Trend tracking CTA hedge funds, which seek to trade on momentum in market movements, have failed to cash in on the recent market rally that has seen stock and bond prices soar,
While markets have rallied in recent weeks, CTA funds have struggled.
The HFRX diversified CTA index has dropped 2.5% this month, while the iShares 20+ year Treasury bond ETF
TLT
has gained 6%, and the S&P 500
SPX
has added 4%.
In 2022, CTA funds surged, with the SG CTA index rising 20%, as they capitalized on clear market trends that were driven by high-levels of inflation, caused by a slew of factors including COVID, supply chain disruption, and the war in Ukraine.
Speaking to MarketWatch, Charlie McElligott, managing director at Nomura, explained that: “Last year, there was a very obvious set of macro trends in place. The Fed was effectively saying to be long cash and short assets, and those were the trades that worked.”
Now, this dynamic has started to reverse, in a shift that has seen trend tracking CTA funds suffer even as markets have rallied.
McElligott explained that “there have been a bunch of momentum reversals” including in bond markets, which CTAs are heavily tuned into, as central banks across the globe have taken a more dovish stance that has caused bond prices to rally.
Momentum following funds previously capitalized on low bond prices, as central banks repeatedly hiked interest rates worldwide, in their efforts to limit soaring inflation.
This dynamic has now gone into reverse, as growth in major economies has started to slow and the labor market has started to cool. The shift has seen central banks take a more dovish stance when it comes to increasing interest rates.
The reversal of these trends has, in turn, forced CTAs to unwind long standing trades that previously generated bumper returns, leading to sharp drawdowns over a short period of time.
McElligott explained that: “CTAs are down on the year because they were very short bonds, pretty short equities, and what you ended up having with this dovish inflection is bonds rallied, equities rallied and those shorts simply had to be covered.”
JPMorgan summed the situation up in a note, by stating that: “CTAs/momentum traders suffered sharp losses over the past week as they were forced to unwind previously extreme short duration positions.”
But in McElligott’s view, the situation is simply a case of the CTA strategy “doing what it’s supposed to do” by reacting to the change in circumstances by “turning the boat.”
“Any time you lose a clear trend… there is inherently going to be a performance shift,” McElligot said.
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