Amidst a period of poor performance by CTAs, speakers at Forex Network Chicago discussed how these firms should be adapting to a period of sustained low volatility.
The panellists all agreed that a large part of the reason why CTA returns have been so low since the financial crisis — with the exception of 2014 when oil prices led to a strong year for them — is that central banks have proven very effective at suppressing volatility.
“Credit where credit is due, the central banks said that one of their goals is to maintain price stability and they’ve done a fairly good job of that,” said Andrew Strasman, a principal at Totem Asset Group.
“When volatility gets sucked out of the market, it provides less opportunity. And whatever model you’re utilising, you’re trying to find these opportunistic times to try and profit. So less volatility just takes the bite out of your gains,” agreed David Klusendorf, the CIO of Typhon Capital Management.
The question facing CTAs then has been whether they should stick with their strategies and their models, trusting that market conditions will eventually change again and returns will pick up, or adjust and adapt these strategies in order to be more profitable at the risk of reducing their diversifying effect within investor’s portfolios.
As Jeff Malec, managing partner at RCM Alternatives, put it: “From a purely academic standpoint, you should be dedicated to your model. Investors want you to be dedicated to your model because they want to rely on that one performance profile. But you also have the management company that runs the strategy and if you’re losing $10 billion in assets then that management company isn’t doing so well. So then the question is: do I stay true to the pure CTA performance profile or do I adapt to save my business? And I think that more often than not we’re seeing managers pivot in order to save their business.”
He continued: “So what does that look like? Firms are adding outright short vol they’re adding vol arb strategies and they’re adding long bias, because if you back test all of those things over the past ten years they’ve worked much better than pure trend following strategies.”
As previously stated, the problem with such an approach though is that it might not provide investors with the diversification benefits that they might be anticipating from a CTA in the event of an equities downturn. Malec pointed out that this was evidenced at the back end of last year when volatility spiked and equities sold off and CTAs mirrored these losses rather than mitigating them, according to indices which track their performance.
“When investors see that everything in their portfolio is down at the same time they tend to think: ‘What’s the point of having these CTAs in there?’. They think they want the non-correlation that they provide, but what they really want is negative correlation,” he added.
Klusendorf, meanwhile, made the case that even when market conditions are not particularly conducive for CTA strategies there are still steps that can be taken by fund managers to improve their returns.
“I’m a big believer in having a tool belt — what type of tools do you have that you model around your programme? These tools can be as simplistic as seeking alpha through improved execution of trades, looking for places to glean those extra basis points. Is this a total panacea for every problem that you’re looking at? Of course not, but it gives you some real flexibility to be able to engage certain aspects of your programme at certain times, and this is I think where you see the importance of a good manager, whether that’s on the systematic or discretionary side,” he said.
Expanding on this idea of ‘execution alpha’, Klusendorf continued: “I was one of the first people that ever had a Globex terminal and I traded eurodollar, which is a very bulky market that doesn’t really move and where there’s volume on both sides. So one of the first things we did was just a simple time-weighted execution, we literally just used an egg timer that I would put on my desk and every ten minutes when it dinged you would execute. The point is that sometimes there can be very simple ways of improving your execution. It could be just looking at your slippage when you execute and seeing if there’s any certainties to glean from it. Sometimes there aren’t, but it’s a nice place to start because then you see how your model interacts with the market.”
On the issue of performance, the panellists noted that FX used to be one of the best markets for CTAs to trade in, but that following the global financial crisis it has become a challenging market for them to trade profitably because central bank coordination has largely kept interest rates moving in lockstep, limiting currency moves.
“The reason why currencies used to trend the best is because these products are unhinged. FX is a concept, it’s a construct, it’s the faith that the market has in a sovereign nation. By contrast, if the price of corn goes down low enough people will just stop planting it — FX doesn’t have those constraints,” said Strasman. “But it’s been a very difficult market to trade recently, which might be why more and more people are now looking towards the crypto space.”
Given the challenges that CTAs have endured in the current environment, the question was posed to the panellists: do these funds still play the same role within investor portfolios that they traditionally have?
“I would say yes and no,” responded Malec. “Yes, there are investors that are just going to grab some trend-following beta product and put it in there for cheap to have that exposure. But I think that the rest of the industry is going to become more like an equity replacement, so more of an absolute return vehicle that has a more dynamic structure to it.”
From his perspective, Strasman said that CTAs could and should fulfil their expected role within portfolios but that investor attitudes have moved in a direction that makes them less receptive to these funds.
“I think that investors have largely run out of patience and that might be because they’ve become performance chasers. After 2008 CTAs had a plus-size year and investors flocked to this space, but 2009 didn’t turn out so well and since then we’ve had all the dislocations from central banks which hasn’t helped,” he said.
However, Strasman did make the case that CTAs remain a good investment vehicle for certain types of firms.
“You’ve got to separate the investment vehicle from the trading strategy. In the CTA space you’re talking about separately funded account, and these days they’re mostly notionally funded. This gives investors the transparency, control and ability to lever up and lever down their exposure with ease, while still having effectively top-day liquidity features, which in my opinion means that CTA strategies through separately managed accounts remain a very attractive investment vehicle for family offices in the $30m-$100m range. But it’s not for everybody,” he said.