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Lessons learned: How luck, as well as skill, drove CTAs’ performance during the historic coronavirus sell-off

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Managed futures strategies experienced an entire year’s worth of performance dispersion during a dramatic first three months of 2020, with trend-following hedge funds’ returns hinging as much on luck as skill, a new deep-dive analysis by multi-manager CTA portfolio investment firm Efficient Capital Management shows.

CTAs, particularly those trading short-term trends, were widely hailed for their strong returns during the coronavirus-driven sell-off earlier in the year, when other hedge fund strategy types suffered agonising losses.

But the sector was marked by a wide dispersion in returns, Efficient Capital Management, the Chicago-based managed futures specialist, noted in a webinar on Wednesday.

The first quarter of 2020 saw a remarkable 29 per cent spread between the best and worst performers, said Chad Martinson, Efficient Capital’s co-chief investment officer, citing data from Société Générale’s CTA indices.

By comparison, over the past decade, dispersion has averaged about 30 per cent per year from the top performer to the worst performer, Martinson said.

“The first thing that we can say without a doubt is that performance was widely dispersed,” he noted.

The firm’s wide-ranging research indicated that timeframe, sector exposure, factor-loading, “and a little bit of luck” all played a role in explaining the performance dispersion.

Expanding further on this point, Martinson said the luck element rested on an individual strategy’s “parameter sensitivity”.

“If you happened to be on just the right side of markets, and got out of your long equity exposure before the big 10 per cent down day on 12 March, you tended to outperform other managers,” he said. “There was a component of luck during the first quarter of 2020.”

Nonetheless, he added that elements of skill were also involved, mainly in terms of what factors managers chose – such as momentum or carry – as well as the time frame in which they chose to trade, and the levels of exposure to each different sector.

While equity markets did play a role in CTAs’ performance this year, returns hinged more on how strategies fared across other asset classes rather than in equities.

Turning to what lessons can be learned from Q1’s historic gyrations, Martinson said investor understanding of underlying risk factors, and their attendant behaviour during different market environments, remains vital going forward.

“This was a market environment where short equity volatility was not a favourable risk premia to be exposed to,” he said. “You need to understand what you’re exposed to, and then you need to make sure that your portfolio is constructed with the best building materials.”

He stressed that high quality managers with the best infrastructure, the most sound research processes, and risk management will deliver the best results over the long-term.

“Although there is performance dispersion from time to time, it’s important that you stay with quality,” Martinson added. “We emphasise diversification across managers to remove some of that idiosyncratic risk.”

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