Investors allocating to trend followers are clearly paying no attention to the trends.
Commodity trading adviser (CTA) hedge funds – a category of strategies that broadly use futures to follow trends – lost an average of 0.72% in the year to September, according to data firm Preqin.
In the Ucits space, the average fund in Citywire’s Managed Futures sector was down 0.6% in the same period; US managed-futures mutual funds fell by an even worse 4.9% over the past year.
Despite this rather dismal outturn, CTAs attracted the greatest inflows in the second quarter of this year among all the types of hedge fund tracked by Preqin, pulling in over £7.5 billion to take their year-to-date inflows to £13.6 billion.
The catch, however, was that inflows were enjoyed by only 39% of CTAs; 47% suffered net redemptions. This also reflects the wide dispersion of returns in the sector: in the Ucits universe, the range over the past year has been from gains of 16.4% to losses of 18.4%, and in the US it has been from plus 7.7% to minus 22.9%.
CTAs among the pigeons
It is into this fray that JPMorgan is stepping with its JPM Managed Futures Ucits ETF, expected to launch soon.
It will invest across two factors: momentum, in commodities, currencies, fixed income, and equities; and carry – whereby the fund will take short positions in low-yielding securities and long positions in higher-yielding securities – in bonds, currencies, and commodities. Its total expense ratio will be up to 0.57%.
CTAs have tended to be defensive instruments, not funds that perform best when chasing bull markets. This helps explain both their muted recent performance and buyers’ steadfast enthusiasm for them.
A number of studies published this year emphasise the point. The team at AQR alternative asset managers examined 67 markets spanning commodities, equities, bonds, and currencies going back as far as 1877.
Since those far-off days, trend-following approaches delivered positive average returns in each market, with an average Sharpe ratio of approximately 0.4.
More importantly, their momentum strategy posted positive absolute returns in eight of the 10 largest drawdowns for a 60/40 equity/bond portfolio through that long period - the two exceptions being the 1937 recession and 1987 correction.
Appreciating that few were likely to invest in managed futures alone, the authors also explored a portfolio that was 80% in a traditional 60/40 allocation with 20% in their momentum strategy.
Better than 60/40
Compared with a simple 60/40 mandate, and net of fees and net of transaction costs, this delivered higher annualised excess returns (4.8% to 4.1%), lower annualised volatility (8.7% to 10.7%), a better maximum drawdown (-50.2% to -62.3%), and a superior Sharpe ratio (0.55 to 0.39) for that full sample of almost 140 years.
Separately, the Alternative Investment Management Association and Société Générale Prime Services found that from 2000 to 2016, a conventional 60/40 portfolio complemented with a 20% weighting to managed futures had a more attractive profile than 60/40 alone; higher annualised returns (4.52% to 4.28%), lower annualised volatility (8.25% to 10.16%), less pronounced drawdown and an improved information ratio (0.55 to 0.42).
Why? ‘The intuition is that most bear markets have historically occurred gradually over several months rather than abruptly over a few days, which allows trend followers an opportunity to position themselves short after the initial market decline and profit from continued market declines.’
It added: ‘In contrast, the strategy may not perform as consistently in bear markets that occur very rapidly, such as the 1987 stock market crash, since the strategy may not be able to take positions quickly enough to benefit from sharp market movements in those environments.
‘Nevertheless, the tendency for the strategy to do well on average in major bear markets, while still achieving a positive return on average, makes it a valuable diversifier for investor portfolios.’