FM: Tell us about your risk management process.
KK: We’re a small team of five people. But three of those people are intimately involved in the risk management process. Every night we go through our portfolio. We have stops and targets and we look at each individual position. We look on a portfolio basis also and at what our risk is overall. After that we go through the portfolio and look at it in terms of where we are in our P&L, from our year-to-date and from our peak.
We [determine] how much we want to risk given where we are. We have certain parameters that are set up where we view risk and every night we check to see where we are relative to those parameters. If we are outside [them], then we’ll de-risk some of the positions in the portfolio. So we have a very systematized approach to risk management where you take the over-thinking out of it. We have rules where we add risk, and we have rules where we take risk out of the portfolio. And that is very similar to what I learned at Tudor, except not as systematic; but now we’ve taken it and given it our parameters so we know exactly when we’re cutting back and when we are adding.
FM: What would be your dream market? And conversely, is there a nightmare market?
KK: There isn’t a dream market. There’s always a cycle some place, so we don’t need a bull market or a bear market. We find opportunities in everything. The tough markets are the ones where there is no follow-through because by the time we have an investable idea we’ve spent so much time on it. Going through the data and the analysis that if we got the inflection point right but there was no follow-through, that’s tough. Like the crude market this year, which seems to be about to go down then it comes screaming back, then starts to go down, then comes screaming back and ends up being a great big sideways range. Or the gold market for the last month-and-a-half. That’s tough.
FM: Tell us about some of the more difficult markets you’ve seen and traded.
KK: Well, 1998 was pretty interesting. You know, we tend to view commodities and most of the markets we trade as cyclical. So there’s always a cycle someplace that we’re looking to identify and figure out the inflection point in that cycle. We’ve seen a lot of those over the years and some were bigger than others. That whole increase in volatility in macro markets over 2007, 2008 and 2009 — those were interesting and challenging times.
Watching 1998 evolve was pretty fascinating. There was Europe and the introduction of the euro. We also went through the Asia crisis and [saw] what that meant for commodities markets, given that was the marginal source of demand. [Some] different things have changed dramatically over that time. One, that there was this passive investor in the commodity markets that was long-biased that made it harder to use fundamentals to analyze individual commodity markets — but now that flow seems to have stalled and slightly reversed. That’s probably the biggest change.
FM: You watched the trading go from open outcry to almost exclusively electronic. How did that affect the markets?
KK: It just brought our commissions down a lot and forced the creation of a more specialized market maker or broker. But for us, we’re not really high-volume, so that hasn’t been as big a thing.
FM: Do you think the high-frequency traders are having much effect on the markets?
KK: No, not really. I mean, people complain about them when they’re losing money and say that it’s all high-frequency traders’ fault. But I don’t see it as much of an economic phase; it’s more of an equity thing. But volatility has definitely gone up a lot. The trends are not as long as they used to be. There are some things you can partially blame on [HFT], but it’s hard to say if it’s that or just the access to information we all have or faster response times brought about by technology. I’m not sure.
FM: Well, something else you’ve seen change completely over the years is the access to information. How has the information flow changed things for the professional trader?
KK: I think it’s a way to differentiate yourself because we all have the same information, so it comes down to the framework. I actually think for us that it’s a good thing because we have a very different framework for evaluating the market. So I think that comes through even more clearly.