Managed Futures Strategies Deliver Solid Year Amidst Market Tumult
Managers of managed futures trading strategies tout their lack of correlation to equities and their ability to deliver returns regardless of market direction as reasons to allocate to them as part of a diversified portfolio. Now that the book is closed on 2020, this subset of the hedge fund industry has reason to feel that their opinions, at least based on last year’s performance, are justified.
The family of closely-watched daily CTA indices published by Societe Generale Prime Services and Clearing has, by and large, had a solid year. The firm’s flagship SG CTA Index, which tracks the performance of 20 managed futures-based strategies run by brand-name investment managers like AQR, Campbell & Company, John Street Capital, Millburn Ridgefield and Systematica Investments, ended 2020 up +3.14% thanks to a strong end to the year; December’s returns were a handsome +5.56%.
Short-term traders - those with an average holding period of less than ten days - had a solid year last year. The SG Short-Term traders index finished 2020 up +2.99%; the index was up each of the first three months of last year and held onto those gains as the market tumult at the start of the year provided a tailwind for these strategies.
“Most of the big moves in the markets happened in the early part of the year, when the news of the pandemic broke,” said Sam Gover, Co-Founder and CEO of London-based short term trading firm Altiq Asset Management, whose Altiq Futures Program is a constituent of the SG Short Term Traders Index. “We saw volatility shoot up at that time. It was a good period for shorter term strategies because they tend to do well in higher volatility situations.”
Altiq trades 50 markets systematically; trading a large number of markets via a systematic approach are, for Gover, two of the prerequisites for success for a short-term trading strategy.
“The key thing is to diversify across markets. We don’t know which markets will work so the key is to have a lot of them to capture the alpha when it’s there. Also, when you’re making thousands of trades in short timescales, transaction costs become a bigger issue so the way in which you trade becomes more important. Having a fully automated system helps with managing that and we think is essential if you want success trading with a short-term approach,” he said.
Denver, CO-based Revolution Capital Management, whose Alpha Program is another constituent of the SG Short Term Traders Index, has been continually tweaking its model to adjust to changes in the markets, particularly in the post-global financial crisis period.
“Prior to the GFC we put more emphasis on premium capture models versus betting on a big shock but after what happened in 2008/09 we deemphasised that in the model and focused more on mitigating downside risk while still capturing alpha opportunities,” said Michael Mundt, Revolution Capital Management Co-Founder. “We’ve spent the better part of a decade building a more robust system which definitely helped us last year. Markets are moving faster and faster, so we’ve been more aggressive in moving to shorter-term timescales, which also helped. But it’s a constant work in progress to ensure that you can effectively mitigate risk.”
Investors taking a look at short term trading strategies clearly have much to consider, but there’s more, according to Alex Hill, Director, Capital Consulting, Prime Services & Clearing at Societe Generale in London.
“Within that short-term space, there is a huge amount of variety. If you take an intraday trading strategy and compare it with a 3-day trading strategy, they can show completely the opposite signals for any given market. That can lead to a significant dispersion in performance between managers,” he said.
Tom Wrobel, also a Director, Capital Consulting, Prime Services & Clearing at Societe Generale in London, adds that manager selection is key when looking at short term trading strategies when compared to longer term ones and that a widely held belief amongst investors that can put them off systematic-based strategies in particular is not necessarily true.
“Investors need to get familiar with the strategy and understand what it’s trying to capture and why that is, or should be, sustainable,” he said. “There is this illusion of a ‘black box’ in the hedge fund space when in fact most of them are now pretty transparent. Investors are getting more sophisticated and want non-correlated returns, and the short-term space is one where you can get that, and some good performance. It’s just that there is a lot of dispersion between these groups and so manager selection is critical.”
Systematic trend-following CTAs also enjoyed positive returns for the second consecutive year - something that’s not happened since 2014-2015. The SG Trend Index finished 2020 strongly with returns of +6.56% in December for annual gains of +6.25%. Wrobel says that part of the reason for the return to form is because managers of these strategies have been learning and adapting after years of underperformance in the post-global financial crisis period.
“One of the ways trend-following managers have tried to answer the questions asked of them is to start to build additional model sets into their products – adding different time frames and bringing in complementary strategies into their offerings. Managers that have done that have tended to do better,” he said.
Mick Swift, CEO of Dublin, Ireland-based managed futures manager Abbey Capital Limited, agrees.
“When an environment gets more difficult it focuses the mind; managers have added new tools and new markets to reduce volatility and add returns. In the last 10 years - the post GFC period - there were less trends for them to capture, possibly due to volatility being very low. But in recent years, we’ve seen non-price-based inputs used more actively and machine learning has come more into vogue. New markets have been added like carbon emissions. It’s an evolving ecosystem that all bodes well for the long term,” he said.
The outlier in performance has come from Alternative Risk Premia strategies; the SG Multi Alternative Risk Premia Index ended 2020 down a massive -14.88%, a brutal drawdown for investors in these products. Losses from bond and FX carry trades account for some of the losses posted by these strategies but not a lot went right in this space generally.
“A carry strategy works well when there aren’t big volatility shocks in the market, so if there are, a carry strategy can be obliterated” said Hill. “Momentum strategies should benefit from more volatility, though, and they didn’t. Very few premia strategies worked well last year.”
Despite the underperformance, it’s likely that a healthy appetite for ARP products will remain because of investor beliefs and price. That said, challenges are on the horizon for ARP distributors.
“There are really two schools of thought with ARP. One is that there is a consistent premia that should be able to be extracted; some investors continue to believe that and that’s why they allocate to these products. But the second is that some investors continue to see ARP as a kind of cheap access to hedge fund strategies because most ARP products don’t charge a performance fee. That may be true, but last year, hedge funds outperformed risk premia so that’s a selling point for hedge funds,” said Hill.
Managed futures investors are sometimes accused of being fickle with their allocations and the data backs it up; according to eVestment, managed futures strategies were down -3.96% in 2011 and up only +2.46% in 2012 and +3.04% in 2013; three consecutive years of outflows totalling roughly $70bn occurred until 2015, when $13.47bn was added on the back of returns of +10.80% in 2014 only for the industry to lose -1.62% the next year. It was a similar story in 2018 and 2019 when approximately $30bn was pulled from these products only for 2019 to deliver gains of +7.59%. Whether 2021 sees money flowing back into these strategies remains to be seen, but the message is that investors should stay the course.
“It’s very difficult to time allocations to managed futures strategies,” said Swift. “For example, there were some trend-followers that responded to the sell-off in March last year by positioning for a follow-through to the downside, which didn’t happen. There is a lot of dispersion amongst managers because of sectoral allocations, like those who trade more equities and bonds over commodities and FX. But a strategy which, by its nature, is responsive, liquid and diversified will always add value over time. Before we allocate to a manager, we look at all the possible outcomes but during that process we’re taking a longer-term view. Over the long term, managed futures have performed very well and it’s uncorrelated to equities,” he said.
Mundt agrees and adds that managed futures strategies are strongest as part of the whole.
“If you have a conviction to get into managed futures as a diversifier or alpha generator, you have to be willing to stick with it. Equities and managed futures work best as a team, and good teams tend to win over time,” he said.
In 2008, trend-following-based managed futures strategies had a blockbuster year, riding the long bond trade and short equities trade to double-digit returns. That was a situation where there was a slow and steady decline in equity markets and a slow and steady rise in bond prices, a perfect environment for a trend-following strategy. Whilst the environment in 2020 was very different, overall, however, managed futures disciples have reason to be cheery.
“Last year was generally a good year for different types of CTAs, not just trend followers, and they have navigated the turbulence well,” said Wrobel. “2020 is a good example of why a variety of managed futures strategies deserve a place in an investor’s portfolio.”
© The Sortino Group Ltd
All Rights Reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or scanning or otherwise, except under the terms of the Copyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency or other Reprographic Rights Organisation, without the written permission of the publisher. For more information about reprints from AlphaWeek, click here.