2015 started out as a great year for the trend-following CTA hedge fund style. The chest thumbing by the managers got louder during the first quarter as performance continued to show strong positive results after a strong second half of 2014, but then performance nose-dived as measured by the Newedge/SocGen CTA index. This decline in performance is stark when compared with other strategies which actually had positive second quarters. CTA's have moved from the best performance in the first quarter to the worst across all major hedge fund styles. Within the global macro/CTA sector, it has been noticeable that trend-followers have done worse this year, with short-term managers also generating negative returns. The quantitative global macro managers have flat to slightly negative returns and the discretionary managers have generated positive returns.
So what happened to the trend managers? There was a crisis in Greece and a crisis in China both of which should have been good for managed futures. Nevertheless, managed futures managers both short-term and longer-term were not able to take advantage of these crises, so the first thing is to focus on why those events were bad for CTA's.
Managed futures (trend-followers) should do well during a crisis, or that is one of the key marketing arguments for managers in this strategy. CTA's focus their marketing on their negative correlation with stocks during market sell-offs implying that when there is a reason for a market decline, CTA's, with the ability to go both long and short, should do better. Nonetheless, all crises do not result in good CTA performance. It is notable that the Greek and China crises did not lead to any strong decline in equities around the world. There was no contagion across global markets. There was only a 4% decline from quarter highs in the SPY during the month of June. There was no crisis effect, albeit there were some key reversals in trends. The discretionary traders have been able to exploit or adapt better than the systematic managers for these unique events.
For a strong trend-follower performance period, there has to be a crisis that either takes time to evolve or will have longer-term impact on prices. A short surprise event that then is resolved will not be a good environment for systematic trading. At best only short-term managers may profit. The are two reasons for under performance. First, if the manager has stop-losses, a surprise event can trigger stops. If the event has a short-term effect that moves back to trend, the stop-out effect will eliminate trading potential. The same problem exists for models that have a single reversals. A sharp price move may lead to a change in position direction that then moves back to trend. Second, a short-term event that reverses may be unprofitable because the time to entry is too late. This results in a whipsaw event. A price trend is identified and entry signal are triggered only to see that the trend does not continue. The crises were more singular events.
These type of singular events will occur more often with individual stocks, but the smaller position sizes and diversification will reduce the impact on the portfolio from non-contagion events. In the macro trading case, the position effects are larger and hence will be more meaningful impact on the portfolio if you are wrong. In currencies and bonds, there was rangebound behavior which precluded profitable trades and loses from the end of previous trends.
A close look at some markets such as WTI, the dollar, and bonds all show the potential for signal reversals and limited profit opportunity. It also shows that trend started in the second half of June have continued and have made for a better performance in July.
For a strong trend-follower performance period, there has to be a crisis that either takes time to evolve or will have longer-term impact on prices. A short surprise event that then is resolved will not be a good environment for systematic trading. At best only short-term managers may profit. The are two reasons for under performance. First, if the manager has stop-losses, a surprise event can trigger stops. If the event has a short-term effect that moves back to trend, the stop-out effect will eliminate trading potential. The same problem exists for models that have a single reversals. A sharp price move may lead to a change in position direction that then moves back to trend. Second, a short-term event that reverses may be unprofitable because the time to entry is too late. This results in a whipsaw event. A price trend is identified and entry signal are triggered only to see that the trend does not continue. The crises were more singular events.
These type of singular events will occur more often with individual stocks, but the smaller position sizes and diversification will reduce the impact on the portfolio from non-contagion events. In the macro trading case, the position effects are larger and hence will be more meaningful impact on the portfolio if you are wrong. In currencies and bonds, there was rangebound behavior which precluded profitable trades and loses from the end of previous trends.
A close look at some markets such as WTI, the dollar, and bonds all show the potential for signal reversals and limited profit opportunity. It also shows that trend started in the second half of June have continued and have made for a better performance in July.
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