The year 2008 has always been viewed as the banner year for CTAs. Given the sizeable equity market falls1, the Newedge Trend Index’s return of 21% certainly raised the profile of the trading style on an investor’s radar.
Here was a strategy that delivered long-term returns with low correlation to other asset classes, and gave protection to traditional portfolios in times of crisis.
But was 2008 really a banner year in terms of the environment for trend-following? To answer that question, it is perhaps worth stepping back a little. Trend-followers require trends in individual instruments in order to be profitable. They trade multiple instruments across many asset classes in the hope of capturing trends in other places when trends in one place are hard to find.
Thus the ideal environment for trend-followers is one with trends at the instrument level, and low correlation across instruments, such that trends can be found in many different places.
In this context, however, 2008 was far from ideal. Sure, there were strong trends in equities, fixed income, gold, oil etc., but they were all caused by the same thing, namely the credit crisis.
Correlation was high. Individual instruments were trending, but diversification was not there. Without diversification, portfolios were vulnerable to reversals. It could be argued that this was the reason for 2009’s poor CTA performance; the Newedge Trend Index lost 5%.
With the index up 20% in 2014, the question is inevitably asked, “will 2015 be another 2009?” Our answer is that there are few signs of similarity.
The environment is very different now. We have written on numerous occasions for CTA Intelligence about the fall in correlations post-2013; current levels are close to those that prevailed pre-credit crisis. In addition, single-market Sharpe ratios are also picking up significantly (see chart below).
This tells us that trends are appearing at the instrument level; a fairly intuitive observation given what is happening in markets, with strong trends in US stocks, European bonds, the US Dollar, Yen, and oil, for example.
Thus it would seem that both of the key ingredients for performance are in place. We think 2015 is unlikely to be another 2009 and, we believe, now is not the time to take profits.
Source: Man database.
1. The MSCI World Net Total Return Index hedged to USD wasdown 38.4% in 2008.