Stockholm (HedgeNordic) – Managed futures funds have been struggling over the recent years, finding it hard to identify market environments that let them shine. Quantitative trend-follower Nordea 1 – Heracles Long/Short MI Fund is no exception to this rule and is yet to be tested in an environment when markets turn sour, typically a good hunting ground for such strategies.
Metzler Asset Management’s fund manager Christoph Sporer, who runs Nordea 1 – Heracles Long/Short Fund (Heracles) on a mandate, explains the fund’s strategy, discusses the role of trend-followers and shares his thoughts on the future of trend-followers.
The Heracles long straddle
Christoph Sporer joined Metzler in December 2016 as a portfolio manager focusing on quantitative absolute returns strategies. “I have always been cautious about trend following in general. These strategies have a certain behavior which leads to meager returns most of the time,” Sporer tells HedgeNordic. “But these strategies also have the potential for stellar returns exactly during times when you need them the most, which makes them great diversifiers.”
Heracles has been following the same strategy since its inception in March 2008. When Christoph Sporer took over the reins of Heracles less than two years ago, he “didn’t feel the need to change a well-proven model.” Heracles uses rule-based derivatives strategies to take long and short positions in liquid index futures, bond futures, and currency forwards. The fund seeks to profit from three- to 12-month trends and avoids focus towards a particular region or asset class.
In contrast to “many quantitative trend followers that fit their models to historical data, Heracles follows the unique approach of option replication,” Sporer tells HedgeNordic. “We set up a long straddle position. Instead of buying expensive options, we replicate the delta of the hypothetical straddle with liquid futures on a daily basis,” further explains the portfolio manager. The fund manager builds a new straddle at the money with a delta of zero, and the delta develops as markets start moving either on the upside or downside. “This is the most robust and efficient way to follow trends I came across so far,” reckons Sporer.
Trendless markets for managed futures space
Trend followers included in the Nordic Hedge Index (NHX) have struggled recently, taking a particularly strong hit during February, and again, more recently, in the first half of October. The month of February was not the main problem, according to Christoph Sporer. After all, equity securities, especially in the United States, had been trending up until January and then had a somewhat normal correction. “You would expect a trend follower to give up some gains in such a move. It’s in their nature,” Sporer explains. The real problem, however, emerged after the February correction, he reckons. The problem still exists. “We find that the lack of trends in either equity markets, yields, and currencies simultaneously over such a long period is historically unique,” says Sporer.
Nordea 1 – Heracles Long/Short MI Fund is suffering unusual losses in 2018, with the fund giving up 16.6 percent year-to-date through September. “Admittedly Heracles has taken a strong hit in 2018, but the fund also performed quite strong in 2017,” Sporer says about the performance of Heracles. “In relation to this fund segment as a whole, we seem to have been somewhat more aggressive than others. I would expect this to normalize in the next strong trend phase,” adds Sporer. Heracles gained 6.7 percent last year when the members of the NHX CTA fell 2.4 percent on average.
What’s in store for trend followers?
Trend followers tend to perform best in trending markets, of course. Mystery revealed. However, negative trends create the ideal environment for trend followers, according to Sporer, as “they tend to be stronger as everyone rushes for the door.” “Trend followers would benefit from short positions and recapture their reputation as strong portfolio diversifiers,” further adds the portfolio manager. The current politically-driven market environment serves as an explanation for the lack of trendiness. “Political events like trade conflicts, central banks changing course, or developments in the Eurozone create erratic price movements in most asset classes,” he adds.
Talking about the future of trend followers, Christoph Sporer believes trend following’s prospects are weakening. “Trend following has strong benefits,” reckons Sporer, “strong trends just occur very infrequently.” “This makes trend-following funds look rather unreliable,” he adds. For that reason, the portfolio manager of Heracles believes we will see fewer trend followers as stand-alone solutions going forward.