There has been a lot of talk about the performance of hedge funds, and in particular CTAs/Managed Futures funds, in February when markets sold off for the first time in recent memory. People seem to be surprised that these strategies posted negative returns in February, while the S&P 500 was down 3.69%. I’d like to address why such a focus and such expectations are unjustified. While I am going to focus on the managed futures space, the following themes can be applied to all strategies.
I believe most seasoned investors would be hard-pressed to say that one month is a reasonable timeframe to judge a strategy, especially a quantitative strategy. Quantitative strategies are mostly about playing the probabilities; and unless your probability is 1 or 0 there are no guarantees. Our previous blog shows how there is meaningful variance to the benchmark over six months for even the best funds. Judging a strategy over one month will inevitably lead to poor decisions.
Zero Correlation is not Negative Correlation
After February people have implied that managed futures funds should provide positive returns whenever the market is down, over any timeframe. There seems to be a belief that managed futures funds are portfolio insurance. That is not correct. If you are looking for a strategy that always makes money when equities are down (a perfect -1 correlation) then you are looking for portfolio insurance; and insurance is expensive, as equities have typically gone up over time. Over their history, managed futures funds have had a close to 0% correlation with equities, but on any given day their correlation will be +1, 0, or -1. A zero correlation provides portfolio diversification, not portfolio insurance.
Understanding a Strategy
Most managed futures funds in the category–our funds are among the exceptions given their unique counter-trend methodology–are intermediate to long-term trend followers, and are not designed to capture a 6-day(ish) market drop and reversal, along with a sudden volatility spike. If a trend follower was not long equities and short fixed income coming into February, I would question their ability to follow trends. Trend followers performed exactly as I would expect them to in February. Trend following has historically provided protection in prolonged down markets, but cannot be expected to hold up during short term, sharp sell-offs. By doing the necessary diligence work on the front end, investors will greatly reduce the chance of being disappointed at exactly the wrong moment.
Read our last blog post, Should this Year’s Large Sample of Upsets Change your Bracket Strategy? >