Allocators caution on limits of CTAs as ‘portfolio insurance

Computer-driven hedge funds have had a difficult time in torrid markets this year, and allocators to them are cautioning investors should not expect the strategy automatically to act as ‘portfolio insurance’ in stressed markets.

The funds, known collectively as CTAs, have made 1.53% by mid-August according to data vendors Barclayhedge, less than half the 3% from hedge funds more generally.

Some investors might have expected more from CTAs, given markets have been turbulent and CTAs are characterized as benefiting from exactly the kind of market conditions that hit other strategies.

False expectations in this regard may been fuelled by 2008, when CTAs bucked the losing trend of hedge funds (down 20%), and shares (off 43%), by making 14%, according to Barclayhedge.

But David Lashbrook, senior analyst at fund of funds Momentum Global Investment Management, said: “Some people may be wanting CTAs to provide insurance protection, but we do not view them that way because, while they demonstrate no or low correlation to markets, they do not show negative correlation to markets. If you look at CTAs correlation jumps around, it does not stay stable.”

Back in 2008 a heavy allocation to the strategy by MGIM’s flagship Global Spread Capture fund of funds helped limit losses to 8.45%, less than half the 20% plunge of their average rival.

But the CTA position MGIM had more recently, in May, did not help it, as markets fell in too ‘smooth’ a way for the manager’s system to trigger taking the best ‘risk-off’ positions.

GSC had 5.11% of assets in the CTA strategy, whose loss that month led to a 0.34% diminution of the MGIM fund’s return. This year to July, though, Global Spread Capture made 1.2%.

(Since launch in 1999 it made 7.3% a year, on average, and posted gains in three months of every four.)

Lashbrook says of May: “You saw a series of consecutive daily falls in an orderly sell-off, whereas normally the sell-offs are characterized by daily moves back and forth with increasing volatility.”

The Eurostoxx fell nearly 7%, and the SPX was down 6.3%, but realized volatility actually fell by between 28% (Eurostoxx) and 15% (SPX).

“If you look at the peak to trough drawdowns of the S&P over five years, of the top 20 drawdowns, April and May was the only one where the maximum daily drawdown was less than 2%. In 2008 it was 9%. Recently we had a slow, orderly sell-off, which made it very difficult for some CTAs.

“They run a lot of different models that are designed to have low correlation to one another but when volatility is low by definition correlation among different models will increase.”

Lashbrook said MGIM was not overly concerned about the CTA in question. MGIM started trimming CTAs around the time central banks started instituting QE since the crisis, and since 2009 Lashbrook describes the allocation to the strategy as “pretty small”.

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