By James Williams (pictured), Hedgeweek – Trend-following strategies have endured a difficult few years. At the height of fear regarding the future stability of the Eurozone, central bank intervention in the west led to low volatility and highly correlated, non-trending markets. Read any financial article from the 2011/12 period and chances are the term ‘risk on risk off sentiment’ was used.
The evaporation of market trends proved anathema to managed futures. Fast forward to 2014, however, and this strategy has returned to form. At a time when fears still remain over the fragility of economic recovery – more so in the Eurozone than the UK and the US – managed futures are proving once again that they can be an effective portfolio diversifier. This report aims to explain not only why managed futures should be reconsidered by investors but also how a more effective risk allocation strategy can benefit investor portfolios in both correlated and non-correlated markets.
“It’s very interesting what is taking place with managed futures this year,” says Philippe Ferreira, Head of Research, Managed Account Platform at Lyxor Asset Management. “What we are seeing now is that since the Fed started to retrench, buying fewer securities in the market, CTAs have started to outperform again.”
Key drivers of performance
Indeed, with YTD gains of +6.4 per cent (through 30 September 2014) long-term CTAs are currently this year’s best performing strategy. In Q3 alone, long-term CTAs were up +6.8 per cent according to Lyxor’s figures. Preqin have also released figures. They confirm that Q3 2014 was the best quarter for CTAs since Q4 2010, returning +5.52 per cent to deliver YTD returns of +7.13 per cent; slightly higher than Lyxor’s.
There are two important drivers behind this performance.
“First, there’s a divergence between growth conditions in the US and in Europe. In the US, the Fed is about to end quantitative easing while in Europe conditions remain weak with the ECB doing more. This has allowed an FX trend to be actively played by CTAs. They have been shorting the euro quite aggressively.”
Since May the greenback has performed strongly against the euro, rising from USD0.72/EUR to USD0.79/EUR at the start of October.
“Second, there have been more pronounced trends in the commodity markets. There’s been a sharp fall in commodity prices in recent months with CTAs shorting energy in particular,” says Ferreira. “We also need to highlight the fact that CTAs are maintaining a long position on interest rates, which is not the case for global macro. This is the difference between systematic strategies and discretionary strategies; it’s a case of machine versus man.
“Most economic indicators point to the US improving. As a result in Q2 and Q3 global macro strategies went short rates. CTAs on the other hand have interpreted the signals differently and remain long rates. They have extracted alpha from this long rates position.”
Among the 12 to 15 CTAs that Ferreira and his team tracks on the Lyxor platform only two are in the red. If one compares that to long/short equities, whilst the number of funds is higher only half are in positive territory.
“The best performing CTA is up more than 10 per cent YTD. Four or five funds are in the +8.5 – 10.5 per cent range. Our own fund – the Lyxor Epsilon Global Trend Fund – is up more than 20 per cent YTD,” confirms Ferreira.
Short-term versus Long-term CTAs
In Q3, short-term CTAs were only able to return a modest +1.1 per cent. However, in the last couple of weeks market sentiment has wobbled leading to large sell-offs in equities; between 18 September 2014 and 15 October 2014 the S&P 500 index shed 7.5 per cent.
“Short-term CTAs benefit from unstable markets and have outperformed in the last couple of weeks. These strategies follow trends over a period of weeks whereas long-term CTAs follow trends based on a 200-day moving average over two to three months. Long-term CTAs are still long equities while short-term CTAs have already turned short,” says Ferreira.
There is a place for both long-term and short-term CTAs in investor portfolios but it is worth remembering that 2014 is only the start of what could be more favourable conditions for managed futures. There’s a long way to go to improve investor confidence given how far this strategy fell out of favour a few years ago.
“CTAs will therefore need to consolidate their recent outperformance to attract investor inflows again. What we are signalling to investors is that they need to update their views on managed futures. They should no longer be underweight. It’s difficult to take large overweight positions after such a difficult period, and indeed putting money into a strategy that has now risen 10 per cent over the last four or five months is not advisable.
“At the very least, investors should move from an underweight position to a neutral one,” advises Ferreira.
CTAs are experiencing a revival and are once again demonstrating that they can protect portfolios against losses arising in long-only assets.
As Ferreira concludes: “In the current macroeconomic environment they are benefiting from the fact that central banks are less prominent in the markets, trends have become pronounced and volatility has returned to some extent; these three factors are important for CTAs.”