


Susan Roberts: Actually, it was the opposite. One of the reasons that we started looking into the question of CTA performance during different interest rate regimes is because there was a belief amongst some in the market that it was the declining interest rate environment that drove CTA returns for many years. And the reason for that is because in a declining rate environment, bond prices are generally rising and, all else being equal, will result in trend following strategies holding long exposure to fixed income. Because long fixed income is usually a positive carry trade, it has the potential to provide a nice little tailwind to performance.

Now because interest rates had been declining for a few decades prior to the financial crisis, some people began to pose the question: is the CTA industry just a by-product of the interest rate environment over the last 30 years? It was in response to that question that we wrote the original paper in 2013, when we were still in a zero interest rate environment, and now we’ve updated the data and found that our original findings still hold – CTA performance during rising and declining interest rate environments has been statistically indistinguishable. In fact, as we note, if anything it’s been a little bit better when rates are rising.

GS: So I’ve heard the view from allocators before that CTAs are only worth having in the portfolio during a bear market and, as you note in the report, equities performance is typically negatively impacted by rising interest rates. This could imply that CTAs are wanted in the portfolio when interest rates are rising. Do you accept this assumption that CTAs are only worth having in an equities bear market?

SR: Well the CTA industry overall has a number of objectives. One is to provide diversification to traditional asset portfolios that can get hit hard during equity bear markets – there are even CTA strategies designed and optimised to that specific goal of providing offset-type returns during a crisis period. Then there are other types of CTAs that are much more focused on standalone performance, with more of an absolute return objective.

This industry has matured significantly over the last decade and, whereas in the ‘80s and ‘90s the industry was almost all trend following, you now have an entire range of strategies that will tend to perform differently in different types of environments. In retrospect, we might have made a mistake using the phrase “CTAs” in the title of this paper rather, than “Trend Followers”, because we focused mostly on trend following in the paper and so may have inadvertently contributed to the common misunderstanding that the CTA industry is synonymous with trend following, which is not the case.

The other important point is that it’s often very difficult to know if you’re in a bear market until you’re already in it and are experiencing some pain. It’s notoriously difficult to time these things and so in our opinion the best approach to CTA strategies overall is to take a more long-term view.

GS: Were there any big surprises in the data for you?

SR: One thing that was notable was just how impacted traditional assets were by the interest rate environment. That was a big surprise for me because, although one might assume the fixed income sector would do better when rates are declining, the data suggests that the equity sector is even more sensitive to the rate environment.

GS: Post-financial crisis has not been a vintage period for CTA performance. What do you attribute that to?

SR: The zero interest rate environment from 2009 to 2015 was suboptimal for CTAs for a few reasons. In particular, with many of the global central banks acting in synchrony, there was a significant dampening in volatility and high correlations across regions. Within each of the three financial sectors, markets exhibited unusually high correlations. When sectors are co-moving in a very tight way it’s typically not good for CTAs, which generally perform better when markets are diversifying to one another. When correlations are lower, there is a potential for more independent trades.

GS: OK, but since the start of 2016 I’ve spoken to optimistic fund managers who pointed to a variety of reasons – from the US Fed beginning to increase rates, to Brexit, to the US election, to European elections, to financial deregulation and changing economic policies in the US – in order to argue that this “diversifying” of markets is likely to occur imminently. And yet, for the following two years volatility remained fairly low and CTAs generally continued struggling for performance. Are things really about to change now?

SR: Well that’s the million dollar question, isn’t it? But the reason why we’re optimistic now is because we’ve already seen the environment improve over the last few months, as the Federal Reserve pursues its hiking initiative and continues to diverge from many of the other major central banks.

And so, for example, strong trends have opened up in the currency sector, with the US dollar moving higher versus most of our traded currencies. We’ve also seen the opportunities in fixed income improve, as global interest rates – which are no longer being uniformly held at zero – move more freely. Global policy divergence has also created trading opportunities outside of trend following. Regional spreads, like short US/long European fixed income, have recently worked quite well. That’s a trade that our macro strategies have had on since mid-2017.

GS: The conventional wisdom regarding managed futures is that they come into their own during a “crisis period” when there’s a large drawdown in the equity market. And yet, the data that I’ve seen suggests that this didn’t happen during the sell-off in February. Why didn’t we see the performance that some people might have expected during this? Was it too short to be considered a crisis?

SR: Yes – although it was a significant drawdown, markets recovered extremely quickly so we wouldn’t necessarily characterise it as a crisis. If an investor is looking for a sure payoff during such a short-lived correction, options would probably be more appropriate, but that comes with a fairly high premium cost.

The reason that CTAs can be helpful in a crisis period is because they can respond by taking positions that can capitalise on whatever the new market dynamic is. In 2014, the “crisis” was in energies and in foreign currencies vs the US dollar, and so that’s where you saw CTAs allocating risk and capturing profits. In 2008, there was a collapse in global equities and a rally in safe haven assets, so that’s where CTAs were allocating risk. The real benefit that CTAs provide is being able to dynamically allocate capital wherever the opportunities are, on either the long or the short side. That’s something that you can’t do in a traditional strategy. But if there’s a very short-lived correction, the only thing that matters is how you were positioned when it started.

The final point to make is that, with regards to trend following strategies, the one risk exposure that they fundamentally all have is to trend reversals. And I would characterise the February event as a very, very big reversal period rather than a crisis period, because equities rebounded right away.

GS: So here’s perhaps a more philosophical line of questioning: What is a CTA fundamentally in the portfolio to do? Should they aim to get the best risk adjusted returns for the client, ignoring correlations, skew, etc? Or is their purpose to get the best returns within a defined asset class? Broadly speaking, it’s been a difficult period for CTAs post-financial crisis, in some cases leading to tough questions about whether they stay true to the asset class profile or stray slightly to improve performance…

SR: That’s an incredibly relevant question. Ten years ago there would have been a much simpler answer because, as I said earlier, there was much less heterogeneity across the manager group.

Now you have managers with specific investment objectives across different programmes that they run – for example, at Campbell we have a crisis risk offset programme designed to explicitly provide diversification during an equity sell-off, while we have another programme with an absolute return objective, which has done quite well since the financial crisis despite the bull market for equities. We have a few other programmes as well with varying objectives.

So it really depends on the programme. This adds another layer to due diligence, and reinforces how important it is for investors to be clear on what they are looking for in a CTA manager. How important is standalone performance versus diversification to them? What do they need diversification from? How an investor answers those questions can help guide them towards the right type of programme.

Galen Stops

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