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CTAs Are Back In Vogue

CTAs are back as a diversification strategy amid US mid-term elections and trade war risks, according to a report from Lyxor’s Cross Asset Research team.  

The report put out by senior strategists Philippe Ferreira and Jean-Baptiste Berthon and research analyst Anny Mauny, states that in the context of the positive correlation between equity and bond returns and in light of rising political risks ahead of U.S. midterm elections, which the trade war rhetoric exemplifies in our view, CTAs are increasingly attractive for portfolio diversification purposes.

It cites a backdrop of easing market tensions as US earnings season looms, but geopolitical concerns remain and trade wars have legs.

According to the report, low beta strategies have performed well in recent weeks and since the beginning of April CTAs and long short equity market neutral have outperformed. It also found that merger arbitrage has been resilient, especially in light of the widening of deal spreads since the beginning of April.

 “The overall backdrop is tactically supportive for risk assets after the recent 6% drawdown of the MSCI World since the peak on January 26th. But our appetite for risk remains limited from a strategic standpoint. The 3-month correlation between equities and bond returns remains in positive territory, limiting portfolio diversification options,” the report says.

CTAs are not expected to capture any market rebound but from a strategic standpoint have gained back their diversification benefits.

“Critically, the strategy will provide protection if risk assets experience a major drawdown going forward. Historically, the strategy has provided much needed protection during large and long lasting equity market selloffs (early 2000s; 2007-2009; eurozone crisis; mid-2015 early 2016). While we are not expecting an imminent major correction, investors might find that CTAs are attractive to hedge tail risk events at present. As a result, we upgrade the strategy from Underweight to Neutral. A neutral stance on CTAs implies a 10% allocation in a hedge fund portfolio (based on BarclayHedge data),” the report states.