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litmus test

2020: A litmus test for CTAs

01/12/2020
3 min read

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CTAs1 have had a rough time of late. Data from Aurum’s Hedge Fund Data Engine2 over the last 12 months shows the peer group is down by an asset weighted average of over -4.29% (as of October 2020) and down just over -5.34% YTD (to October 2020).

Reporting that CTAs as a strategy have experienced a long period of difficulty is not exactly ‘news’. Those following the strategy will be aware that it has struggled for a prolonged period of time, as the chart below demonstrates. CTAs are, on average, performing at the same aggregate net-asset value as they were at the end of 2014*. Indeed, in the last five years, the compound annual return for the peer-group is just -0.22%*.

Performance (NAV) Dec 1999 – Oct 2020

Source: Aurum Hedge Fund Data Engine

While the broad heading of ‘CTA’ encompasses a range of trading strategies, by far the biggest on an asset weighted basis are what is known as ‘trend followers’. As the name suggests, such funds are typically using statistically generated rules to identify whether particular asset prices are in a ‘trend’ and attempt to ‘capture’ or ‘participate’ in these trends. They typically control risk through diversification across instruments and asset classes and by ‘cutting their losers’ while ‘letting the winners ride’.

What role do investors look to CTAs to perform in a portfolio?

Trend following strategies have, in the past, been discussed in the media and marketed using phrases such as ‘protection’, ‘insurance’, ‘crisis alpha’ and ‘non-correlated long gamma’3. What does this mean? Essentially it is the hope that they will be able to provide some protection in the event of a significantly large risk asset sell-off.

Have they fulfilled this role in the past?

In the Global Financial Crisis they certainly did with 2008 being the poster-child for CTAs. The strategy delivered an asset weighted average return of nearly 20% in a year when MSCI World Index USD lost over 40% and many other hedge fund strategies were in turmoil. However, performance since then has been considerably more challenging.

Looking at the years since 2008 where MSCI World Index USD posted negative returns we can see that CTAs have struggled; in 2011 and 2018 they had negative performance* and they were barely positive in 2015*.

Are they able to fulfil this role today?

The question as to whether trend following strategies are able to structurally provide ‘crisis alpha’ today is much debated. Q1 2020 saw some of the most extreme market moves ever witnessed and CTAs as a group failed to provide the protection that many investors were hoping for. In both the volatile months of February and March in particular, while many global equity indices were experiencing drawdowns of over 20%, on an  asset weighted average CTAs experienced negative performance.

The asset weighted average CTA monitored by Aurum’s Hedge Fund Data Engine returned -2.12%* in February and -1.49% in March, while the median performing CTA lost 51 bps** in February and made 48bps** in March. This does not paint a picture of a strategy that delivers ‘crisis alpha’, but of course these headline statistics do not tell the whole story.

There was significant dispersion across CTA fund performance, funds in the 75th – 90th percentile posted returns in March approximately between 4.58%-9.00%** (see return dispersion chart below). Top quartile CTAs are up over 4.07%** year to October 2020 and nearly 4.47%** over the 12 months to October 2020. However, the flip side to this is some significant losers in the bottom quartile which are dragging the peer-group down.

Notably, some of the largest CTAs were amongst the worst performers. The strategy group’s median returns outperform asset weighted returns; YTD a median return of -1.06%** relative to an asset weighted return of -5.34%*. Larger funds appear to have suffered more than smaller ones in 2020. Over the last 12 months; the median performing CTA delivered around -0.51%**, compared to the asset weighted return of -4.29%*. Indeed, size and scale of CTAs appears to have been more of a hindrance than a help when looking at recent performance.

CTA Dispersion

Source: Aurum Hedge Fund Data Engine

CTA Performance Dispersion – Spread between 10-90th percentile

Source: Aurum Hedge Fund Data Engine

Given that many CTAs are ‘trend-followers’, a relatively generic categorisation of funds, one would expect them to behave in a very similar manner. But, as with all hedge fund strategies fund selection and rigorous due diligence remain absolutely critical. It is certainly not a case of ‘buy a trend follower and hope for the best’.

*Asset weighted return – Source: Aurum Hedge Fund Strategy Database

** Equally weighted return – Source: Aurum Hedge Fund Strategy Database

  1. A CTA (Commodity Trading Advisor) is a regulatory term for a type of hedge fund that trades futures contracts to achieve its investment objective. Sometimes they may also trade options and swaps. The most common will trade equity index futures, commodity futures, government bond futures and foreign exchange. Some funds may also trade other instruments such as credit index products.

  2. References to Aurum Hedge Fund Data Engine refer to Aurum’s proprietary Hedge Fund Data Engine database maintained by Aurum Research Limited (“ARL”) containing data on over 4,000 hedge funds representing in excess of $2.9bn trillion of assets as at June 2020. Information in the database is derived from multiple sources including Aurum’s own research, regulatory filings, public registers and other database providers.

  3. Long gamma definition: an option position where if a stock rallies (or declines), the share equivalent position (also known as delta) gets longer (or shorter).

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