Be friends with your instincts

Trend followers are hot again. After a run so bad that the FT ran close to death three years ago, the CTAs/managed futures funds/trend-followers/momentum jockeys/whatever you want to call them are back.

Even after July’s market rebound wrong-footed many trend-followers, the strategy has returned 12.3 percent this year, according to HFR. That crushed the performance of every other major hedge fund strategy, and compares to an average loss of 4.1 percent for the industry as a whole. Some analysts even say CTAs are to thank for the strength of August’s stock-market gains.

But what is most interesting about the performance of trend-following funds is the recent dispersion of returns.

Campbell, Systematica and Aspect Capital were up 26.9 percent, 22.9 percent and 29.1 percent respectively by the end of July, according to documents seen by FT Alphaville. Roy Niederhofer’s flagship fund returned 44.5 percent through the end of June. Meanwhile, the Man AHL’s trend-following funds, after a strong run, have been largely average this year, and Forte’s funds have plateaued.

Often, the different performance of trend-following hedge funds can come down to what markets they play, how much they leverage, and what kind of timeframes they use. Short-term trend-following worked well in early violent movements. 2020, but since then these long-term trend-followers seem to have performed well.

However, Clifford Esnes’ AQR Capital Management presented another interesting reason for the unsettled fortunes in a Quant House report published last week: Some trend-followers got away from their knitting when trend-followers were fearful.

The Federal Reserve has a clear dual mandate. One of the implications of managed futures strategies is that – in particular, 1) provide positive returns on average and 2) generate particularly attractive returns during large equity market drawdowns.

This dual mandate is one of the big reasons why managed futures strategies can be valuable in a portfolio. Unfortunately, by and large, the industry – intentionally or not – is optimized for one at the expense of the other.

As Esnes admits, he’s talking too much about his book here. After a long time, the better. . . sucking — one of Asness’s favorite tech phrases — AQR’s managed futures fund is now up 30.2 percent this year. The high-vol version of the strategy returned 44.3 percent.

Asness argues that this is because AQR tries to invoke the second mandate of trend-following. Here’s a chart showing how AQR’s more “pure” strategy has done compared to trend-followers in general, using SocGen’s trend index as a proxy. (Yes, that’s AQR’s emoji right there).

Asness thinks the industry has just “gone out”—literally, he’s making up a word about Carrie.

Let’s go back a decade. Managed futures were a rare bright spot in options during the Global Financial Crisis (GFC). However, since then — and until recently — strategies designed to profit from price trends have had a tough road to hoe. Since the GFC, markets have trended lower than their historical norm. Also until recently, while there have been some scary times, the markets have generally been very strong. Markets trending lower than usual (ie, a challenge to Mandate #1) and few tails to hedge (ie, little need for Mandate #2) have been an offensive combination for the regulated futures industry.

But bad times come with good strategies. Everyone knows that. So, what does a good strategy with over 100 years of evidence in a very wide range of markets and with sound financial intuition have a decade of lukewarm performance for reasons that are very easy to explain? Naturally, you change it, right? This seems to be (in an admittedly grim summary) much of the managed futures industry.

. . . Anecdotally (from many sources) many systematic futures managers try to improve their Sharpe ratio and realized total return by adding carry strategies. It’s fine if you’re trying to improve mandate #1, but carrying is often an “at risk” strategy. Therefore, this can be a real problem when it comes to mandate #2.

This is a point that some other major trend-followers have made in the past. All strategies must evolve, and sometimes adding a few other bells and whistles can improve long-term risk-adjusted returns. But if you stray too far from the core, you won’t be able to deliver your main selling points to institutional investors—portfolio ballast when the market waters turn cold.

This may be only part of the explanation, or at least an incomplete one. Whatever the strategy drift, many trend-followers are enjoying a good year. And after a few looks at individual fund performance, it seems difficult to make a definitive decision.

For example, David Harding’s Winton fund underwent a high-profile shift away from its traditional trend-finding approach a few years ago, and after a disappointing spell now appears to be on the cusp of its best post-financial crisis year. So despite what AQR seems to be the posterchild for suggesting, outcomes have actually improved.

Still, it’s an interesting report on one of the oldest but still-misguided hedge fund strategies. And judging by AQR’s own improvement results, the computer screen in Greenwich may once again be safe from Asness.

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