What a difference a year makes… After three lackluster years of investors treading water with Managed Futures – 2014 finally saw some of the outlier moves needed for the asset class to thrive. We’re talking likely gains of around 15.57% for the Newedge CTA Index, in a year where stocks continued to climb, proving once again that the asset class is non-correlated to the stock market, not negatively correlated.
In our annual end of year tradition, we take a moment to dig a little deeper into the overall asset class performance number and give some color on the different types of strategies which make up the managed futures asset class (no… it isn’t all trend following). Without further ado, our 2014 Review of the Strategies that comprise Managed Futures:
Trend Following:
If we had to give a managed futures strategy MVP on the year, it would absolutely be Trend Following. Trend Followers had a year to remember – after several long years to forget… but the journey wasn’t a cakewalk.
After the first quarter, the Newedge Trend Index was down almost -6% on the year {past performance is not necessarily indicative of future results}, and it appeared as if the choppy markets of 2013 were here to stay in 2014. That’s not to say the first half of the year was all bad. There were notable trends, including up trends in Coffee, Natural Gas, and Cattle. Thanks in part to extreme drought in Brazil and parts of Asia, the coffee market was up 100% on the year at one point, and some trend followers we track were able to get in on the move. Over in the energy markets, natural gas experienced multiple volatile environments, with many blaming the “Polar Vortex” in the Midwest.
But these trends were insignificant in comparison to the action in the second half of the year, and especially the fourth quarter, where the big sell offs in energy markets, metals, and foreign currencies fueled one of the best quarters for trend followers in years.
The selloff in foreign currencies was especially important, as that meant an upward trending US Dollar, which is like profit oxygen for trend followers. The US Dollar Index’s +13% move in the last 6 months of the year was a heck of a move in its own right – and many trend followers were long US Dollar Index futures – but it represents so much more than that. It means multiple currency markets are trending as well, and a trending Dollar can actually affect non currency markets as well. Remember that all those Gold, Corn, Oil, Cotton and other commodities are priced in US Dollars – so all else being equal – a rising US Dollar means a falling commodity priced in US Dollars. As we said in a September blog post, “a trending US Dollar is one of THE best environments around for managed futures, at about 3.5 times the monthly return of periods when the US Dollar isn’t trending.”
Firms such as EMC (of turtle trader fame) and Covenant Capital (manager of our Trend Following Fund) were able to capitalize off this dollar move, as well as many others, posting estimated returns of +25% for the EMC Classic program and +29% for the Covenant Aggressive program.
How did they do it? Take the move in Energy markets such as Crude Oil (-49%), Gasoline (-52%), and Heating Oil (-38%); which are almost inconceivable when you look back on it {past performance is not necessarily indicative of future results}. How could these markets, which account for the economies of whole countries like Russia and whole regions like the Middle East, which hundreds of billions of corporate revenues are based on, and which are traded by professional speculators, producers, and big commodity players day in and day out; lose over half their value in just six months? How could millions of people involved in Oil’s discovery, production, refining, accounting, drilling, transport, etc, etc. etc – not be waving warning flags back in June that prices were about 2x too high. How could hedge fund titans like John Paulson who correctly bet on the housing collapse in 2008 not foresee such a move in a market like Crude Oil when much smaller players were able to?
We don’t know the answer to those questions – but we do know that this is what trend following is designed to do. It is designed to participate in the unforeseen… How? It isn’t magic. They participate in the move nobody saw coming by participating in all the moves that didn’t happen before that. They participate in the Coffee and Crude Oil move, not because they knew that is where trends would happen; but because they are active in dozens of global markets to make sure they’re in the next market to make a big move.
As John Krautsack of EMC Capital puts it:
“A great deal of discipline is required in order for a manager to successfully navigate different market environments. Consider that the most difficult sectors in 2013 turned out to be our best sectors in 2014. Our systematic strategy eliminates the natural instincts of wanting to change risk weightings in systems, markets, and sectors in reaction to poor market environments, resulting in an odd circumstance where some of the most difficult trades to put on turn out to be the best trades. The global bond market has proven this over the past few years.”
Overall Performance: Excellent
Short Term Trading:
Now here’s where things get confusing. Because despite low correlation to trend following, the very same expansion in market volatility and sustained trends that helped trend followers were also good to short term traders in 2014. Short Term traders saw big gains later in the year off of short grain trends, long cattle positions, short Sugar, and the Energy markets.
How? Think of it like a movie – with the trend followers needing the whole movie to have good scene after good scene strung together without interruption, while short term traders only needing a few scenes to be good, not caring if they are one after the other or separated by a lot of interruptions. But if the whole movie is indeed good, then the short term traders have that many more chances to grab the short bits of good scenes.
Now, there are different types of short term traders, and we found that the Short Term managers we follow with allocations to a diverse number of markets were able to capitalize off sustained trends, while other short term traders who only allocate to stocks and bonds had little performance to speak of.
One notable exception to the good performance was short term bellwether QIM, which was at -8.74% through Nov.; as compared to eco Capital management, manager of our Short Term Alpha Fund with returns of 7.08% for the year through the same period (and +8.64% for the full year).
Performance: Good
Multi-Strategy:
Multi-strategy programs typically have a trend following base, with other non correlated strategies (such as short term) added to their portfolio of models to perform during flat to losing periods in trend following. Generally speaking; these strategies will usually do well, but underperform Trend following when Trend Following does well, and are designed to outperform when trend following is not. However, as we have seen over the past few years, while not correlated with each other – many of the multiple models in multi-strat portfolios were correlated to volatility, underperforming along with trend following during period of low volatility.
Whether multi-strat programs fixed that problem – creating models that aren’t as tied to volatility; or whether volatility just returned – remains to be seen. But suffice it to say 2014 was a good year for the strategy type, with many multi strategy mangers having made small but consistent gains for the majority of 2014, while participating in the same trades which benefitted trend followers at the end of the year: the short grain trade, short foreign currencies, short metals, and especially the short Crude Oil trade. All in all, multi-strat programs did what we would expect them to do in a year with plenty of directional volatility. The trick now will be performing when there isn’t the trend following tailwind.
Overall Performance: Good
Specialty:
Specialty traders are too often the Belle of the Ball one year, while getting drunk and thrown out of the party the next. This is because most specialty traders focus their efforts on one market or sector, with performance dictated by the actions and makeup of said market from year to year. The tough part is that markets are cyclical by nature, thus what is a good market to trade one year can be most difficult the next. For example, energy traders who have been conditioned to trade nothing but bullish oil fell flat and missed most of this downside move. Systematic stock index traders also struggled as group, primarily due to the many V shaped recoveries we saw in the second half of the year. Of course, there were some exceptions, most notably the Coffee trader Martin Fund Management, which managed to post 200%+ gains in 2014 in their Martin Fund One Program (albeit on less than $25 million, but still…that’s impressive!) [past performance is not necessarily indicative of future results].
Overall Performance: Average
Agriculture Traders:
So called “Ag Traders” went from heroes to zeros over the course of 2014. The Barclay Hedge Agriculture Index went from up 17% on the year in October, to just under 3% towards the end of the year, all because of a very quick trend reversal in grains at the end of the year.
The year started with grain prices (Corn, Wheat, and Soybeans) moving upward, until the USDA released report after report showing there were record crop yields and the grain markets started to experience a 5-month fall in price. Most Agriculture traders we track were short grains based on these reports and the massive supplies, and it seemed to be another successful year for Ag traders. But then difficulties arose in the cost of shipping the grains, specifically in soybeans where soy crushers were unable to get their hands on enough beans to support operations. And before you knew it prices weren’t meshing with fundamentals as nicely. Corn, for example, rebounded 25% since October, and many agriculture traders were caught on the short side still {past performance is not necessarily indicative of future results}.
Now, some agriculture traders were able to outperform their peers, and they were the mangers that focus entirely on the meat markets. Most of those managers were long meats throughout the year as both live and feeder cattle hit new all time highs, and outperformed those that had a mixed allocation in meats and grains.
Overall Performance: Poor
Spread Trading:
Spread trading, also known as Relative Value trading, struggled in 2014. Historically, CTAs trading this strategy have benefited from what is known as the “Goldman Roll” aka a fancy term for arbitraging the rolls of long only commodity funds and ETFs. However, as with all good arb trades, this strategy of collecting from the ETFS has dried up for some time now as they have gotten smarter about rolling their positions. Thus, relative value traders have shifted focus to look for other value opportunities in the marketplace. Some are trying to time the rolls of other products (like the big trend followers) while others are focusing on trends within the spread and/or on imbalances in the market curve in expectation of the price disruptions coming back in line. But these strategies did not pan out as expected in 2014 as performance dwindled when volatility reemerged in markets like grains and especially energy – where spreads not only widened out, but have remained that way in a rare resistance to reverting to the mean.
Overall Performance: Poor
Option Trading:
As we like to say in our Thanksgiving Day post, option trading can be like the Turkey, fattened up day after day for the Thanksgiving feast, only to come to a sudden and abrupt end when they become the feast. Unfortunately, this was the year of becoming the turkey on the table for some Options traders. Now, the last five years have generally speaking been wonderful for Options traders, as QE has kept the stock market marching slowly upwards and any sell offs have resulted in sharp V shaped recoveries. If fact, the first half of 2014 looked to be more of the same, and options traders were definitely capitalizing off of it. But then we saw a minor uptick in volatility in August, a huge uptick in October (when the S&P 500 lost around 7% in a couple days), and one in between those two in December. Each of those spikes represents the thing option sellers are betting against, and results reflected those painful periods, with many option traders finishing the year in the red to the tune of double digits {past performance is not necessarily indicative of future results}. We don’t know where volatility is going from here, but if volatility returns in an even nastier form as stocks retreat off all time highs; there might be too many turkeys to count in 2015.
Overall Performance: Poor
Overall Summary:
It’s ironic that just half a year after many managed future managers were trying to distance themselves from being labeled trend followers, the trend following connection came through in spades; proving that with the right environment; these strategies, and the asset class as a whole, can make the outlier gains they’re designed to make. In the end, 2014 saw Managed Futures post its best quarter (qtr) since 2008, and it’s best single month gain (month) since 2002. {past performance is not necessarily indicative of future results}.
Now, it wasn’t all butterflies and rainbows. There were struggles amongst several strategy types, with the best strategy the past few years, Ag Traders, having a very difficult end to the year. But overall, Managed Futures strategies proved that the noise is just noise. Trending Following isn’t dead. Managed Futures can perform well when stocks are moving higher. Commodities move in different directions than stocks, and true alternatives can capitalize off of those trends.
Now, on to 2015! Speaking of which, look for our Managed Futures 2015 Outlook coming soon, with a deeper look at the statistics behind the overall market environment. Sign Up to receive the 2015 Outlook and all of our other research and education here.
