By Neuberger Berman Alternative Investment Management
These managers execute their strategies by establishing directional positions at the asset class level to express a positive or negative top-down view on a market. Of all of the hedge fund strategies, discretionary macro affords the manager the most flexibility, with managers able to express either long or short views, across any asset class, in any region, globally. Some discretionary macro managers may focus on a more narrow set of asset classes or on a specific geographic region.
The systematic macro strategy is something of a hybrid between discretionary macro and CTA/managed futures. Most often, the signals that the manager uses to enter into positions are based upon an analysis of fundamental data, similar to the discretionary macro funds, but the determination of those trades is based on a systematic, or model-driven process, as is the case with CTAs.
The instruments that CTAs trade tend to be very similar to those that discretionary macro managers trade. However, the manner in which they arrive at those long or short positions could not be any more different. The vast majority of the CTA universe applies priced-based trend-following algorithms to the trading of equity index, fixed income, currency and commodities futures contracts.
All three of these sub-strategies can be correlated, or they can exhibit wildly different behavior depending upon the environment. As we begin 2014, we believe that the latter outcome is more likely, and our view is that discretionary macro funds are the best-positioned macro sub-strategy. We are less constructive on CTAs.
It is not a controversial statement to say that we have been living in a policy-driven world since the global financial crisis in 2008. Since that time, central banks have employed various forms of monetary easing, first in the U.S., then in Europe and Asia. Five years later, with the U.S. leading the recovery in developed nations, policymakers are now searching for ways to draw the largest quantitative easing program in history to a close. Their actions will continue to have implications for the success of various Global Macro strategies and will continue to present fertile trading opportunities for select sub-strategies.
In addition, we believe that consideration of a discretionary macro strategy is timely, given the reduction of global proprietary trading desks spurred by the Volcker Rule. Many talented traders have launched their own funds. In the remainder of the article we explain the rationale for our view in more detail.
Have CTAs Lost their Touch?
Historically, performance and lack of correlation to credit and equity markets have made CTAs popular. There are several types of CTA strategies, including trend-following, mean reversion and pattern recognition. The vast majority of managed futures assets under management (greater than 85%, by our estimates) are trend followers; we are currently bearish on this class of CTAs.
Trend followers do not actively predict the direction of markets, but instead respond to changes in market prices. If the changes do not turn into a persistent trend or if the prevailing trend reverses direction, the algorithm will incur losses. Typically after initiating a trade, the algorithm will instruct a sell (or a cover for a short position) if losses exceed predefined limits. As such, trend followers perform poorly when markets trade sideways and when trends are frequently interrupted by factors such as government policy or intervention that can result in sharp turns in markets—precisely the type of environment we have been in since quantitative easing was initiated. And while we are starting to see signs of easing in certain markets, this process will likely take years to fully complete.
The deficiency in performance since the global financial crisis has been supported by empirical data on CTA returns. In Figure 2.2, we can see that the annual returns of three commonly referenced CTA indices, the Barclays CTA Index, the HFRX Macro-Systematic Diversified CTA Index and the Newedge CTA Index have been muted since 2009. Even when taking positive performance in 2008 into consideration, the indices’ cumulative returns from 2008 to October 2013 are lower than that of the S&P 500 Index and the Merrill Lynch Fixed Income Index.
the more prominent trends in tradeable markets. Despite this, we believe developed nations are more likely to experience a secular period of rising rates going forward (witness the yield on the U.S. 10-Year Treasury backing up from 1.6% in May 2013 to 3.0% by the end of 2013, as well as the recent start of tapering by the Federal Reserve).
such, CTAs may not necessarily provide the same diversification benefits on a consistent basis going forward.
In this article we outlined why we favor discretionary global macro strategy and underweight CTA/managed futures. While we feel most strongly about these strategies, we also continue to find other, more niche macro-focused investment opportunities (e.g., co-investment opportunities with commodity-focused managers, fixed income relative value-oriented hedge funds that at times appear macro-oriented, and systematic global macro hedge funds that trade on longer-term signals) appealing.