Saturday, March 7, 2020

Are CTAs too rigid?

“When different CTAs were each exploiting their own way of trading trends, their performance was great. The aggregate performance of these independent traders set the name for successful trend following. However, the moment this was recognized and sold as a style, the unlimited discretion of the traders became bounded by an overly rigid definition. CTAs embraced this loss of freedom, partly because investors and their advisors liked them to be easily defined. Conformism, or essentially lack of unorthodoxy, led to decay in performance.”
-from the head of research and development at Transtrend Harold DeBoer 

This is a provocative comment on the state of CTAs from Harold DeBoer of Transtrend, a long-standing successful CTA. It is also a battle that has been fought for decades. Stick with a model or change. Be a singular iconoclast or adaptable manager. Be a hedgehog or fox. Focus on a style or just try and make money based on perception of what should work now. Was this solely the choice of the manager or was it foisted on managers by an investor base desiring categorization.

I have spent long hours with managers who stuck to the same model. I have been around those who have followed a policy of kaizen, incremental improvement. I have listened to those who followed their "feel", and those willing to hold onto winners and cut strategies at the first sign of failure. The evidence on sticking or switching can be marshaled in either direction. Trend-following and momentum clearly has worked through the decades, but that is not same as saying that it will work all of the time or that blending won't provide value.

What is clear is that sticking to a strategy versus being flexible is a manager's preference or choice. It is a part of their personality. Some are comfortable with change and others are not. An investor has to ask questions about this preference and understand the manager style comfort.

However, DeBoer makes an important point. With the hedge fund market increasingly institutionalized, there has been a greater demand for categorization. Managers have to fall into a style box. There has to be a benchmark. If you are not in a box, no one wants you, and heaven forbid the manager who changes style. Just watch the asset fly out the door if the long-term trend manager becomes a shorter-term trade. The momentum guy who adds carry better be ready for the calls, the placing on watch, and possible redemptions. 

There is limited freedom to innovate once classified. It is no longer just a manger's investment preference, but a penalty imposed by the outside as a business cost. Call it the "Innovator's Dilemma" for CTAs and all hedge fund managers. Once typecast, it is hard to try other ideas. This will be costly for investors.

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