Popular Quant Hedge Fund Strategy Is Suddenly Doing TerriblyBy
Commodity trading advisers are down in August and September
Mistimed bets on rates and commodities are to blame, CS says
For once, the trend was nobody’s friend.
Commodity trading advisers, the catch-all phrase for a breed of quantitative investors who use trends in asset prices and volatility as trading signals, posted some of the hedge fund industry’s worst losses in August -- and it isn’t getting better. The group is down between 1 percent to 1.5 percent this month, according to Credit Suisse Group AG.
Wrong-way bets on everything from Treasury rates to commodities have cost trend followers as market correlation whipped up before this week’s meeting of the Federal Reserve. In particular, CTAs paid a price for betting interest rates would fall in the second half of the year, Credit Suisse said.
“The trend-following CTAs have given back the vast majority of a profitable first half of 2016 as their long equities, long rates and short crude gambit results in losses,” wrote Mark Connors, Credit Suisse’s global head of risk advisory in New York, in a note to clients Tuesday.
It’s a reversal of fortune for the group, which by Credit Suisse’s estimate had been one of the best hedge-fund categories in the nine months through June, rising 5.4 percent. That compares to a 5 percent decline for long-short equity hedge funds and a 1.5 percent decline for quantitative, market neutral hedge funds.
As their trades got crushed in August and September, CTA managers spent the past few weeks pulling in their horns. The group’s exposure to the U.S. equity market went from 11 percent two weeks ago to net short, at negative 14 percent, according to Credit Suisse data.
Given the force and speed at which they ditched equities, it’s likely CTAs contributed to the recent bout of volatility, said Connors, particularly since equity long-short funds increased stock holdings to near-peak levels. During the stretch, the VIX spiked 40 percent in one day and the S&P 500 Index had its worst daily loss since the British vote to leave the European Union.
The stage was set for a rough patch starting in June, when crude’s decline caused the trend-following managers to bet against the commodity. While that bet worked as oil dropped 14 percent in July, it burned shorts the following month when crude snapped back 7.5 percent.
“When trends switch, they have a short-term model and can pick up on that, and they caught the move in oil in June,” said Connors by phone. “The frequency of shifts in oil are hard to trade.”
CTAs fell 3.1 percent in August, compared to 0.4 percent gain for long-short equity funds, data from Credit Suisse show. Pain lingered into September, as their long equity and bond bet went awry. Their position would have only benefited should both bonds and stocks gained, but the S&P 500 fell 1.4 percent while the iShares 20+ year Treasury Bond ETF fell 3.6 percent.
Still, two months of freefall doesn’t mean it’s over, said Connors. Because the funds are built to switch their positions quickly, they’ll likely be able to make up for lost ground.
“When trends switch, they have a short term model and can pick that up. When there are risk reversals, these guys are making money,” said Connors. “Does that work every time? No it doesn’t.”