Programmatic investors who make their fortunes chasing momentum have had a particularly rough year.Getty Images/iStockphoto
The trend is not your friend – at least not lately.
Between sleepy movements in global assets and short-lived macro shocks, programmatic investors who make their fortunes chasing momentum have had a particularly rough year. In fact, by some measures, commodity trading advisers are on track to post the worst yearly return since 1987, when data were first collected on the group.
CTAs, the majority of which bet on price trends using futures contracts across asset classes, are known for being volatile strategies, billed for their low correlation to equities. Hit by choppy trends, especially in fixed income and the dollar, they're are now finding it difficult to live up to return and diversification expectations, said Pravit Chintawongvanich, head of Derivatives Strategy at Macro Risk Advisors.
"From 2014 to early 2015, the combination of a rising dollar, falling crude, and declining yields led to strong performance among trend followers," Chintawongvanich wrote in a note to clients Monday. "Over the past year, the only trend that is working is equities. Clearly, that is not a very helpful diversifier to long equities."
Killer combination
Chintawongvanich offers three reasons for the change: sector overcrowding, the suppression of notable price moves in either direction due to enduring central bank stimulus, and, relatedly, lows in cross-asset volatility.
"Trend followers typically do well during periods of high volatility," he wrote.
Over the past two years, these investors have faced a deadly combination where prolonged market volatility has undercut momentum, while bouts of market rallies and selloffs have proven relatively short-lived.
Quick occurrences of volatility have kept markets churning underneath the surface, throwing off once reliable trends, according to Andrew Lapthorne, head of quantitative strategy at Societe Generale SA. Trend-following relies on price changes, which works because it does a decent job of reflecting underlying fundamentals. But between Brexit and central bank chatter, the link between prices and fundamentals has dissolved, he said.
Sluggish performance
"We've gotten these macro shocks where prices are not dictated by underlying company fundamentals," Lapthorne said. "If you're a fundamental stock picker, it's nice because it creates stupid price momentum you can take advantage of. If you're slavishly following price, you don't have that option."
The sluggish performance is troubling for a new slew of investors that have pumped up managed futures – including CTAs that invest in futures contracts – to a record $350-billion in assets under management. Likewise, pension funds have parked cash with trend-following funds over the past year to diversify their exposure as stocks notch record highs. For example, in February the Teachers' Retirement System of the State of Illinois invested $100-million with KeyQuant SAS, a Paris-based systematic asset manager.
CTAs have lost 5.4 per cent in the first seven months of the year, compared to a 7.4 per cent annualized gain over the past three decades, according to a BarclayHedge database of 20 managers that represent at least half of the CTA universe. Typically, those funds have nearly zero correlation to equities, yet their current correlation to the S&P 500 is 61 per cent, according to Chintawongvanich.
That was apparent over the past two weeks, when global central bank hawkishness caused a simultaneous selloff in stocks and bonds. That send CTAs plunging 5.1 per cent, their worst stretch in a decade.
Far horizons
Still, investors in trend-following funds can take comfort by looking out over a long horizon.
In each decade since 1880, time-series momentum – meaning long positioning in markets with recent positive returns and short positioning in those with negative returns – has on average posted gains with low correlations to traditional asset classes, according to an AQR Capital Management LLC paper last month, which sketched the sector's historical performance from annual reports of the Chicago Board of Trade.
And if the hawkish tilt among central banks is accompanied by a sharp downturn in prices for risk assets, managed futures could take off soon enough, Chintawongvanich concluded.
"We're sure that not only trend followers would be happy about higher volatility," he wrote. "Far be it for us to call 'the death of trend following' as has been done many times in the past."