testing

It is always worth monitoring the long view with trends. Beyond the last quarter or year, there are return patterns that show longer-term changes in style performance. Take a look at managed futures. There was a long period for which it was out of style, but that has changed markedly. (Saying a strategy is out of style is the nice way of saying it has performed poorly.  In style, means it is doing well and investors are chasing performance.)  We fitted a long-term linear trend through the performance curve of the SocGen managed futures index. The times of strong or poor performance from trend are obvious by looking at periods above or below the trend line. A fitted polynomial through the data can find periods when the slope of returns was rising or falling and provide a smoother view of performance. There are clearly long periods of strong and poor performance. There is an uptrend in performance through the Financial Crisis, but the slope turned down during...

There was a disconnect between the performance in market sectors and the performance of managed futures funds based on our simple review of market sectors. We run each market through a simple trend model each month to determine the direction of the majority of markets in the sector and then make a sector profitability assessment.  April was a strong month for commodities although the increase in volatility made entry into these trends difficult.  Grain markets saw a significant increase in volatility that made active trading in options very successful. For trend-followers, the environment was challenging but did offer strong opportunities. There were also good trends in cocoa, cotton, and sugar.  The oil complex showed strong gains in spite of fears about the oil rally be overdone. Base metals were also volatile but generally moved higher. Precious metals, especially silver and platinum, generated good trends.  The currency markets moved in tandem with commodities al...

The SocGen managed futures index declined by over 2 percent for the month of April. This decline was in the face limited movement in equities and fixed income markets for the month and a strong move for commodities. Currently, the managed futures index, year to date, is higher than equities but has fallen behind bonds and commodities. The monthly returns for an asset class can miss the gyrations that may occur during the month, but equity as well as fixed income markets were relatively calm for April relative to what was seen earlier  in the year. The mix of continued unconventional monetary policies even with no further action by the Bank of Japan and increased fears of slower global growth were enough to keep stocks and bonds somewhat rangebound.  What is surprising is the negative performance in the face of strong upward trends in commodities. There are no rules of thumb, but trend-followers generally will do better in up markets than down markets. Up trends are usually smo...

What was the main cause for the negative performance with managed futures for March? The reversal in sentiment across bonds, rates and currencies is the easy answer. Bonds were selling-off in early March as a result of the strong equity rally. The switch from less risk to riskier assets dominated the movement in financial futures. However, the change in sentiment mid-month from the belief in a more dovish Fed caused bonds and rates to rally and reverse the bond outflows. After the bond rally from the earlier equity sell-off, traders shorted positions in March only to find themselves wrong-footed toward central bank sentiment. Long-only bond returns were flat but active traders were hurt by the intra-month gyrations. The dovish Fed sentiment carried over to currencies where trades based on the high rate differential in favor of the US were hurt. Currencies are expectational markets and the forward view is that central bank policies will converge not diverge. The dollar rally continues t...

A key driver for holding managed futures is crisis beta, the low or negative correlation during times "bad times" versus traditional assets. The crisis beta is a direct result of the divergent strategy of long/short trend-following. If there is a market dislocation, the trend-following may short the assets that are doing poorly and increase long exposure to those assets that are doing well. This will dominate long-only investing that is not fully diversified.  Unfortunately, there are few guarantees of when trendS will occur and there is the potential for momentum crashes when trends reverse. Simply put, trend following will do well during bad times but there is a cost during normal times or period of trend reversals. You have to pay price for the benefit of trend-following.  One way of reducing the risk from trend-following is to diversify the strategies employed within managed futures. Instead of only using trend following, diversification can be achieved through investing ...

We have seen this story before. A reversal of negative fortunes for equities, a loss of momentum with global trends, and asset protection through monetary policy liquidity all lead to under-performance of managed futures. While managed futures has still be a highlight for hedge fund strategies in the first quarter of 2016, March was not kind to the strategy. The differential between managed futures and equities was close to 10%. The CTA index also underperformed relative to bonds and commodities. The first quarter still saw managed futures lead returns relative to equities, commodities, and diversified bods. Managed futures under-performed relative to the long bond which had good performance over the first two months of the quarter.  An ongoing issue for any strategy investor is determining when to invest. After the first two months of strong performance, the potential for a profit giveback from trend-followers was enhanced although there is little evidence to support an allocation...

The futures industry meets at this time each year to have their annual FIA Expo in beautiful Florida. It allows the executives of the exchanges, FCM's, and regulators to rub elbows and discuss the issues of the day. The FIA does a lot of good behind the scenes work for the industry, but an interesting question is the value of this event for the futures customers, the actual end users of these markets. The agenda gives little information on this value, so I thought I would list some of the issues or questions that may be important for end clients. Market consolidation of FCM's -  The number of FCM alternatives are shrinking with the big firms (banks) only taking more market share. Why is this good for the industry? Market liquidity and the potential for flash crashes -  A growing concern across all markets is liquidity or the lack of liquidity at key times. This concern is different than the risk management of large market moves. A liquidity crisis will affect the indust...

Often times you will hear managed futures managers discuss the markets they made money in, but the really relevant issue is whether they were able to exploit trends in a sector. Trend-followers need to capture sector trends, or more bluntly, there have to be sector trends that managers can exploit. Hence, we have developed a simple table of sectors, their recent direction, and the macro signal that is coming from these prices.  We look at a trend indicator for each major market within a sector and average the simple direction signals to form a sector  up or down indicator to show sector trend. For example, we look at a set of stock indices around the world which show all are now in major up trends. For bonds, we look at all major global bond markets as well as the different futures markets along the yield curve. Here the story is mixed with US markets rolling over from their up trend but the EU continuing to trend higher.  We also discuss what the prices are indicating as...

The SocGen CTA index gained 2.89 percent for February and the SocGen Short-term Traders index posted an increase of 2.88 percent for the month. Both indices are solidly positive with 7.19 and 6.47 percent gains for the the year. Managed futures were able to post gains in spite of a reversal in equities to the upside and a stalled bond rally near the end of the month. Even with the reversal in equity fortunes based expectations of better US growth and continued monetary liquidity around the globe, US equities are down 5 percent for the year. The return differential between equites and managed futures is now double digit. This advantage is even greater for global equities. The Barclays Aggregate bond index is the most often used benchmark for institutional investors. Its returns are more muted than the long bond because of its heavy skew toward mortgages and credit. Managed futures is outpacing this key bond index by 5 percent. Long bond exposure would have done better over the last two ...

Everyone talks about the retune to risk trade-off, but it is a concept that is at times hard to visualize.  A simple tool is to form return to risk boxes with well-known benchmarks. The return to risk boxes represent the area of higher return and lower relative to some benchmark. If you are in the box, you have a better return to risk trade-off. If you are outside the box, your return to risk is inferior. You can look at a large number of managers or indices in one graph through the box approach.  In the graph above, we have included global macro and managed futures indices as well as the S&P 500 index (green circle) and Barclays Aggregate bond index (green square) for the last 12 months of return and 36 months of volatility. The triangles represent the major managed futures and global macro indices. We have not labeled them to make the graph a little cleaner. The other green circle is the MSCI world index.  The graph tells a very interesting story. All but one index ...

Investors have be abuzz with talk about the good performance for managed futures so far this year, but this performance should be placed in perspective. First, the best month over the last twelve for managed futures and global macro was generally last January. Second, most of the global macro and managed futures indices are below their high water marks for last twelve months. It is not too late to invest. Third, global macro discretionary have done better than managed futures on a risk adjusted basis. However, managed futures has done better than many other hedge fund styles which have been disappointing investors with their flat to negative performance of the last year. The key allocation decision for alternative investments this year may be focusing on style differences that focus away from equity trading.

How do you grade your CTA portfolio or an individual manager? A simple way compares manager or portfolio performance with a benchmark. Unfortunately, there are wide variety of benchmarks, so  performance result may differ based on the index chosen. All of these hedge fund benchmarks are representative samples of large managers equally weighted or weighted by assets under management, but even with a large group of managers, there will be large performance differences. Many will argue that of course there will be differences, but the size of these differences will not be economically meaningful because all of the benchmarks closely track each other. This is not the case as seen in our first graph. There can be wide differences in cumulative return. The differences or spread usually get much large when there is a crisis period. Those indices that have a high trend tilt or more crisis beta will move ahead of the other benchmarks. The difference between the high and low monthly performa...

The CFTC and the European Commission agreed on a framework to recognize each other’s clearinghouses, central clearing counter-parties (CCP’s), as subject to the same regulatory oversight. The question comment from many traders is likely to be, “So what”. Well, this is a big deal. If this was not done, then US clearinghouses would not be qualifying CCPs under EU law. The impact would be that European banks carrying positions there would be subject to a penalty capital charges.    Now, under this agreement, the European Securities and Markets Authority (ESMA) can authorize a US derivative clearing organization (DCO) as an equivalent to an EU qualifying CCP for bank capital requirements. The equivalence will occur if the US DCO’s provide for three changes to make them similar to EU CCP’s.  European CCP will now have to meet all of the requirements of a derivative clearing organization (DCO). This goes a long way to standardizing regulation for CCPs around the world and will ...

Investors have seen a surge in market turbulence. There has been significant price dislocations and a rising flight to safety by many market participants since the beginning of the year. Consequently, it is important to look at strategies that may do well in this type of environment. Hedge funds, in general, will provide diversification protection because they have less beta exposure. Less directional risk will mean lower correlation with the overall markets, but that lower risk exposure does not mean hedge funds will be able to exploit opportunities from turmoil. However, there are strategies that work well under market turbulence. Global macro and managed futures can do well during these difficult times as evidence by their past conditional returns. From "Hedge funds: The case for trading strategies" Picket Alternative Advisors SA shows the value-added from these divergence strategies in three ways. First, during periods of stress, managed futures will outperform direct bet...

There has been a significant amount of research on the value of managed futures when there is a crisis, but most of the work has been empirical. The results show that there is a strong negative correlation between managed futures and large stock declines. This conditional correlation has been referred to as crisis alpha. Crisis alpha is measurable, but there has been little discussion on why markets dislocate and why some strategies such as managed futures will do well during these special times.  I have referred to the advantage of managed futures during these crises as divergent trading. Managed futures managers make money when markets are mean-fleeing, but that is a description of what the strategy does and not why it will make money. Nevertheless, a recent paper in the American Economic Journal: Microeconomics provides some insight on why divergent trading may be successful. It does not discuss managed futures or investment strategies but focuses on the bigger issue of why mar...

When there is a market dislocation or divergence, there will be good opportunities for managed futures. January saw an equity sell-off, continued downward pressure on commodities, and economic expectations for slower growth. Many of these themes began in December and were clearly were strongly displayed in price.  CTA's had their best month in a year with a monthly return of over 4 percent for the strategy index. This was significantly better than the S&P 500 and MSCI World equity indices. The Soc Gen CTA index also outperformed the Barclays Aggregate bond index which only gained a little over 1 percent. The CTA index also posted positive returns versus the Bloomberg Commodity index (DJP) which fell almost 4 percent. The only asset class that outperformed managed futures was the long bond as measured by the TLT ETF.  The positive correlation with the long bond but slight relative underperformance tell the strategic story behind managed futures. Managed futures gains from h...

The '40 Act mutual fund space has grown significantly for CTA's and this sector now has its own index. It is not the same as the SocGen CTA index that has been reporting returns for the last fifteen years. A comparison between the SG CTA index and the SG CTA mutual fund index shows there is value in moving looking outside the mutual fund area. There are more managers to choose from which adds diversification from more styles of managers, timing of trades, and markets traded. Starting a new index is never easy. You have to figure out the criteria for the constituent managers and actually back-fill to provide some history. The result of this construction is a new index which may not track the performance of similar existing indices. The existing CTA index has 20 managers while the new mutual fund index has 10 managers with a minimum size in the mutual fund AUM of just under $100 mm. There are only two names that overlap. Both are equally weighted. Our first chart ...

Effort and results were not linked for managed futures managers in 2015.  For all of the trends, opportunities, and trading, the SOCGEN CTA index ended the year up 10 bps. Going to sleep for the year with money in a mattress would have gotten the same return. Nevertheless, equities as measured by the S&P 500 stock index (SPX) fell less than one percent while bonds as measured by the Barclay Aggregate Index (AGG) gained just less than 50 bps. It was a sideways year in spite of the historic change in Fed behavior,  significant oil shocks, and negative interest rates in the EU. A closer look at the monthly returns show an interesting story for how and when managed futures managers made profits and lost money. Of course, we are generalizing, but we believe a simple comparison with traditional assets can tell an effective story.  Looking at equities, there were two big positive return months, February and October. During these months, managed futures posted loses. The powe...

If you are a managed futures trend-follower, you need market dislocations, divergences, to make money. You follow a mean-fleeing strategy. Most managers futures managers can be classified in this manner. If there are no market moves, that is, markets are range-bound, trend-followers will not have any viable opportunities.  If we look at the moves for 2015 in the futures markets, it is clear there were limited long opportunities. The major potential trends were from the short-side in the energy and metals markets. Unfortunately, these markets are usually the most volatile and have smaller weightings in the portfolios of most managers futures managers. The high volatility of these markets also makes it more likely to be stopped-out of positions or harder to find trend identification.  Clearly, it is hard to extrapolate from year over year changes but even a high level examination tell us  that there were limited opportunities. For all trend-followers, there is a cost of tre...

What causes price momentum? You can define prices moving over a time period in different ways, but price momentum is the manifestation that that there is a change in the equilibrium price, or a change in supply and demand for a market. The reason for this change is the receiving of new information that will change the price. If there is no new information, there will not be a change in price. Hence, the process of how information enters the markets will define how price should  move.  If there is a discrete increase in information, there will be a discrete jump in prices. If there is a continuous increase or disclosure of information, there will be a continuous movement in price. This is consistent with rational expectations and market efficiency. If there is one surprise, there will be one jump in price. If there are a series of surprises in one direction, there will be a trend in price.  Recent research has discussed and analyzed this issue in the context of the "frog-i...