Saturday, June 24, 2017

Mixing collateral with a managed futures portfolio - Need to know marginal contributions

In an earlier post we discussed the issue of using capital more efficiently in a managed futures investment. The premise is simple. If only limited funds are used for margin, the majority of cash associated with a managed futures investment are held in low interest investments. This portion of the managed futures capital can be better deployed to increase returns. Similarly, managed futures can be used as an overlay to an existing portfolio to better use cash. See "Use your collateral wisely and enhance managed futures efficiency".

In this post, we use a simple example to look at the trade-off of risk and return when using the collateral more efficiently. We take a simple combination of two assets, the managed futures portfolio and the cash portfolio which we have set at 80% of the funds invested. Our example starts with a managed futures fund that has a 10% volatility in the table below. With the collateral investment in cash, the marginal increase in volatility is zero, so the volatility of the fund is just the risk associated with managed futures trading positions.

Any movement of funds away from cash will be affected by the volatility of the investment and the correlation between the managed futures trade portfolio and the collateral investment. We can first determine the volatility of the overall portfolio when there is an investment in a trading account and an alternative cash account. From this number we can subtract the volatility of the portfolio that just holds cash for collateral. This will tell us the marginal increase in risk from holding alternatives to cash at different volatility and correlation combinations. This matrix can be changed to a smaller investment of collateral to, say 40%. In that case, the marginal change in volatility will be lower as well as the increase in return.

If you invest collateral in a negatively correlated asset, there will be a decrease in overall volatility. If there is an asset that is liquid and can be negatively correlated with the trading account, the fund volatility can be decreased and returns can be increased to improve the fund information ratio. If there is an expected return from the collateral investment, the investor can determine what is the volatility and correlation combination necessary to have a positive marginal information ratio. This post shows that collateral management can be analyzed in a systematic manner in order to explore issues of fund capital efficiency. 

Friday, June 23, 2017

Northern Trust - EIU Survey - "See" the risk - "Know" the risk

The Northern Trust/EIU Transparency in Alternatives Investing Survey 2017 focuses on some important investment considerations from investors around the world. Once again the most important issue seems to be the degree of transparency provided by managers. This applies to both traditional and alternative managers. An investor needs to know what he is buying when he gives money to a manager. Funds are entrusted to others. The purpose for this transparency is very clear - understanding the degree of risk being taken. 

Transparency on a simple level means information. Investors want to know the contents of the portfolio and the foundation of the investment process or style, but the degree of risk is more complex issue. You may have the information, but you may not know the actual risks within the portfolio. The true demand of investors is with interpreting the data. What are types of risk being taken? What are the risk premiums being exploited? How will the portfolio react to changes in the investment environment? Transparency is more than information but clarity with the expected behavior of the manager and the types of risks hidden when securities are aggregated in a portfolio. 

Wednesday, June 21, 2017

Use your collateral wisely and enhance managed futures efficiency

Managed futures investments have the key structural feature that they do not use leverage in the sense of borrowing money to increase notional positions relative to cash. In most cases, margin requirements are a small fraction of the capital invested in a program or fund. A managed futures fund may only use less than 20 cents on the dollar for margin while 80 cents or more may be held in a custody account at close to zero interest rate. Nevertheless, some managers are more aggressive and may hold funds in an enhanced money fund or short-term bond fund to add to return. Of course, some investor will use a separate account and only provide funds for margin with a cushion.  This cuts the excess cash held by the manager. 

Generally, capital is not used efficiently with this hedge fund strategy. By efficiency we mean that returns can be enhanced by deploying more of the money in the fund in investments that have a return higher than cash. This will have an impact on overall volatility, but this can be managed to still target a specific volatility level for the fund.

A simple way of more efficiently using the capital is to employ managed futures as a overlay program so that all of a portfolio's capital is used to generated the highest returns possible. The notional trading size of the overall portfolio will be higher, but the volatility of the overall portfolio can still be managed to specific volatility target.

There is both potential benefits and costs with using the capital that is held in cash based on the correlation between the managed futures program and the choice of investment for the non-margin funds. If the funds are held in an asset or strategy that has higher volatility than cash, the net result may be an increase in the overall volatility of the fund. The portfolio volatility will be based on the combination of the volatility for the cash component and the correlation with the futures program. An investor may not want to pay for the higher volatility or return that is not associated with this use of the cash; however, that is an issue of negotiation between the manager and the investors. 

The cash component decision can be thought of as a continuum of risk and return with the base position being cash which has no correlation with the managed futures returns and has limited or no return. The manager or investor can move out the risk spectrum for the collateral usage. However, the impact on overall volatility will be related to the correlation between the collateral account and the managed futures program. If there is a negative correlation, the enhanced collateral may actually reduce overall program risk. 

The choice set of how to employ managed futures and efficiently use capital is fairly broad but can help widen the return opportunities for both manager and investor. Holding cash may be the best alternative but that decision should be made after looking at all of the choices for excess collateral. 

Tuesday, June 20, 2017

Clustering of hedge fund returns - where is the difference?

A close look at all of the HFR hedge fund index returns over the last three years shows a significant amount of clustering of styles with the only outliers associated with country and sector indices. For 60 indices, the average three year (May 2014 - May 2017) annualized return was 3.04 percent and the average annualized volatility was 5.61 percent. Outliers are focused on sector indices like technology and energy and country or regional indices like India or Latin America. 

The quest in hedge fund investing is to find managers who do not fall within the cluster but can generate better returns. Of course, the range of return and risk would be wider of individual managers but if you had to start with a simple judgment of what you will receive with a portfolio of hedge fund managers it is likely to be closer to an information ratio of .6 and a return and risk of 3 and 5.5 percent. These numbers are dynamic, but they are a long way from the expectations that managers provide information ratios above one and annualized returns over 10 percent. 

Smart beta - Why look at these investments? Diversification

The FTSE Russell annual survey on smart beta does a good job at describing trends in investor thinking with respect to this growing area of portfolio allocation. Smart beta is extending its breath and reach to other asset classes as well as a wider selection of risk premiums and formats. What is still clear is that investors are looking for smart beta in all forms to help with risk reduction and improve diversification. These are the number one and three reasons for holding exposures. Nevertheless, the fastest growing investment objective is cost savings. It is likely that smart beta is being used as a substitute for more expensive active management. 

The number one smart beta strategy is a multi-factor combination with low volatility and value coming in second and third. There is a clear investor bias for having factors blended under the name of smart beta. 

This desire for multi-factor combinations gets to the heart of one of the key issues of smart beta. At what point is smart beta allocated across a number of factors quantitative active management allocated across a set of strategies through a set of rules? The lines are blurring and this will have an impact on the costs and demand for active managers. The active manager will have to prove whether he is smarter than a smart beta portfolio.

Sunday, June 18, 2017

Can momentum and diversifications solve every investment problem? Perhaps.

I listened to a number of presentations concerning crisis alpha and crisis offset at a recent hedge fund conference. The idea of holding assets and strategies that will do well in "bad times" is a critical issue for any portfolio construction discussion. It is the bedrock and foundation of any portfolio that attempts to protect against bad states of nature, control risk, and gain during good times.

There are two solutions that will mitigate negative return extremes in any crisis:

1. Diversification - Loses will always be less even if correlations increase during a crisis if there is a well diversified portfolio in place. Nevertheless, diversification is not a "one size fits all" solution. The level and choice of diversification is an active decision no different than the choices made to increase return. Diversification is an active bet on correlation and volatility. 

While not oversimplifying, different asset classes and strategies have different responses to "bad times" or crises. Hence, the cross-asset returns and correlations will change with the business cycle and with changes in the financial environment. If there is the expectation that crises are more likely, investors should be increased demand for assets that have characteristics of negative or low correlation during these states. 

2. Momentum  - Increase allocation to winners and cut exposures to losers. This is the simplest form of momentum. The next level of momentum trading is to short losers. Everything else could be considered just extra to portfolio construction. Of course, there are numerous ways of measuring winners and losers and there can be wrinkles based on forward expectations, but the concept is still very straight-forward. Momentum may not predict a crisis, but if a crisis occurs, momentum will help any investor to get on the right side of the market move. The adjustment from momentum occurs without even a clear view on the how or why a market declined. It is non-predictive and simply responsive to market forces.  In a macro sense, momentum adds the equivalent of option gamma to the portfolio.

If you want to add an extra, do one thing:

Risk manage the portfolio - Allocate based on volatility (higher volatility tied to lower risk exposure). Target volatility so that if correlations move to one there is a cut in overall risk exposure. If the momentum signals will not adjust fast enough to market directional changes, then use stops to exit the market. 

Asset management may not be that simple in reality, but it can be that simple in terms of guiding principles. If in doubt of what should be done in any situation, the guiding principles of diversification and momentum can serve as a first pass for construction. 

Saturday, June 17, 2017

Two components of active management, style and skill - Investors need to choose both wisely

There has been much discussion about benchmarks and beta with hedge funds, but it is important to take a step-back and discuss how active returns are generated. Active management can be divided into two parts, the style used and the skill employed within that style. You can call a style a risk premium as is the case for value or small investing; however, all returns from styles may not be from risk premiums. Style is simply a descriptor or means for generating returns. Skill comes with the method of employing the style. Within a style, some managers are better at it than others. 

Styles will differ because they attempt to capture different return streams. A value investor will be different than a global macro manager because they are attempting to find different return phenomena. A momentum manager will clearly be different from merger arbitrage. If the style is not associated with a clear risk premium, then it may have to be measured by a peer group. In this case, skill is ability to beat the average of a set of peers. 

Styles may go in and out of fashion no different than risk premiums may be time varying and change with a market or business cycle. Hence, there can be a skilled manager within a style, but if the style is generating poor returns, the manager's skill may not be able to offset the negative style effect. Finding the best may not be good enough. Style choice and diversification matters. Some will say choose your manager wisely. Perhaps more important is choosing your the styles for your portfolio wisely. 

Friday, June 16, 2017

Quants vs. Discretionary - Numbers vs. Story - Is one better?

Most of our quants have a computer-science background. They can code in either Python or C++. Whereas on the discretionary side most of them come from a more traditional investment-banking background and are digging into 8-Ks and company fundamentals and being able to look at companies from a bottom-up perspective as compared to trying to use many different data sets to help predict the prices of stocks.
-Ryan Tolkin CIO Schonfeld Strategic Advisors 

As the old joke says, "There are only two types of people - those that type others and those who do not." However, this dichotomy may be applicable for current money management. There are two camps of analysis, the quants who are looking for repeatable behavior in data and the discretionary analysts who are looking for unique or special situations across markets. The quant plays the averages and the probabilities while the other places value on what cannot be counted and handicapped. One focuses on the numbers while the other looks for the firm story as a thesis for investing. 

Is one better than the other? I would say that it depends on the problem to be solved and the market to be analyzed, or whether the focus is on counting or the focus is on uniqueness. There is a continuum on research processing. At one extreme will be the focus on large data and an analysis of statistical relationships based on counting versus the other extreme where there is little data that is countable and research requires looking for similarity or a limited number of cases. 

An example of a countable market will be the mortgage-backed securities. There is a lot of data to measure relationships. An example of a countable style will be statistical arbitrage. The alternative is a style that is based on "newness" or a market that has limited data A case-based approach is more applicable for analysis of tech firms and an example of a discretionary style based on uniqueness may be deep value. The approach to research and analysis is affected by the choice of markets and style. In case-based approach, there is a premium on story-telling.

The research approach matches the sale and market. There are reasons for quants focus on some markets and investment-banking types focusing on others; however, an interesting intersection will be those researchers that can marry numbers with story-telling.

Wednesday, June 14, 2017

Language, perception, and numbers - The translation problem

“March Hare: …Then you should say what you mean.
Alice: I do; at least – at least I mean what I say — that’s the same thing, you know.

Hatter: Not the same thing a bit! Why, you might just as well say that, ‘I see what I eat’ is the same as ‘I eat what I see’!

March Hare: You might just as well say, that “I like what I get” is the same thing as “I get what I like”!

The Dormouse: You might just as well say, that “I breathe when I sleep” is the same thing as “I sleep when I breathe”!Lewis Carroll’s  - “Alice In Wonderland”

“If you cannot say what you mean, your majesty, you will never mean what you say and a gentleman should always mean what he says.” – Reginald Fleming Johnston (The Last Emperor)

 “let your yea be yea; and your nay, nay.” - Matthew 5:37

I meant what I said and I said what I meant. An elephant’s faithful one-hundred percent.  - Dr. Seuss book “Horton Hears a Who”.

When managers or investors use language, there can be a significant amount of uncertainty in what meant. There is little precision in language so quantitative analysis provides more details in the highly competitive money management field.

This issue of imprecise language was first discussed by the CIA analyst Sherman Kent who identified the problem in the reporting by other analysts. If someone says that an event is "likely" what does that really mean? Sloppy language leads to sloppy thinking. We have discussed this issue in the past in our posts Sherman Kent - the godfather of precision in forecasting language and What does failed intelligence tell us about investing, but we came across an enhanced analysis based on survey work. A large number of people were asked to provide probabilities to different word phrases. This information was translated into these beautiful graphs. See these posts for more information on how the graphs were constructed. Look at the high degree of uncertainty associated with these phrases. Be warned; someone who tells you that something is unlikely will still have a median of 20% chance of occurring. A probable outcome has only a 70% median with a range of plus or minus 20%.

The same problem applies with perception of numbers. A lot could mean anything from 10 to 100. Scores could be close to 100 but range from less than 10 to 100,000. The operative phrase is "watch your language". 

How many times have you sat in on an investment meeting only to have those around the table use "squishy" language which has no meaning? (I have been to dozens.) It is a fine way of avoiding accountability. Of course, numbers can be used to provide a false sense of certitude, but given a choice; I will take the precision of a number. The number can be checked and verified. The lesson from "super forecasters" is that the process of adding precision to a forecast improves the forecast.  

Momentum as the big embarrassment to market efficiency

“Momentum is a big embarrassment for market efficiency,” he proclaimed, saying he “hopes it goes away” and that the concept was “not exploitable.” - Eugene Fama from CFA Society of Chicago keynote speech.

“Never let the truth get in the way of a good story.”― Mark Twain

You cannot help but think about Thomas Kuhn and The Evolution of Scientific Revolutions when there is now a discussion of market efficiency. During the 70's and 80's market efficiency studies "proving" this hypothesis took the field of finance by storm only to have alternative studies and work chip away at the theory through the 90's and 2000's only to currently be relegated to a simplifying assumption or a view as "frictionless" market. 

Thousands of finance students and MBA's were indoctrinated with the idea that markets were efficient. We now have behavioral, limits to arbitrage, transaction costs, agent-based, and time varying risk premium stories to explain momentum and trends in prices. The theory of finance is much broader and those that were efficient market supporters have had to adapt and change their views.

Still financial markets are competitive. It is hard to make money in money management. Few have been able to beat benchmarks. Passive low fee investing is a good investment starting point. Perhaps excess returns are mainly compensation for the hard work of finance or the compensation for risk. Nevertheless, the momentum and trend-followers who were outside the mainstream can take pride that their efforts were not in vain. They were rewarded with profits and now the knowledge that those that said it was not possible have to eat crow. 

Monday, June 12, 2017

Should I care if a managed futures fund has a five-star rating?

So you see a manager with a good Morningstar rating. It has five-stars. Should an investor care? Past performance is not indicative of future returns, so should it matter if you had highly rated past risk-adjusted performance? 

Certainly, a rating is not definitive, but as a heuristic on a fund's relative performance, there is positive information to be gleaned from ratings. 

Some simple important facts across mutual fund research:
1. The Morningstar rating is done over a minimum of 3-years so it provides historical perspective.
2. The Morningstar rating is based on risk-adjusted returns that account for utility and not just standard deviation. Hence, it offers and alternative view relative to rankings by Sharpe or information ratios.
3. The rating is based on a category classification, so it is related to peers.
4. The 5-star and 1-star ratings each represent 10% of the sample, so it is hard to maintain  over long periods. 
5. Investors will both punish and reward managers when there is a change in ratings. There are abnormal flows when a rating changes.
6. A 1990's study show that 5-star mutual funds have a fall-off in performance after the rating is given and there is higher risk after the rating is announced.
7. Low-rated funds do predict future poor performance. Higher-rated funds may not outperform the next lower rating category in the future.
7. Mutual fund managers that receive low ratings are likely to be replaced.  

If you expect the 5-star funds to always stay as 5-star funds, you may be disappointed given the 10% star threshold. The signals on performance are mixed, yet the most exhaustive study from Morningstar done last year shows that the rating does make a difference. See the research piece by Jeffery Ptak. There is value in the rating even after accounting for the standard four-factor model in equities. There is also value from a high rating for a fixed income and balanced funds even after account for other risk factors. However, the value associated with alternative investments is not as statistically significant. The author argues that this may be caused by a smaller sample but the general take is that star rating has some marginal meaning.

Research has also found that rankings and performance are tied to costs. Lower cost funds will naturally have an advantage relative to higher cost funds.  A closer analysis may show that the more dispersion around any benchmark will reduce the impact of costs as a driver for rankings. Hence, in alternative investment category where there may be more dispersion around an benchmark and there is less agreement on the benchmark, cost impacts will be less. Still, when in doubt look for lower cost alternatives.

Can this be related to choosing managed futures or alternative investment funds? As a heuristic to help identify potentially better funds, the rating system may be a useful first pass. It is a not a substitute for more exhaustive analysis but there should be strong reasons to bet against the best and worst funds regardless of asset class.

Thursday, June 8, 2017

A difference between theory and practice

The historian will tell you what happened. The novelist will tell you what it felt like. 
- E. L. Doctorow

Academics will tell you what happened to generate returns in finance, but the manager will have tell you the feel for how it is done.

There is difference between theory and practice. The academic research study that identifies an obvious new risk premium may be difficult or impossible to implement in practice. The good firm is able to separate theory and practice and avoid implementing bad ideas. They will have a feel for whether it can be done in practice.

An important part of any hedge fund due diligence is understanding the process of moving from theory and research to implementation. Some firms are good at it. Others are not, so asking the right questions is important to finding how who is good at research implementation. Implementation processes add realism to determine the success of new ideas. For example:
  • How is research conducted to add realism?
  • How is new research actually included in a portfolio? 
  • How are changes in existing models addressed? 
  • How are new research ideas sized relative to existing strategies? 
  • How are new ideas traded in different market situations? 
  • How is liquidity for a new strategy addressed? 
  • How does a manager address crises or extreme events with a new strategy? 
  • How are the experiences and unique situations faced by the manger employed within strategies? 
A good trader or portfolio manager may not be the best at measuring statistical relationships, but they should be good at addressing the intangible issues of market dynamics in order to accept research and size risks.

Wednesday, June 7, 2017

Networks and plumbing - The mechanics of systemic risk

Behind the backdrop of the vast changes in monetary policy over the post Financial Crisis period has been the movement to improve the regulatory environment for financial markets in order to reduce systemic risk. Significant work has been done to improve monitoring and rules to eliminate excessive speculative behavior, but as more regulations are proposed and more changes to the financial system are made, there is demising marginal benefit and a greater likelihood for unintended consequences. A rule that makes sense for one group may lead to a shift in risk capital and changes in behavior toward unregulated areas.  Simply put, risky behavior will shift to the places where the cost of speculative behavior is least. 

Money and credit will always seek the lowest cost environment. The micro dynamics of markets where there are different players seeking to reach various objectives is all the more critical when thinking about crises, liquidity, regulation, and pricing. The microstructure of markets matters and the behavior of players toward changes in the "rules of the game" is important. In an older school of thought, this would be called market structure or industrial organization. In the current environment, we can relate this market networks.

Given a focus on the financial behavior of agents, there has been more research on the interaction or connectedness of players within the financial environment.  The economics of networks is an important advancement on our thinking of markets work and how market agents or players interact to changes in the environment. 

If you believe that markets are efficient, then the behavior of players in a network may not matter. If you believe information comes from disparate sources both exogenous (from economic policy announcements and data releases) and endogenous (based on the players in the market, hedgers or speculators), then the network and connectedness of player matter. More importantly, if the costs for trading change for agents in the network, the connectedness of players will change. The efficiency of the market is based on the interaction of dealers, traders, and hedgers.

The network approach will suggest that regulations that change the cost of trading or place restrictions on traders will impact the efficiency of markets. If the cost of trading is higher, arbitrage may be more expensive and there will be more market frictions. Price relationships will change with the relative expenses of trading. 

A network view of market behavior will focus on structural changes that will affect the flows of information and capital through the network. Systemic risks will change with the blending of the network. The systematic risks of yesterday will be different today when you change the costs to players in the network.  Follow the transaction, regulatory, and capital costs to determine the changes of risks within the network. Then follow the money through the network. The simple answer is that the systematic risks today will be different than from 2008 because the network of trading has changed.

Monday, June 5, 2017

Global Macro in one page - Forget the noise and watch the numbers

As a more quantitative focused analyst, I keep focus one thing - the numbers. Stories are good, but numbers are better. At best stories, provide context for numbers, but stories of politics will not lead to market trends. Capital flows on trends in profits, growth, liquidity, and risk. Do not suffer from "shiny object" syndrome. The news of today may not impact the important fundamental trends.

The stories and themes for this month are similar to the last few. An investor has to address three questions. What is happening to global growth and is there a rotation in capital? What is the impact of potential liquidity changes from central banks? Will there be actual fiscal stimulus that can ignite growth and profits? Focus on these three to determine any changes in portfolio construction.

Sunday, June 4, 2017

Sector behavior consistent with economic story but wider dispersion

While large cap and international stocks continued to move higher, the markets are starting to see more dispersion with small cap, growth, and value indices all posting negative returns for the month. The Russell value index has fallen to negative returns for the year. A growing dispersion is also evident in sector and country returns. Bonds have been a safe asset with positive gains for the year across all sectors. The returns are consistent with slow but positive growth around the world with controlled inflation.
With oil prices moving lower, the energy sector had a strong May decline and is negative on the year. The finance sector also declined in May while technology has moved to well above 15% for the year. Investors are being rewarded for making sector bets. 
Country equity indices mostly reported strong gains for the month and generally have done much better than the US, albeit over 5 percent of the move may be associated with currency moves. Commodity-driven countries showed poorer performance this year.

While the gains have not be strong for the month or the year, bond sectors are all positive for the year. The only negative sector for the month was TIPS given the decline in inflation and forward expectations. Our trend and breakout indicators are all showing that bonds are a buy for any portfolio. 

Trends for June - Up for equities and bonds

May was a mixed month for many trend-followers. Some did well while others got caught on the wrong side of mid-month reversals. The month saw a mid-month equity sell-off which could have stopped-out a number of key positions in equities and bonds. This sell-off was based on political uncertainty and not macro fundamentals.

While volatility was reaching multi-year lows, there was still risk in the markets through short-term rapid changes and trend reversals. The second half of the month started to show some better trends which may be profitable in June. Nevertheless, we are concerned that the usual negative correlation between bonds and stocks does not seem to present. Both equities and bonds are trending higher. One could argue that this is a result of lower inflation expectations, but we fear that equity and bond traders have different expectations on growth. Equity optimism and bond pessimism cannot both be right.  

The dollar has again started to move lower which is a continuation of the longer-term trend for year. Precious metals have moved higher with the dollar decline. There is a renewed down trend in energy prices, but many of the other commodity markets have no clear trend direction. 

Right now, the financial sectors offer the best opportunities albeit muted given the lower volatility across many markets. Our largest concern is that volatility spikes may cause positions to be lost in a muted trend environment.

Saturday, June 3, 2017

Hedge fund behavior consistent with major asset classes

Many hedge styles are generally tied to the direction of equity markets, albeit at lower beta. Hence as the equity markets go, so go equity hedge funds. Similarly, relative value will be affected by correlation and volatility in equity markets. If markets are correlated and have lower volatility, then there is less opportunity in relative value. There is less stretch in the market. 

May was a difficult market for hedge funds that are more focused on small cap and value stocks given the poor performance for these indices this month; nevertheless, hedge funds styles have generated positive returns for the year. The only exceptions have been global macro and CTA's. Interestingly, these are two styles that have been classified as crisis risk offsets. In simple terms, if there are no crises, these strategies may underperform. They will make the greatest returns when there are market divergences. While these two strategies are absolute return managers, we generally find that larger market dislocations across many markets will be more favorable for return generation. 

As we reach the mid-point in the year, we have mixed views on the performance of hedge funds. While generally positive, it seems as though managers have not been able to capitalize on the strong equity performance around many global markets, and have missed the weakening in the dollar, Political noise seems to have dampened risk-taking and without risk exposures, there will not be returns.

Friday, June 2, 2017

Managed futures - All dressed up but not going anywhere

Money has flowed into managed futures under anticipation that there will be a crisis event that will need the diversification benefits of trend-following strategies. These investors adjusted portfolios away from perceived overvalued assets to the value from long-short diversified trend-following. What is the sense of increasing allocations after the divergent event of a equity sell-off? 

The only thing that is missing is the crisis event. There is now the waiting for the event. However, let's not forget that crises are by definition unexpected, and the value of trend-following is not with their ability to predict these crises. Systematic trend-following is non-predictive; nevertheless, given risk management which will exit losing positions and the ability to dispassionately enter new positions, trend-followers should adjust to a divergent crisis quickly and should be able to exploit an extended decline.  

The problem is that forward-looking investors are ready, the strategy is ready, but the markets have decided to continue to move in directions that do not allow managed futures to profit. This month was almost the same as last month with respect to equity and managed futures behavior. A representative index shows flat performance and equities have continued to march higher.  There are manager winners and losers this month, but generally, opportunities have not been exploited. Although the dollar declined, commodities in general were lower, stocks trended higher and bonds were up, managers have not found strong opportunities which translate to higher returns.

The 12-month rolling returns show managed futures consistent with long duration Treasury (the other main crisis offset tool) performance. There is an opportunity cost for those who have sold equities and bought managed futures over the last year. We will have to wait and see if the early allocation changes will be rewarded. 

Asset class performance - The "Global Rotation"

Call it the "Global Rotation", but last month was a continuation of what we have seen for the year. There has been a flow of money into international stocks and increasing divergence between the rest of the globe and US risky assets. There is a dollar adjustment component to these returns, but there is no mistake that there is a preference for cheaper opportunities around the world. 

Using a simple adjustment based on the DXY dollar index, the local returns should be moved down by over 2 percent which would have put returns closer to large cap US. The dollar has fallen about 5 percent since the beginning of the year which places global returns more in-line with large cap US. However, the switch from small cap and value in the US to other parts of the world is unmistakable along with the switch to large cap in the US. 

Bonds posted strong gains both for duration and credit for the month. With a smaller probability of any inflation overshoot and monetary policy which seems to be measured, there is stronger demand for fixed income. This is more muted around the rest of the world after accounting for the move in the dollar. Commodities continue to slide and are the asset class laggard.