Piece from the Dan Collins Report on trend following:
There was an odd story in the Financial Times last Wednesday titled, “Quant hedge funds hit by US bonds sell-off.”
It was odd in that it treated a rather obvious observation as something more ominous and didn’t seem to have an understanding of the industry they were writing about. It further identified the “quant hedge funds” as “so called CTAs.”
Someone needs to inform the FT and the author Sam Jones that CTA is a term of art, a regulatory designation meaning Commodity Trading Advisor (CTA). These CTAs trade futures contracts through various strategies on behalf of customers to hopefully earn positive returns similar to equity based mutual funds. Unlike mutual funds, however, CTA programs are absolute return vehicles that do not rely on positive equity performance. CTAs can go long or short a variety of futures markets across numerous sectors including fixed income, currencies, equity indexes, energies, livestock, grains, metals and soft commodities.
Here is what they need to know. A large portion of the CTA universe is made up of systematic diversified medium- to long-term trend followers. (This apparently is what the FT was describing as quantitative hedge funds). That means that when certain markets and market sectors have sustained trends, CTAs are likely to earn strong profits. They will give some of those profits back when those trends end and may face significant losses when those trends reverse dramatically. It also means that they are likely to struggle during sustained periods of choppy non-directional markets.
I haven’t been reading the FT every day so I don’t know for sure but doubt they are in the habit of pointing out every strong run CTAs have. In fact, they did acknowledge that some of these managers are having a strong year despite the recent drawdown, it somehow saw as a scoop. They described what happened but didn’t quite seem to understand. These managers earned money on the trend and gave some back as it reversed. That is what trend followers do.
The losses the FT cited were not extreme and not so unusual: It noted Geneva-based BlueTrend was down 4.4% for the month of May as of May 24; Graham Capital was down 3.9% for the month, Holland-based Transtrend was down 3.1% and London based Winton dropped just 2.5% in May and was still up 6.5% for the year. The FT should have looked at some of the performances in 2011-12 where most CTAs struggled mightily.
Apparently Man Group’s AHL program had more dramatic losses, which is a testament to its size and concentration in fixed income.
While the sharp reversal in the bond market may have resulted in net losses, no trend follower gets out of a trend at the top so to report a loss based on a market reversal misses the point. Many of these managers probably did well with their bond positions and many may now be short.
If there is a cautionary tale in this story, perhaps it is to look for smaller CTAs who do not have to concentrate allocations to the most liquid sectors such as fixed income and currencies.
If the bond market continues on its current path will they report that quantitative hedge funds “so called CTAs” are doing very well because they are short fixed income?
There seems to be confusion over what they are reporting. The first clue of that is their reference to fixed income investments. While customers allocate to CTAs as part of a larger portfolio of investments due to managed futures’ proven ability to provide non-correlation to traditional investments, CTAs do not invest in certain markets, they trade them. They trade them as part of an overall philosophy that markets trend (yes there are some fundamental discretionary based CTAs but we are concentrating of those identified in the FT story) and if they can catch a couple of those trends out of the dozens of markets they trade, their strategy will produce strong non-correlated (to traditional investments) returns.
The story also stated, “Most quant funds only privately communicate performance data with their investors on a weekly – or even monthly – basis.” That is unless they offer managed accounts, as most CTAs do–in fact it is all they offer unless they are also registered and Commodity Pool Operators (CPOs)–which provides daily performance data through the Futures Commission Merchant the end users account is parked at.
Systematic CTAs do not have (or at least trade off of) opinions on the market. The don’t make investments. They will just as well trade Japanese Azuki beans as long-term bonds, the S&P 500 or crude oil futures, provided there is an active liquid market in them.
Dan is next episode coming on the podcast.