend-followers. It had its best year, 31.65%, in 2009, a difficult year for most CTAs. The strategy often catches people on the wrong side of the market who eventually will have to get out of their positions and move the market in their favor.
“In my fantasy scenario, at the end of the move people will say, ‘Oh my God, I am totally missing this market; I have got to get in,’ and then there is a stampede into the market. That is my opportunity to get out,” Foster says. “Buy it when people are ignoring it, and sell it when people are stampeding to get into it. It never works out exactly that well, but that is our cue to get out of the market, when sentiment finally catches up with the price action.”