Industry innovators: How CTA veteran David Gorton’s quant firm DG Partners is thriving amid trend-following turmoil
The aim of London-based systematic managed futures hedge fund manager DG Partners is simple, says founder and chief investment officer David Gorton: “To be the best trend-follower we can be in the business.”
Established in 2002 by Gorton (pictured, above-right) – a former JP Morgan prop trading chief and 30-year industry veteran who later launched a joint venture between DG Partners and hedge fund giant Brevan Howard – the firm today manages around USD1.5 billion in assets, with its flagship quantitative managed futures strategy running about USD850 million. DG Partners only manages assets for professional clients.
Despite rapid shifts in markets and technology, which have dramatically altered trend-following techniques in the past two decades, the firm has maintained a creditable track record in the industry which stems from a “strategic choice” to avoid any style drift, explains Gorton.
An independent business
In practical terms, this has meant innovating its trend-following strategy by adding new strands to it as well as additional modulators and frameworks designed to better capture market trends.
In early 2015 the firm introduced a second model, dubbed ‘conviction trend’, followed two years later by a ‘trend efficiency’ algorithm modulator. Now, there are plans to add a new theme – which Gorton calls ‘topology’ – before the end of this year.
Beginning his investment career in 1986 at Chemical Bank as a market maker in bonds and rates, Gorton joined HSBC in the US in 1989 where he served as executive VP and chief dealer, heading interest rate derivatives trading and government bond prop trading. Before launching DG Partners in 2002, he worked at JP Morgan Chase from 1997 where he was CIO of the Chase London Diversified Fund, and head of proprietary trading for its European Rates division.
Having originally started with a broad scope of global macro strategies, in 2006 DG Partners began to grow its focus on CTA-based investing. In 2010, the firm established a joint venture with Brevan Howard, the high-profile macro hedge fund firm set up by Alan Howard, in the form of its BH-DG Systematic Trading business unit.
“Brevan were one of our earliest investors,” Gorton explains of the relationship, and in 2010 “they became a stakeholder via our BH-DG joint venture. However, we are still an independent business – run entirely at arm’s length, independently capitalised and risk-managed.”
‘Robust and consistent’
Reflecting on his firm’s evolution, Gorton describes how the traditional trend-following objective of extracting alpha from markets grew trickier after 2008 as volatility became suppressed, central bank interventions proliferated, and general “noise” increased relative to volatility.
In response, trend followers began to seek alternative sources of alpha as returns grew sporadic for the classical approach to trend following.
“They tried to move away from trading momentum and find other means of making alpha,” he tells Hedgeweek. “That often involved some form of mean reversion or other style drift and many did quite badly during big market dislocations and sudden corrections.”
In contrast, DG Partners opted for a different path, remaining focused upon a medium-term systematic strategy, seeking a “robust and consistent approach which remained faithful to trend-following.”
That conclusion ultimately led to the addition of a second trend model to the strategy in 2015 – called ‘conviction trend’ – designed without any in-built long or short biases.
“Many models that use data mining may have a bias towards the data they have mined. If bond markets go up for 30 years or, similarly, US equities – which have produced significantly positive returns over long periods – this may lead to many trend followers ending up being long-biased,” he observes.
“But with our conviction trend model, the aim is to get into those markets that we see as having a more established trend. It has no market bias, so only goes into markets where there’s a strong consensus on market direction.”
Since the conviction trend model was introduced in early 2015 with a small allocation, it has since grown to represent half of the flagship strategy’s risk.
“Both our original ‘core’ and newer ‘conviction’ trend-following models have positive skew and that’s a key measure for us,” Gorton continues. “When you’re positioned in a long-only investment portfolio – typically an institutional pension plan or insurance company – one of the great benefits of having a CTA that is positively skewed is that it can compensate for the negative skewness often present in an institutional portfolio due to corrective market phases.”
The fund has generated an annualised return of 6.3 per cent since its May 2006 inception, comfortably outperforming Société Générale’s SG Trend Index, which rose 2.5 per cent over the same period. It has a 140 per cent return since inception, compared to the SG Trend Index of 41.8 per cent, with annual excess returns of 4.9 per cent versus 1.1 per cent for the benchmark.
Another set of innovations in the strategy are what the team call “adaptive risk modulators”, the first of which was introduced in 2017, named ‘trend efficiency’.
This is designed to adjust allocations to markets according to proprietary measures of market noise.
The firm’s systematic risk committee maintains oversight of these risk allocations, seeking to maintain a balance between allocation stability and medium-term opportunity over time.
“Our trend efficiency signal is an important input into this process that helps guide the allocation process,” Gorton says, adding: “When market noise increases aggressively, it can indicate that you are in a statistically dangerous place.”
This modulator proved particularly effective during this year’s unprecedented market turbulence. The fund is understood to have generated returns of around 7 per cent in both March and in July.
“In March, markets were dislocating, but in July, equity markets were rallying on falling volatility. In both cases, our risk modulators have helped us deal with two extremely different market regimes,” says Stefanel Radu (pictured, above-left), DG Partners’ head of research.
“We didn’t change the strategy – we just let it run systematically, and these risk modulators adapted themselves to the market’s regime shift.”
Expanding further, Radu continues: “We have concentrated on trend-following from the start and we continually seek to produce the best trend strategy we believe possible.
“In conversations with investors over the last few months, we have noticed a consensus in that they seem to prefer – not just in the case of CTAs, but managers more generally – those who are much more consistent in what they are doing. The consistency of our approach gives extra confidence to the investor base that our strategy continues to exhibit the same level of integrity now as it did before the pandemic.”
As the conversation draws to a close, talk turns to how the prevailing low and zero-interest rate environment is bringing challenges – as well as opportunities – for trend-following hedge funds.
“Typically, interest rates have been one of the strongest drivers of CTA performance for a number of years,” says Gorton. “But directional interest rate trading is going to be a much more difficult and less profitable business going forward most likely, until there’s some form of inflationary shock, if there ever is one. So it’s clear trend-followers need to improve and strengthen their approach to markets which don't exhibit that natural long bias. That's what drove us to ‘conviction trend’.”
And the innovation by Gorton’s team is ongoing.
“We hope to add a third model that we call ‘topology trend’ to our strategy before year-end, says Gorton, one which is designed to be “even more selective” in its positioning.
“Our aim is to continue to innovate in ways that allow us to be more aggressive in the markets that develop trends and to try and respond to those as effectively as possible.”