Trend-Chasing Quants Post Worst Returns in 17 Years

Updated on
  • February worst month for commodity trading advisors since 2001
  • Outlook for less-agile programs questioned amid turbulence

A decades-old $350 billion pocket of quantitative money management may have met its match in February’s choppy markets -- and it could get worse from here.

Some quant investors are concerned that the most popular trend-following commodity trading advisers, more widely known as CTAs, are ill-equipped to handle a new era of steeper declines and sudden volatility spikes. The strategy, which rides price trends across asset classes, fell 6.4 percent in February, the worst month since 2001, according to a Societe General basket of the 20 largest managers. CTA funds have fallen 0.7 percent in the first three trading days of March.

Many programs that were built on data from nine years of relative market calm are breaking down, according to Quest Partners’s Nigol Koulajian. Amid a bull run in which stocks rarely sold off more than two percent, funds grew increasingly correlated to equities, learning to wait longer before flipping to a short position, he said. And they bought every tiny dip.

Last month, however, offered a taste of what’s to come for funds that don’t react quickly to market moves. CTAs anticipating reversals held onto long positions as markets sold off, even buying into the downturn assuming equities would bounce back sooner than they did, said Koulajian, chief investment officer and founder of the $1.4 billion quant fund.

“What has worked in recent years is unlikely to work in coming years,” he said. “CTAs are less able to hedge equity corrections because they’ve gone more long term. This is a byproduct of the market environment not being difficult enough, making the strategies lazier.”

If returns worsen from here, that’s problematic for investors who’ve piled in recently and currently back such funds with the most assets on record, according to BarclayHedge data. That follows the fourth-quarter of 2017, when funds posted their best returns in nearly three years. Strategists began ringing alarms when those gains carried over into the new year, as CTAs returned another 3.9 percent in January.

Slow Winners

Over the past few years, slow moving CTAs have fared better than quick ones, capturing the majority of new assets in the industry, Koulajian said. In 2017, fast-paced CTAs declined 6.7 percent, compared to a 2.2 percent gain for their longer-term brethren, according to Societe Generale indexes. 

To be sure, Koulajian’s view reflects his self-interest since he believes Quest’s more reactive model is superior. His trend-following strategy takes risks based on how quickly market volatility changes, so it can better cope with sudden flair-ups, according to the firm.

But Koulajian has a point: Short-term traders did better in February, falling 4.4 percent compared with 9 percent for the rest of the trend-followers. So far this month, short-term funds are flat versus a 0.6 decline for the others. The quicker cohort’s one-month historic volatility is at the lowest level since 2011 relative to the slower speed trend-followers, data compiled by Bloomberg show.

At $7.5 billion Aspect Capital, previous strong uptrends have slowed the reaction time of the trend-following program, according to Christopher Reeve, director of investment solutions at the London-based firm. But the backward-looking nature of CTAs means that Aspect will adapt when market regimes shift, while slow movements can actually be beneficial amid volatile price trends, he said.

“You’re trading a lot and getting whipsawed, whereas a slow moving approach might just ride through a choppy period” and capture the prevailing trend, he said.

Price Of Volatility

But the issue in February wasn’t just choppiness. The selloff caused strategies to cut positions considerably before equities quickly bounced back, said Doug Greenig, the founder of Florin Court Capital and a former chief risk officer of Man Group’s AHL unit.

Still, CTA managers who make assumptions about oncoming shifts as they prep for choppier markets risk creating less-robust portfolios that may not capture the broader trend, according to Philippe Jordan, president at Paris-based Capital Fund Management SA, a quant firm managing about $11 billion. Instead, declines amid volatility spikes are the price to pay for CTA strategies that risk-budget because they see friction and trading costs as they reduce positions, he said.

“We try to build a system that is going to be robust over many different scenarios,” Jordan said. “Trend-following over the longer term, in the next three to five years, I have no concern as to the sustainability and persistence of the strategy.”

Change Coming

Despite asserting their adaptability, funds that have grown based on their success chasing equity momentum are now too large to change pace, according to Koulajian. With billions of dollars under management, they can’t become more reactive, since doing so would mean steep trading costs, he said. 

This leaves most CTA investors without downside protection, paying up for exposure they could get through any long-equity position. Likewise, the returns of slower moving trend-followers have been consistently correlated to U.S. equities over the past year and a half, whereas the measure has oscillated for quick reactors, data compiled by Bloomberg show.

“What investors expect in quant trading generally is steady outcomes,” Koulajian said. “In a normal market with no regime shifts that’s possible. But that is going to change very substantially.”

(Updates ninth paragraph with March returns.)
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