The big story for hedge funds has been the return of managed futures, not that it ever left the investment strategy choice set, but 2014 has proved managed futures to be an effective strategy relative to many other hedge fund styles. Managed futures is still mainly a strategy of trend-following. Hence, its success will be tied to big trends.
To break down the story of its success this year, you have to focus on the major market trends. Nevertheless, individual market trends at usually not enough to drive performance. You need to have asset sectors make big moves and this what made 2014 special. On a more micro level, big fund returns are made when the most liquid markets have a move. It not enough to have a big move in a single illiquid market. Diversification will dampen the effect of a one market trend.
Here were the big moves for the year.
- The return of currency trading. With a significant number of G10 currencies declining more than 10% over the year, it was a great year for currency trading. Given the relatively low volatility for the asset class, it does not take as great a move in price to create profitable trends. The long dollar basket was able to generate consistent performance with volatility still being in the low end of the multi-year range. The drivers of expected tightening by the Fed and loose monetary policy in Japan and QE in Europe created a perfect trend environment.
- The big oil move made the energy sector another winning sector. The oil market declined from year highs of over a $100 per barrel to current levels of $55 which is close to a 45% decline in price in about six months. These intense trends just do not come very often. At current volatility this was more than a two standard deviation event. Heating oil and RBOB gasoline saw similar declines in price over the same time. The exception was with natural gas which declined in the first half of the year before rebounding. In this case the oil complex was a good short trade across the product board.
- Equity indices continue to provide trend opportunities. The market trends for equity indices were generally upward for the last year, but there was a significant difference based on the geographic region. The S&P 500 was up 13.4%, but the European STOXX 50 gained only 4.58%. The Nikkei gained 10% for the year. However, the trend was interrupted by significant reversals such seen in October markets.
- Bonds also showed trends even at low overall levels. The bond rallies for most of the year were the surprise event for many forecasters. However, changing yield curve dynamics meant that picking the right maturity was an important part of a generating sector profits. The gain in the long bond (US) was almost three times as large as the 10-year (TY) futures. Short-rates were not an area of for profitable trend except if trade were made out the curve beyond 18 months.
- Commodity markets required more skill to generate gains even with a number of markets showing strong ranges within the year. The success in commodity trading was more dependent on trading less liquid markets like softs, cattle, and hogs. For example, coffee moved higher by over 50% and cotton saw a decline of over 50% from its intra-year high. Cattle and hogs both saw retreats from large earlier in the year trends. The strong trends in the grain markets saw significant intra-year reversals. For example, corn rallied close to 20% until May only to drop 40% until October and then see a 20% rally. These reversals will cut into any trend strategy. Soybeans and wheat followed a similar pattern. The ability to take profits and reverse positions was the key to commodity success.
- The metals markets generally trended downward but the behavior was not as straightforward as obviously seen in the energy markets. Again, the success with trading metals was based on the market choice. General sector exposure would not be enough for highly profitable trend trading.
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