What’s Next? CTAs Point to a Continuation of Long-Term Trends
Fund performance
Hedge fund observers understand that performance can be as cyclical as the markets themselves. The key driver of fund performance is rarely just skill. It’s driven by market conditions benefiting one type of strategy over another. Their performance also serves as an indicator. It reflects whether the market is changing. It also reflects the types of strategies that have the best chance of continuing to work. After 2009, one of the industry’s worst performing groups has been CTAs. Now, that has changed.
Understanding CTAs
CTAs are generally thought of as systematic, quantitative funds that employ a lot of PhDs and data scientist types. No matter how well these guys map out markets, their “alpha” turns positive when strong directional trends develop. This is what allows them to systematically employ market making strategies that turn “easy” profit by adding liquidity at mathematically predetermined bid-ask levels. This is also what allows their trend following systems to work. They’re highly quantitative funds that perform best when trends are strongest to either the upside or downside. They’re able to participate in many different types of markets including global equity indices, commodities, and fixed income—the list goes on. It’s important to notice that their performance waned after 2009. This was primarily due to quick shifts in trends. The marketplace was finding an equilibrium after the Great Recession.
Global trends
Now, global trends are at their strongest—whether the trends are positive or negative. The likelihood of continuation is high. What can stop it? Will global central banks suddenly stop easing? Will commodities suddenly revert in a meaningful way? Will Putin and Greece announce that they’re Buddhist?
Long-term trends should continue to drive performance. Long-term trends are driven by overarching themes. It isn’t likely that the themes will change anytime soon. There are clear winners and losers emerging. This isn’t just among countries. It’s among asset classes as well.
It isn’t just price trends. It’s trends in risk, geopolitics, and monetary policy. Today, the latter has the most immediate effect on asset prices. Monetary policy drives global currency levels. Global currency levels drive everything else.
Current trends have been dominated by global easing. It pushed the dollar higher, but at maximum velocity. In turn, this poured fuel on the oversupplied commodity markets’ fire. It pushed them even lower. This continues to place a cap on inflation. Since the Fed is closely watching inflation as a signal to raise rates, current monetary policy will be here for a bit longer. Meanwhile, central banks around the world are easing at unprecedented levels. They’re all hoping for the same thing—an American style boost to their economy.
The effect of these prolonged policies and macro trends will continue to determine clear winners and losers. There will be some elements of risk sprinkled in. Mainly, this will involve geopolitical risks coming from Greece, Russia, and the Middle East.
Export-driven economies that are also commodity importers—like most Asian economies—should benefit greatly from the current state of global monetary policy. Some of these countries are already on investors’ radars—like India. Other countries—like South Korea, the Philippines, and Indonesia—should benefit tremendously. We’ve already seen increased volumes of commodity imports by these countries, but at much lower prices—including China—taking full advantage of the commodity price collapse. The opposite will be true for commodity exporters—like most Latin American countries. They rely on commodity trading to fund their account deficits. This will be a burden as the dollar continues to rise.
What can you expect?
Global economic growth will rise at a collective moderate pace. However, the wide range in sensitivity to commodities, effective monetary policy, and the strength of the US dollar will result in an array of winners and losers. This creates a conducive environment to benefit from long-term trends and to bet big on the long or short relative value approach to exploit this divergence. CTAs should continue to outperform.
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