CTAs beat hedge fund rivals in 2014
Deutsche Bank says that CTAs’ fortunes may have changed for good, but questions remain as to whether their supersonic returns will continue
Commodity trading advisers (CTAs) outperformed all other hedge fund strategies in 2014, according to data from Preqin, raising investors’ hopes that the poor returns generated by CTAs in the past four years or so have been a short-term phenomenon.
CTAs returned 10% to investors over the past year, according to Preqin, a research firm, compared with its all-strategies hedge fund benchmark of 3.8%.
The high returns came mostly from systematic CTAs, which generated returns of 12.4%, while discretionary CTAs suffered losses of 1.8%, wrong-footed by trends missed in the past year.
Executives in Deutsche Bank’s alternative funds division reckon that this may be the start of an about turn in CTAs’ fortunes, as central banks in the US and the UK withdraw from loose monetary policies.
“Since the financial crisis, [central bank] intervention in markets has really strangled the ability for CTAs to make money,” says Martin Fothergill, head of hedge funds at Deutsche Asset & Wealth Management. He adds that the change in conditions is leading the bank to increase its allocation to CTAs.
The Deutsche Bank division publicly remained bullish about CTAs while they underperformed in the years after a high-returning 2008. Its only seeded manager has been a CTA and most managers on Deutsche’s managed account platform are CTAs.
Fothergill says: “We see a lot of investors wanting to invest in CTAs because it’s not just a tail risk strategy. You have an opportunity to make money in normal market conditions and then, as we saw in 2008, really make money in a downturn.”
Martin Estlander, chairman of Finnish-based systematic CTA Estlander, points out that measures of global three-month volatility have been at their lowest since 1967, when the Bretton Woods system of fixed exchange rates was in place.
He sees quantitative easing and near-zero interest rates as responsible. “Volatility will return as volatility is a mean-reverting measure,” he says simply.
As central banks across the world turn off their monetary taps, CTAs say they can take advantage of the renewed volatility. In the immediate future, a divergence between US and UK monetary policy, and Japanese and eurozone monetary regimes ought to create arbitrage opportunities.
The uptick in volatility last year swiftly boosted trend-followers’ returns. Most of the money was made from a strengthening dollar and the oil trade in the second half of 2014, thinks Anne-Gaelle Pouille, portfolio construction group member at Paamco, a fund of hedge funds.
Most CTAs were heavily shorting oil as Brent crude oil prices dropped to levels 48% lower compared with where they started the year.
“There’s also been a rotation in a number of CTA portfolios away from long-term trends, towards shorter-term trends,” says Pouille. “This enabled them to reposition very quickly, and capture the oil trends and the currency trends.”
Over the summer of 2014, as volatility rose, the signals of several CTAs’ long-term models were npt functioning, allowing them to reposition to take advantage of the oil price drop.
Not all funds in the broader macro space performed well last year. “Some macro really underperformed. Notably, some macro funds were positioned for an earlier backup in rates in the US, which has been pushed back probably until the third quarter of 2015,” says Pouille. “Others got caught out by agricultural and weather effects, which are always unpredictable.”
Serge Houles, head of investment strategy at IPM, a Swedish systematic hedge fund, thinks that discretionary funds failed when they tried to second-guess central banks.
“Discretionary as a whole struggled for the entire year, because there was a lot of unexpected political intervention and geopolitical risks that weren’t accounted for,” says Paamco’s Pouille, pointing to the Brazilian election and Russian trade sanctions, which wrong-footed many global macro funds in the discretionary space.
Nonetheless, 2014 was a good year for funds of CTAs, which returned 17.3% to investors on Preqin’s estimations. The average fund of hedge funds returned 3.5%.
Deutsche Bank’s alternative funds unit – contrarian when CTAs were underperforming and now content that their fortunes have changed – sees reasons to believe that CTAs’ propitious run will continue.
“We believe there has been a structural change to CTAs,” says Deutsche’s Fothergill. “A lot of managers – particularly the big managers, some of those medium to long-term trend-followers – have done an awful lot of research and changed their models. They’ve been looking at risk management, not getting caught in dead trends.”
“The other thing we think is particularly interesting is the new managers that have come along,” he says. Fothergill is enthused by new managers who are doing unusual non-trend-following strategies, pointing to those who have performed research into artificial intelligence to anticipate and recognise trends. “We believe the market has changed,” he says.
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