Wednesday, August 14, 2019

Stealth CTAs - Away from the negative hedge fund news, systematic and trend are doing well

Managed futures trend-following can be a stealth hedge fund style. Predicting hedge fund behavior by style is not easy. For example, the trend-following style is structured to be non-predictive. Trend-following models generally do not try to predict trends but just identify them and then invest. Any investor should find a trend-follower making predictions about the macro environment odd. At best, they should say that trends will continue. 

If there are trends, trend-following should make money, but it is a necessary not a sufficient condition for success. Nevertheless, there is a link between price trends and fundamentals. Divergences or dislocations in fundamentals will impact prices. Trends in fundamentals will create trends in price. Success with trend-following is more likely if there are market dislocations, but defining when there will be a crisis is fundamentally difficult. Crises are infrequent and are usually unanticipated. 

Investors should play the odds that show trend-following works over the long run and has been consistently positive across asset classes. However, that is not the same as arguing that a particular year should generate positive returns. Other then saying that the trend-following investment style is overdue for better performance, there was little in the tea leaves to predict success at the end of last year. Those who were expecting a recession argued that a long/short diversified trend strategy would do better than a long-only risky asset strategy but this was predicated on financial crisis scenarios. Yet, here we are in August with managed futures (generally trend-following) indices showing potential for one of the best years in the last decade. 

Reviewing markets over the last seven months suggests that trend-followers who focused on fixed income were able to take advantage of two fundamental trends that may not quickly disappear. First, there is a global central bank bias to create liquidity with forward guidance that rates should come down. The Fed has been proud of its jaw-boning to place downward pressure on rates. Second, there been a slow decline in global growth that has provided support for the downward yield movement. 

There has never been a bond rally that trend-followers have not liked and those who have had high bond exposure, either by model design or because of size, have been strongly rewarded. Funds with more diversified exposure have under-performed on a relative basis. Nevertheless, opportunistic trends in equities, currencies, and some commodities allowed for added gains for the nimble manager.

Further gains in trend-following are predicated on our two fundamental trends; one, a continued central bank bias to supply liquidity and two, a deceleration of global growth. Fundamental trends create price trend opportunities and strategies that are fully diversified and willing to take long and short positions will have an edge at generating returns versus a focused long-only investment.  Price trends last longer than expected because fundamental trends last longer than expected.

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