There is a popular meme going around that shows an intoxicated Captain Haddock downing a stiff drink, complaining about having bad a rough week. Tintin smartly corrects him that it’s only Wednesday.
For Managed Futures managers, we can only imagine is how this week felt, especially so after having a rough day on Friday the 10th, when Silicon Valley Bank was halted. SVB was ultimately taken over by the FDIC over the prior weekend.
A lot of the goodwill that Trend Followers built throughout 2022 will likely have been undone. Janet Jackson’s song, “what have you done for me lately” sadly also applies to Trend Followers. No matter how strategic and long-term your client is.
The Bond trend was a nice case of how a trend follower strategy typically walks up the stairs and finally jumps out of the window as the trend change. Or as in this case, figuratively being defenestrated by the collective force of risk managers, traders, and asset allocators striving to reduce duration, credit mismatches, and losing trades in their books. A week where a triple witching coincided with a banking crisis.
While the end of the prior week was not stellar, this week represents a major turn of fortune for trend followers. The market changed from pricing in a FED that might eventually stop increasing policy rates, to pricing in a major banking crisis. The pricing is now offering substantial odds that the FED may actually decrease rates throughout 2023. An implicit macro view held by the average trend followers was the “inflation is transitory for longer” theme.
CTAs, as measured by the NilssonHedge Daily CTA index, lost 3.5% on Monday as bonds rallied. Tuesday offered a small relief and perhaps a good point to liquidate short-duration positions into weakness and the index recorded a gain of 0.9%.
Unfortunately for Trend Followers, the bond rally continued on Wednesday. At this point, a lot of CTAs had reduced fixed income positions by approximately half, in wake of the trend changes and increased volatility. Wednesday resulted in a loss of 1.8%.
Thursday offered a modest relief (+0.5%), but the appetite for government securities continued on Friday. This time, the loss was more normal with a loss of 80bps. This was a near-perfect combination of punches with the two first being the strongest. Here we note that our index is not a pure Trend Index, but also contains managers using other strategies.
Largely explaining the results for the week is the rally in the US 10y futures, which moved approximately 5 handles (from 110 to 115) from Friday the prior week to Friday this week.
What is pleasing to see is that the sensitivity that CTAs have to bond moves have been rapidly reduced (both position and risk-driven reductions), the moves were so significant that CTA suffered one of their absolutely worst daily losses (not the worst, but close), 2-day losses, etc. While CTAs did not trigger the bond rally, they and countless other entities added fuel to the fire as they needed to close out existing shorts.
Not only did the benchmark bonds increase significantly in price, but also the shorter duration instrument (Eurodollar and the SOFR futures) had extraordinarily steep price changes. This also contributed significantly to the negative week.
On the back of this, at least one Global Macro with significant pedigree has closed. Graticule, a Singapore-based fund, closed shop after having taken wrong-way bets in short rates. Given how markets have been trading there may be more fund closures.
As the SVB and FRB (First Republic Bank) crisis morphed into the international area and threatened banks with larger balance sheets (CS…) the quickly evolving banking crisis is still ongoing. Despite various interventions over the last week regulators have yet to install the necessary confidence into markets.
Our Daily CTA Index is now close to the maximum drawdown. The speed of the move is similar to the COVID-related March 2020 drawdown that we saw. You will see a similar picture for other daily CTA indices.
A number of lessons will probably be learned from this. Here are a few discussion points that may or may not be trivial:
- Market diversification matters: We have seen the largest losses suffered by managers with concentrated positions in Short Rates.
- Risk Management – volatility-driven position reductions when market volatility increases is a risk management component occasionally frowned upon by some managers.
- Rebalancing frequency: some CTAs rebalance continuously, while other rejig their portfolios weekly or even monthly. The unusual rapid market moves will refocus attention on this.
- Long-Term Trend Following as a crisis alpha – perception matters and most investors that have been sold managed futures as crisis protection will be dissatisfied. CTAs came into this crisis short bonds (and long equity) and failed to provide protection against the start of the Banking Crisis 2.0. Equities held up fairly well during the week but sold off in the prior weeks.
- Short-term strategies may naively offer better crisis alpha during rapid changes. If the crisis continues, long-term trend followers will eventually adjust their position. If the crisis is magically resolved over the next few weeks and we go back to business as usual, trend managers may be in for another whipsaw.
- Short Duration and Trend Following – 2022 was one of the few years when short-duration bets paid off for trend followers. An interesting question is how much of that profits were given back in the recent rally and how your systems should be constructed to capture trends/outliers while not being subject to large givebacks when trading against the wind (carry). And how it’s compatible with providing equity market stress protection. While equity stress protection is not a stated goal for many managers, it is often the precise reason why long-term trend followers have a substantial allocation from institutional investors.
As usual, these market moves as this will probably not repeat in the future but will result in a number of manager reviews, and potential reassessment of the strategy, followed by flows in and out of managers as the dust settles. Buckle up and put on your best suit for the upcoming reviews
If there is any silver lining to this debacle, it is that since 2019, Managed Futures is still (barely) outperforming other liquid alternative strategies. The setback is painful and Trend Following has again shown that it is a pain arbitrage. It is a difficult partner, sometimes loving and caring, but occasionally also violently abusive.
If you have come this far, you can explore our index data for further insights:
As we are about to publish we learn that UBS has acquired CS. The terms of the deal are beyond our comprehension to fully analyze. But let’s hope that this is a light at the end of the rather short tunnel, and not another train (analog Bear Sterns followed by Lehman).
No Trend Following is not dead, but it is going to take some time to re-establish positions and recover the losses.
As per usual, our databases are updated and available to subscribers.
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