Stockholm (HedgeNordic) – Trend-following CTAs have become commonplace in many institutional-grade portfolios as an insurance policy against extended downturns, with their popularity – and the likelihood of success – often increasing in times of turmoil. To improve the performance of trend-following strategies in environments with abrupt changes in market momentum, some managers have begun to incorporate a dose of “macro” investing.
An all-Nordic team of four led by Lars Wind has launched Wavebreaker, a quantitative trend-following strategy combined with a systematic asset allocation strategy and complemented by discretionary macro overlays. “We always take a more fundamental approach than most other CTAs,” explains Lars Wind, who launched the first iteration of this strategy at one of the world’s largest sovereign wealth funds, Abu Dhabi Investment Authority (ADIA), back in 2006. Wind and the strategy’s co-manager Betina Wolf-Andersen later took an internal ticket of $200 million from Danish pension fund ATP, which had grown to about $500 million before the platform was closed in 2012.
The duo was later joined by Jan Bak and Thomas Gunnarsson, and in January 2019, the Wavebreaker strategy set sail as a managed account and then launched in an Irish fund structure at the beginning of 2022. “Wavebreaker is a trend-following quant system designed to be integrated with macro trading…and this is Wavebreaker in a nutshell,” says Wind, the main architect behind the strategy. Wavebreaker relies on two separate quant-focused strategy blocks; one of systematic trend-following strategies seeking to capture longer-term trends across asset classes, another of systematic asset allocation strategies seeking to capture yield income and equity market risk premiums.
“We always take a more fundamental approach than most other CTAs. Wavebreaker is a trend-following quant system designed to be integrated with macro trading.”
“Typically we have 70 percent of our risk allocation to core trend-following and the remaining 30 percent to our asset allocation side,” explains Wind. “These two components complement each other very nicely and they create a very stable return profile that still retains the crisis alpha ability of a traditional CTA strategy,” he emphasizes. “Then, when two discretionary elements – one for each of the core allocations – are included, it creates a more adaptive strategy that can add value and reduce drawdowns.” Since inception in 2019, the Wavebreaker strategy has compounded more than 10 percent per annum after fees with a volatility of less than seven percent and a worst drawdown of less than minus six percent.
The CTA and AAA Pillars
The Wavebreaker strategy’s source of “crisis alpha” stems from a set of medium- and long-term trend-following strategies across several asset classes. “We have a trend-following system where we run eight different models across four main asset classes, with a medium-term and long-term model in each asset class,” explains Lars Wind. With about 60 “trend-following” trades on average per year, Wavebreaker employs a long-term trend-following strategy. “We follow trends that are correlated to the business cycle or the economic cycle,” says Wind.
“We have a trend-following system where we run eight different models across four main asset classes, with a medium-term and long-term model in each asset class.”
The question of “does this current position make sense in the context of fundamentals?” may trigger the use of the discretionary overlay. “We try to enhance the timing of entry and exit of the CTA models by applying fundamental research,” explains Wind. “In this strategy, we always have the ability to neutralize some of the trend-following positions if it makes sense in the context of fundamentals,” he continues. With this discretionary overlay, Wind and the team seek to solve the “basic issue that every CTA faces,” namely the wait for a trend to reverse higher before entering or the wait for a trend to reverse lower before exiting. “There is always scope for improvement.”
“We try to enhance the timing of entry and exit of the CTA models by applying fundamental research.”
By their nature, trend-following strategies do not examine fundamentals and simply invest in the price direction that is prevalent in a given security. The discretionary overlay enables the strategy to respond more dynamically during trend changes, periods that usually create a difficult environment for traditional CTAs.
“At the beginning of the COVID pandemic towards the end of 2019, most CTAs on the systematic side, including us, were long equities because the trend had been up,” recalls Wind. After studying previous pandemics and their potential impact on economies and financial markets, the Wavebreaker team brought down the equity exposure across its trend-following models as Covid cases in Italy started climbing before the big market sell-off in February and March. “We were out of our equity exposure substantially and up eight percent in Q1 of 2020 versus negative 20 percent for most stock indices. This is a good example of how we work on the discretionary side.”
Wavebreaker also employs systematic asset allocation strategies to capture risk premia from traditional asset classes. “We run a traditional long-only systematic allocation model to invest in equities, bonds and gold as an inflation hedge,” says Wind. “We try to capture some risk premiums throughout the business cycle,” he elaborates. The Wavebreaker strategy can benefit from a discretionary overlay on the macro side as well. “We can eliminate our exposures entirely if we believe fundamentals warrant that decision,” emphasizes Wind.
“We want to offer a product that can offer both stable return and crisis alpha. By design, Wavebreaker is supposed to be an absolute return product for long-term investing that works in all market conditions.”
CTAs represent a great diversifier to these long-only strategies in traditional asset classes, according to Wind. “Systematic CTA strategies and asset allocation strategies work in great conjunction. This combination is designed to work throughout all market cycles,” he continues. “We want to offer a product that can offer both stable return and crisis alpha. By design, Wavebreaker is supposed to be an absolute return product for long-term investing that works in all market conditions.”
The Future of CTAs
After frequently proving their characteristic as effective insurance against downturns such as the one in 2008, trend-following CTAs have experienced a prolonged period of underperformance post-financial crisis. “We can explain that long period of low performance in the context of fundamentals,” argues Wind. “The performance of CTAs is highly correlated to the business cycle and that is not very well understood,” he explains. “We have a very long period post the financial crisis with no or very little central bank moves, which perhaps explains why CTAs hadn’t done very well. Central banks create trends across markets by design when moving interest rates, as changing rates affect equities, currencies and bonds.”
“We are moving into a completely different regime more like the 1960s and 70s with rapidly shifting business cycles, which is probably going to be very good for Wavebreaker.”
“We have had a very long and quite stable expansion phase, which is not great for CTAs,” acknowledges Wind. That environment has changed with the coronavirus pandemic. “We had a very violent businesses cycle in 2020-2021 and now we might have another one due to sudden and very high inflation,” continues Wind. “We are moving into a completely different regime more like the 1960s and 70s with rapidly shifting business cycles, which is probably going to be very good for Wavebreaker.”
