Followers of the trend are hot again. After a run so bad that the FT published a quasi-obituary three years ago, CTAs/managed futures funds/trend followers/momentum jockeys/whatever you want to call them are back in favour.
Even after the market rally in July misled many trend followers who were short, the strategy has returned 12.3 percent this year, according to HFR. That shattered the performance of all other major hedge fund strategies and compares to an average loss of 4.1 percent for the industry as a whole. Some analysts even say the CTAs have August’s strong stock market gains to thank.
But the most interesting thing about the performance of trend-following funds is the recent dispersion of returns.
Campbell, Systematica and Aspect Capital are up 26.9%, 22.9% and 29.1% respectively in the year to the end of July, according to documents seen by FT Alphaville. Roy Niederhoffer’s flagship fund has returned 44.5% through the end of June. Meanwhile, Man AHL’s trend-following funds, after a good run, have been largely average this year, and Fort’s funds have plummeted.
Most often, the different performance of trend-following hedge funds can come down to which markets they play, how much leverage they use, and the type of time frame they specialize in. Short-term trend following worked well in the violent movements of the early years. 2020, but since then long-term trend followers seem to have fared better.
However, Clifford Asness’s AQR Capital Management offered another intriguing cause for the muddled fortunes in a report the quant released last week: some trend followers simply strayed from their fabric when yields that followed the trends were terrible.
The Federal Reserve has an explicit dual mandate. Managed futures strategies have an implicit, namely, 1) they offer positive returns on average and 2) they generate particularly attractive returns during large stock market declines.
This dual mandate is one of the main reasons why managed futures strategies can be valuable in a portfolio. Unfortunately, in general, the industry, intentionally or not, has optimized for one at the expense of the other.
As Asness admits, he talks a lot about his book here. After a long stretch, well. . . suck, one of Asness’s favorite technical phrases, the AQR Managed Futures Fund is up 30.2% this year. A higher volume version of the strategy has returned 44.3 percent.
Asness argues that this is because AQR has tried to stick to what he calls the second trend-following mandate. Here’s a chart showing how AQR’s more “pure” strategy has performed compared to trend followers in general, using the SocGen Trend Index as a proxy. (Yes, that’s the AQR emoji).
Asness believes the industry just “got carried away”, literally, making a pun on carried.
Let’s go back a decade or so. Managed futures were a rare bright spot among alternatives in the Global Financial Crisis (GFC). However, since then, and until recently, strategies created to profit from price trends have had a tough road to crush. Since the GFC, markets have trended lower than their historical norm. Also until quite recently, although there have been moments of fear, the markets have generally been quite strong. Markets trending below normal (i.e., a challenge for mandate #1) and with few tails to fill (i.e., little need for mandate #2) has been a perplexing combination for the managed futures.
But bad times turn to good strategies. Everyone knows that. So what is the right thing to do when a good strategy with more than 100 years of evidence in a very wide range of markets and with sound economic intuition has a decade of tepid performance for reasons that are fairly easy to explain? Naturally, you change it, right? This (in short, no doubt snarky) is what seems to have happened to much of the managed futures industry.
. . . Anecdotally (from many sources), many managed futures managers try to improve their Sharpe ratios and total realized returns by adding carry strategies. This is fine if you are trying to improve mandate no. 1, but transportation is often a “risky” strategy. So it can become a real problem when it comes to mandate #2.
This is a point that some other prominent trendsetters 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 may not be able to offer one of your main selling points to institutional investors: portfolio ballast when the market waters are rough.
It is likely that this is only part of the explanation, or at least it is imperfect. Whatever the strategic drift, most trend followers are enjoying a good year. And after looking at some of the individual fund returns, it seems difficult to make definitive judgments.
For example, David Harding’s Winton fund underwent a high-profile shift from its traditional trend-following approach a few years ago and, after a dismal period, now appears to be on the cusp of its best year since financial crisis So while it seems to be the poster child of what AQR suggests, the results have actually improved.
Still, it’s an interesting report on one of the oldest but still misunderstood hedge fund strategies. And judging by AQR’s own improvement results, the computer screens in Greenwich may be out of Asness again.