Trend-following hedge funds’ “dynamic features” can limit losses amid surging bond yields and rising inflation

Trend following

Managed futures hedge fund strategies may be well-placed to withstand a continuing rise in bond yields, despite CTA performance being squeezed by the recent surge, Lyxor Asset Management strategists say.

Rising inflation expectations saw bond yields tick upwards over the course of August, as core consumer price metrics in the US rose above market forecasts, which in turn negatively impacting certain hedge fund strategies.

CTAs were down some 1 per cent towards the end of the month, according to Lyxor estimates.

But, looking ahead, senior strategists Philippe Ferreira and Jean-Baptiste Berthon, and hedge fund analyst Pierre Carreyn, believe CTAs can “probably manage to limit losses” if the upward trend in bond yields continues, owing to their diversified positions across the curve.

“The trend reversal in fixed income was somewhat smooth and has contributed towards limiting the damage for trend followers, who remain heavily long on fixed income,” they said in Lyxor’s note on Tuesday morning.

Managed futures strategies quickly soared when markets hit the skids back in March, with short-term trend followers in particular making strong gains as the coronavirus crisis worsened. Since then, though, the dearth of strong market trends has resulted in patchy performances for the sector.

Société Générale’s main CTA index, which measures the daily performance of a select pool of large managed futures strategies, is down 1.74 per cent year-to-date. But the SocGen Short Term Traders Index – a benchmark of the daily returns for CTAs and global macro managers with 10-day trading windows – rose more than 3 per cent over the same eight-month period.

Pointing to trend-following strategies’ “dynamic features”, Lyxor said: “Since the beginning of the year, trend followers have further demonstrated their ability to adapt to fast changing market conditions, allowing them to navigate the Covid-19 market turmoil remarkably well.”

Going forward, bond yields going forward look likely to be shaped by an evolving monetary policy strategy from the US Federal Reserve, Lyxor observed, shifting from flexible inflation targeting to average inflation targeting.

“The evidence of the recent years suggests that long term factors - demographics, technology - prevail on accommodative monetary conditions for the inflation outlook,”  Ferreira, Berthon, and Carreyn said.

“In the coming months, we expect moderate upward pressures on bond yields, which, in our view, can be absorbed by trend following strategies.”