Stockholm (HedgeNordic) – There was plenty to talk about at HedgeNordic’s CTA round table in November of 2022. Managed futures once again made the case that they should be a part of every well-diversified, institutional portfolio. After a decade of anemic performance, trend-following CTA managers enjoyed a banner year in 2022 amidst turmoil for traditional asset classes and portfolios. Trend-followers offered tail hedge, diversification, and crisis alpha.
Return to Normality
In 2020, Velliv’s Head of Alternatives Christoph Junge co-authored a paper on alternative investments during times of crisis, in which he found that “CTAs as a group has been the only asset class in our study that consistently performed in each crisis since 1980.” After performing well throughout the market sell-offs of 2000-2002, 2008, and the first quarter of 2020, CTAs came to the rescue yet again in a year when both stocks and bonds simultaneously incurred losses in the face of inflation and monetary policy tightening.
The 2010s were characterized by a set of macroeconomic forces in the wake of the Great Financial Crisis that created an unfruitful environment for persistent price trends and trend followers. In 2022, macroeconomic uncertainty and market volatility rose due to high inflation persistence, a rapid and aggressive shift in central banks’ policies, and the unexpected Russian invasion of Ukraine. 2022 was all about a big lack of equilibrium across regions and asset classes, according to Razvan Remsing from Aspect Capital. “The journey from a lack of equilibrium to steady-state creates trends.”
“On a global level, we had a lot of multi-decade themes that have been thrust into reverse,” added Remsing. “We see deglobalization in supply chains, the return of inflation, the renormalization of interest rates, and big dislocations within energy markets with Europe at the center of it, all having ramifications globally.” This journey to a “new equilibrium” created a divergent set of persistent price trends, which explains why 2022 was one of the best years for many trend-following CTAs.
Patrik Säfvenblad of Swedish Volt Capital Management agreed with Remsing, saying that we were adjusting to a new normal in market by market. According to Säfvenblad, the beauty of trend-following lies in the ability to capture multi-year trends that happen once every six to seven years. “Whenever CTAs are doing well, it’s one thing happening and this one thing is that investors across different markets are adjusting to a new normal.”
Lynx Asset Management’s Martin Källström added that one of the most important developments of 2022 was the pullback from the stimulative central banking policies. “Taking away monetary stimulus means removing the safety net that investors have become so dependent upon,” explained Källström, who has the role of steering Lynx Asset Management alongside founder Svante Bergström. “We built our strategy to capitalize on cognitive and emotional biases, which have had an increasing influence on investor behavior since inflation started to be a threat.”
Although Harold de Boer of Transtrend agreed that there is one big driving trend in markets in the form of returning inflation, he observed that “this driver is going through different phases, manifesting itself in a different way in different markets in different phases of the trend.” According to de Boer, “this results in increased diversification for trend-followers, as well as healthy dispersion among trend followers.”
RPM founder Mikael Stenbom said that “we are going back to an environment that looked more like the period before the great financial crisis.” Back in the 2000s, “we had what one can possibly call the normal regime with trends coming and going, and markets going up, down or sideways,” according to Stenbom. “After a decade of what one might call the central bank regime, we are starting to see some similar patterns from the pre-financial crisis environment evolving.”
While 2022 was a banner year for trend-following CTAs, Jeremy Taylor from ISAM argued that 2022 is not that instructive of a year for looking at the CTA universe. “It has obviously been a great year for reminding people of why CTAs are useful in a portfolio, but I actually don’t think it’s that instructive a year for looking at what drives and differentiates CTAs,” said Taylor. “There have been some strong trends across sectors, but they have actually been quite concentrated and quite easily accessible trends, so almost everyone has done well.” Taylor suggested looking further back to get a more informed perspective on how trend-following managers work.
And yet, 2022 offered some interesting episodes for trend followers. Trend-following vehicles, for instance, acted as a better diversifier than bonds in a period of turmoil, partly because of short positions betting on falling bond prices. “By successfully shorting bonds early in the year, we have delivered strong returns in an asset class that some doubted whether trend-following could perform in a bear market,” said Källström.
Can One Trend Follow a Trend-Follower?
“There is a big misconception out there, and the biggest question we get asked is, have we missed it?,” said Remsing in late 2022. “Just because we have had a very fruitful environment with highly dislocated moves, it does not mean we cannot go through a number of years where trading opportunities for CTAs are above average,” according to Remsing. “You can’t really trend follow a trend follower,” he argued. But can anyone? Christoph Junge has been considering research into defining a regime-switching model that would help identify a trendy or non-trendy environment and asked the experienced group of managers for their thoughts.
“I am very skeptical of the ability to time trend,” considered Jeremy Taylor. “Ultimately all of us in the room, if we could time trend, we would probably have done that inside our own strategies,” he elaborated. “The purpose of trend-following within a portfolio is not its standalone input on the P&L, but rather to offer protection to the long exposure to equities and bonds in periods of stress,” explained Säfvenblad. “Perhaps you are going to be able to time the allocation to this strategy somewhat, but you are not buying into trend-following for its individual alpha but for the correlation benefits to the portfolio,” he elaborated. “You risk hurting your correlation-based protection by timing trend-following.”
Performance Dispersion and Evolution
Despite the market environment being fertile for trend-followers, one should still expect performance dispersion among trend-following CTAs. The dispersion in recent returns confirms that trend-following is not a “generic” strategy and manager selection is important. Dispersion among CTA managers is essential, argued de Boer.
“The CTA universe does well when all of us make different choices every time, that is what makes us strong. Biodiversity is also something that we should want in this industry,” emphasized de Boer. “Through research and innovation, all of us should make different concept choices that are reflecting what is happening in this changing world. This development is very healthy for the industry and investors.”
There are strong reasons to consider trend-following as a strategic part of a diversified asset allocation. However, investors need to be well aware of why CTAs do what they do, why trend-following works, and how it can improve diversification, risk control, and returns in a broader portfolio. “Doing that homework is very important,” argued Säfvenblad. “If you haven’t done that homework and suddenly see a P&L number that is out of the ordinary on the positive or negative side, you are going to be questioning your initial analysis and decision. That’s when you are going to be walking away from the portfolio benefits of a CTA allocation before it has done its job.”
The full CTA roundtable discussion can be read here.