2019 CTA Challenge: Managed Futures are Back
2019 was somewhat of a breakout year for commodity trading advisors (CTAs) and the managed futures industry. The BarclayHedge CTA Index returned 5.28%, its best year since 2014 and only its second positive year since that breakout year. The index, which only posted three negative years in its first 29 years of existence has been negative in six of the last eight years causing some to question the viability of managed futures in general and trend following—its largest strategy— in particular.
The top performers in the Coquest CTA Challenge exploited what was a positive year for trend following but mainly relied on the unique individual attributes of all the managers and strategies competing.
The CTA Challenge was created to evaluate and rank investment programs in managed futures. Unlike similar rankings, which focus exclusively on returns, The CTA Challenge incorporates the risks taken to achieve those returns. The participants are professional money managers that are registered with government regulators and can take on customer investment accounts, specifically separately managed accounts, that trade solely in the futures markets.
The CTA Challenge utilizes robust quantitative evaluation tools that analyze the performance and risk characteristics of participating managers based on the desire to standardize the intensive quantitative review process required to appropriately measure managed futures programs (see “CTA Challenge Metrics,” below).
For example, the 2019 CTA Challenge included 90 liquid alternative investment programs competing for our top ranking. The program with the best pure rate of return with 127% did not crack our top five.
Return of Trends?
While 2019 represented a return of long-term trends—particularly in the fixed income and equity sectors—only one of our top five performers can be classified as a pure trend following CTA.
The Quantica Managed Futures Program—the CTA Challenge top ranked manager— is a fully systematic trend following program, which identifies trends on a risk-adjusted, relative basis. It returned 25.03% in 2019, its strongest annual performance since 2005. “Quantica’s investment universe is comprised of the most liquid futures markets, to ensure efficient trade implementation regardless of market conditions,” notes Bruno Gmuer, founder and chief investment officer of Quantica Capital. “The market environment was very favorable to our investment philosophy, we had less trading activity than in average years, and could fully capitalize on the two dominating trends of 2019 in fixed income and equity markets.”
Those trends played into the hands of the County Cork Acclivity program, which trades U.S. 10-year notes, Euro Bunds and E-mini S&P futures with both a long-term and short-term trend following approach as well as a mean reversion element.
While there was a lot of geopolitical noise, County Cork stuck to its systematic knitting to earn 20.16% in 2019. Thomas Senft, President and COO of County Cork, says issues such as tariffs, trade wars, Brexit and impeachment made 2019 a challenge, but mainly for the people who trade off of those fundamentals. “This is the very noise that normally disrupts traders to a higher degree,” Senft says. “With our approach being systematic, we find that it greatly filters out what is challenging to most traders.”
The challenges in 2019 were mostly the product of geopolitical volatility driven by the Iran situation, Brexit and trade wars; particular the on-again/off-again nature of the U.S.-China trade deal negotiations. “With both [the United States] and China changing their import policies and U.S. implementing new tariffs, the tension provoked commodity fluctuations,” says Aistis Raudys, principal and chief investment officer of Automaton Trading. “Since China consumes about 50% of global copper and is one of the biggest consumers of soybeans [the fallout of trade tensions] made them volatile commodities in 2019, creating obstacles for longer term trades.”
For global macro AG Capital Investments, the environment was fine, except of course for the continuous bull equity market. Not that it was a draw on performance, but on the overall business of managed futures. “The biggest challenge of the year was on the business/marketing side and not the trading side; getting and maintaining client interest in macro/managed futures given how strongly the stock market continued to rally,” says AG Capital Principal Asim Ghaffar. “Allocators know that they need to diversify away from equities, especially after an 11-year bull market, but every year that the cycle continues to grind on seems to dilute the urgency to do so.”
Of course, given the performance of our CTA Challenge Champions (see below) there should be no fear in diversifying away from equities.
- Quantica Capital AG (25.03%),
- County Cork LLC, Acclivity Program (20.16%),
- FORT LP, Global Contrarian Program (14.8%),
- Automaton Trading LLC’s, Diversified Strategy I (12.01%) and
- AG Capital Investments LLC’s, Discretionary Global Macro Program (25.76%).
Institutional investors would be wise to invest in these non-correlated strategies that proved they could produce strong risk-adjusted returns in a bull equity market environment and will likely provide shelter from the storm when equities turn south, which is ultimately inevitable.
As noted above, fixed income and equity indexes were top performing sectors. “Performance for the year was dominated by fixed income/rates and equities with both asset classes delivering robust and near equal positive contributions to the overall return,” Gmuer says. “Most of the positive attribution from bonds and rates were generated during the first eight months of the year. In contrast, equities provided most of their positive P&L in the last four months of the year.”
While nearly all top traders were able to exploit the major trends in fixed income and stock indexes, some traders did so in unique ways.
Like other managers, equities provided the best opportunity set for Fort’s Global Contrarian program, on both an absolute basis and relative to trend followers, Fort noted in their yearend letter to investors. However, because they are neither long-only nor trend following they capture value in different ways. “After the sharp sell off witnessed by global equity markes in the fourth quarter of 2018, Global Contrarian started buying equities as the program anticipated a potential reversal,” Fort reported. “As a result , Global Contrarian profited from the rally in global equity markes in the first quarter of 2019 while many trend followers were whipsawed from trading the asset class. Global Contrarian remained net long equities for the remainder of 2019.”
Most managers exploited moves in fixed income and equities, albeit in different ways. Raudys believes the Federal Reserve may had a positive impact on the sectors. “The Fed had a slight positive impact for this sector’s success as no surprising decisions or statements were made during 2019,” he says. “Unpredictable actions by [the Fed] likely would have had an adverse effect on our strategies.”
Ghaffar says metals was the best sector for AG Capital. “In Q1 we were able to catch the short side of the palladium market. We have been bearish palladium based on our thesis that global auto demand has peaked and is declining.” Ghaffar says.
Palladium is used in catalytic converter components of automobiles and has garnered a greater market share from platinum, which is also used to build these auto components, in recent years. “Despite the fact that the palladium market moved to new highs later in the year, we were able to catch the bearish move and then wait for better opportunities to re-enter on the short side,” He says. “We also made profits long gold, which we actually view as more of a currency than a metal. Gold broke out of a six-year base, and we carried a long position for a large part of the year.”
Of course, AG Capital’s global macro approach puts them in different sectors than technical based traders.
As noted above, the on-again/off-again nature of the trade war and U.S.-China trade negotiations created whipsaws in commodity markets. “Commodities were the only detractor in 2019 as no meaningful trends developed throughout the year,” Gmuer says. “Although losses were minimal, they mainly came from our positions in energies and soft-commodities. Both markets were hit by sudden spikes of volatility, which made it very challenging to build up meaningful exposures given that we capture trends on a risk-adjusted basis.”
The only negative sector for Automaton Trading was currencies, notes Raudys. “The loss in currencies did not a have a great impact on total results as it was only around -1%,” Raudys says. “During 2019 we saw volatility decrease in most of the currency futures we trade. Such calm markets did not provide many opportunities for our strategies to earn profit.”
Some programs outperform competitors not necessarily by better models, but by models that reduce exposure to sectors that don’t appear to be offering opportunities. It was a more challenging year for commodities and currencies, and Fort’s Global Contrarian program mostly stayed away. “Global Contrarian took comparatively less risk in commodities and currencies, as the program perceived there to be fewer opportunities in these asset classes,” Fort reported. “The program remained short foreign currencies vs the dollar during 2019, although exposures decreased as signal strength declined as the year ensued.”
The Fed & Central Bank Impact
As noted above the Fed has been a relatively calming influence; or put another way, the activist central bank is the new normal and as long as there are no sudden reversals, should provide the markets with stability.
While the Fed did reverse course in 2019 following the final, and much criticized, rate increase in December 2018, the easing regime was well-anticipated and its repo operations calmed what could have been a major event when Fed Funds spiked in September.
“When the Fed or the global central banks move quickly to overtly manage an emergency situation, they may disrupt markets in the short-term, however, the practice of the Fed and global central banks is to not disrupt or upset the markets,” Senft says. “Obviously, central bank policy is important to the stability of the marketplace and the Fed desires that stability.”
Of course, many managers are not Fed watchers. “Whatever the effect of Fed and global central bank policies, our systematic investment process is agnostic to it,” Gmuer says. “The sole inputs into our model are price in the markets we trade. If there were some effects from central bank policy in the markets that are reflected in sustainable trends in market prices, our models were well able to capture those and capitalize on them.”
Ghaffar agrees that the Fed has had less of an impact on markets. “Sure, the Fed’s rate cuts and resumption of QE (or QE-lite) and the Fed’s repo operations have added liquidity and have had some impact on rising equity markets,” Ghaffar says. “But we would argue that a bigger driver of equity markets has been share buybacks by corporates and investors placing a premium on stable, mega-cap growth names that currently account for a high percentage of the S&P 500 Index.”
Raudys adds, “It is difficult to say with certainty [what impact Fed policy has had] since the effects are long lasting and it takes time for them to fully impact the economy but as of now the impact is rather positive.”
What Made 2019 Unique?
Managers sometimes do not like to comment on market environment because they must trade and manage their strategy in whatever conditions the market offers, but every year is different.
“We don’t believe our strategy’s performance had any correlation to the market environment in 2019,” Ghaffar adds. “Our trades are uncorrelated to market environments as well as the broader hedge fund and CTA community. That means that we have a tough time hiding behind market regime based explanations for times when we underperform — our drawdowns are always due to mistakes that we make and we have to own them.”
Senft saw 2019 as a relatively normal year where his strategy performed to its expectations. “We deemed  to be more of a normal environment, thus allowing our strategy to capitalize on those very patterns which is what our program was built and designed to do.”
That said, 2019 was unique for some; “2019 was a wild ride and had many major events which could have an adverse impact on [markets],” Raudys says. “The perpetual Brexit extensions and trading tension between [the United States] and China were dark clouds on the horizon for the global economy.”
That made Automaton’s performance more impressive. “We are proud to [have ended] every month of the year with a positive return without any instrument providing significant loss. About 80% off all traded instruments were profitable during 2019,” Raudys says.
A common theme among the top performers is their models’ ability to not only profit on the opportunities available, but for their strategies to overweight the sectors where opportunities existed and underweight those sectors where fewer opportunities existed.
“Quantica’s risk-based, relative approach to trend following was able to detect and capitalize on both major asset class trends that developed throughout the year by dynamically reallocating risk between the asset classes,” Gmuer says. “Starting the year with high exposures to fixed income markets, we fully benefitted from the strong appreciation of government bond prices. During the course of the year, risk has been partially shifted from fixed income into equity markets allowing the program to benefit from the equity market rally as well as from increased diversification, which limited the drawdown caused by the sharp correction in bond markets after Q3.”
Fort’s Global Contrarian program gradualy decreased risk levels in 2019. It managed to exploit thoses sectors where opprtunities were greatest and reduce exposure in sectors that struggled. In its yearend letter, Fort stated, “Equities continue to represent the largest risk by asset class, with long exposure across regions. Currency exposure was approximately flat vs. the dollar at yearend as the program gradually reduced exposures. In commodities risk remains light with a small short position in metals and long position in energies.”
A common theme was the ability to adapt, even within a systematic approach. “There are a lot of factors which have led to our trading success,” Raudys says. “One thing in particular is adaptation to externalities. Markets are always changing, and quick adjustments are necessary to be profitable. In 2019 we tried to be more proactive regarding strategy evaluation and selection of commodities, resulting in constant tweaking of portfolio construction and tuning algorithms to adapt to new environments throughout the year.”
As most traders know, there will be winners and losers and a key—regardless of strategy— is to get the most out of your winners and reduce the impact of your losers. “As with every year where we’ve done well, we were able to leverage our core winning themes, be selective and not press ideas that weren’t working,” Ghaffar says. “Get rid of losing trades quickly, whether they were wrong fundamentally or just stopped out technically. In short, we executed well.”
What Does it All Mean?
Coquest provides the CTA Challenge results to the public to help investors and industry brokers with identifying quality managed futures programs. Conducting quality research is difficult. The amount of information to breakdown requires substantial bandwidth and can be overwhelming and confusing, for even the savviest investor. Many rankings of CTA programs are a mere comparison of monthly or annual returns extracted from a large list of products that only show basic performance information. These ranking sites really do nothing to evaluate the potential risks and leverage utilized to achieve those numbers. As noted above, the program with the highest raw performance did not make our top five.
As the CTA Challenge 2019 illustrated, investors should have no “fear of missing out (FOMO)” in regard to equities as our CTA Challenge Champions have proven that they can produce solid returns—with less risk—in the strongest bull equity markets.
Most, if not all, long-only equity investors would have improved both their overall returns and risk adjusted returns, if they would have diversified a portion of their portfolio into one of (or several of) our CTA Challenge top performers.
Imagine what an allocation would do in a period where equities don’t have the wind at their backs? That time is coming.Back