In recent years as we discussed the difficult environment for managed futures in general and trend following in particular, many traders and analysts blamed the poor performance on the risk-on/risk-off nature of markets since the credit collapse of 2008. The thinking went that with markets reacting to central bank policy instead of real fundamentals — or technicals for that matter — trends could not be sustained.
While the performance across the board was poor — there are always managers, even trend-followers, who perform well in difficult periods — there seemed to be something different this time. The trend-following strategy periodically goes through difficult periods — so much so that headlines of “Is trend-following dead?” or “Does trend-following still work?” are a running joke in the industry. But few poor performance periods lasted as long as the most recent. The Barclay CTA Index had never had back-to-back negative years since its launch in 1980 until 2011-12 and 2013 made it three consecutive negative years (see “A tough stretch,” below).
Turning off risk-on/risk-off
“For the first time since 2008 we had trends in markets that were not driven as much by political announcements and governmental interference in the markets,” says Sol Waksman, president of BarclayHedge.
Martin Bergin, president and CFO of Dunn Capital Management (up 35.67% in 2014), says, “The influence of the central banks created this risk-on/risk-off, which means you had sharp reversals. That is always bad for trend-following and then sharp recoveries because central banks were actually coming into the market and putting things back in sync.”
“During the [poor performance period] trends just didn’t last long enough to capture [moves],” says Donald Wieczorek, founder of Purple Valley Capital, who earned 87.49% in his trend-following program in 2014. “As soon as the market started going one way there would be some sort of an intervention that would cause it to reverse. Trend-followers got chopped up for a while.”
The Fed had trumped the economic fundamentals.
“You had this huge amount of cash that was falling into the economy that had to be put to work. Now people have to actually choose, based on economic fundamentals, where they want their money to work,” Bergin says.
Marc Levitt, founder of Silicon Valley Quantitative Advisors (up 85.93% in 2014) agrees, “Some of the risk on/risk off was driven by Fed policy but most of it was a reaction to Fed policy.”
“Never before had a Fed or central bank been actively trading the market,” says Edward (Bill) Dreiss founder of Dreiss Research Corp., up 85.89% in 2014. “You could imagine every morning when they got up they were checking to see what the Dow had done. You had fairly high volatility but it would rear off in one direction and then either economic reality would raise its head or the Fed would do something and it would run off in the other direction. That is horrible for a trend-follower, particularly a long-term trend-follower.”