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Prime Services AlternativeEdge

The Alternative Investments Consulting team is a thought leader, our AlternativevEdge papers combine quantitative and qualitative techniques to analyse a broad range of thought provoking industry issues related to alternative investments:
• AlternativeEdge Notes – market leading white papers into industry topics
• AlternativeEdge Snapshots – targeted reviews of key industry/market trends & issues

Please contact the Alternative Investments Consulting team or the Capital Introductions team to request a copy of any of the papers or for more information about any of the commentary notes or snapshots.

SG Prime Services Hedge Fund Commentary Papers

2018

Name
Type
Details
A Closer Look at Quantiative Equity Market Neutral Strategies
Snapshot View

In recent years we have seen an increased level of interest expressed by the institutional investor community in quantitative equity market-neutral strategies. In this snapshot we take a closer look at this hedge fund strategy and provide an overview of the different investment approaches and the strategy’s unique performance characteristics. We also demonstrate the exposures that equity market-neutral strategies have to commonly known equity style factors, and we highlight the value of constructing a diversified portfolio of quantitative equity market-neutral programs.

A Review of Equity Hedge Fund Performance first half of 2018
Snapshot View

After the two-year-long run with record low realized volatility levels in the equity markets, the dynamics changed considerably over the first half of 2018. In line with the increased market volatility, equity hedge funds also displayed considerable performance dispersion. Nonetheless, both of the Long/Short and Market Neutral peer groups that we maintain were able to return positive average performance over the first half, while many long-only equity market indices were negative. Across the Long/Short manager universe, we have witnessed a mild increase in the beta exposure from a relatively low base at the beginning of the year. Geographically, European- and US-focused strategies outperformed, while Emerging Markets managers struggled to manage the selloff. For sector-focused strategies, the first half saw Healthcare and Technology managers continue to outperform. Market-neutral-style premia performance was split, as Value and Yield factors struggled, while Growth, Quality and Profitability factors performed well across most geographic regions.

A Review of CTA performance in 2018 H1
Snapshot View

CTA performance for the first two months of 2018 was a rollercoaster ride for many managers, followed by a sideways grind for the remainder of the first half. A run-up in January put the SG CTA Index within 3% of its all-time high watermark, before market reversals at the end of January and beginning of February led to losses that have not yet quite been recovered. Despite challenging market conditions, a number of CTAs generated positive performance in a six-month period that highlighted the differences between CTA strategies. This was primarily related to time frames, from short-term to long-term, but also asset allocation and technical versus fundamentally based Quantitative Macro approaches. This snapshot analyses the performance of CTA strategies during the first half of 2018 using the SG CTA Indices and constituent data, attribution data from the SG Trend Indicator, and simulations designed to show the opportunity set for momentum trading across varying time horizons and markets.

Global Macro Performance: Searching for Persistence
Snapshot View

Discretionary Global Macro is consistently one of the most discussed strategies in our conversations with institutional investors. The flexible, top-down approach to markets is of perennial interest in investor portfolios, but in recent years the performance of many Global Macro funds has been underwhelming. The performance of our Discretionary Macro index is evidence of this disappointment, and the index has been below high watermark since November 2015. This snapshot analyses the distribution of individual Macro manager returns, which is markedly different from the index-level data. We reveal significant dispersion of returns both upwards and downwards, and that an investor’s experience of Macro performance may therefore be somewhat different from the index. There have always been significantly positive Macro returns that are higher than the Macro Index. We look for outperformance persistence: first by analysing the turnover of outperforming managers from one year to the next, and second by calculating how persistently an individual Macro manager ranks amongst its peers. Persistently outperforming Macro managers are rare, suggesting it may be difficult for an investor to find these managers, if indeed they exist, and the disclaimer may have got it right all along: “Past performance is not an indicator of future results...”

A Review of Equity Hedge Fund Performance Full Year 2017
Snapshot View

With the MSCI World Index posting the biggest gains (+24.0%) since the recovery rally of 2009, Equity Long/Short managers also posted solid returns (+13.44%) for the year. It wasn’t only market beta that contributed to this performance, as the peer group was also able to deliver positive alpha. In the Market-Neutral universe, performance recovered modestly from the stress of 2016, ending 2017 up +1.92%. In this snapshot, we review the 2017 performance of Long/Short and Market-Neutral equity strategies, observing record low volatilities in world equities and among Long/Short hedge funds. Interestingly, we also noticed decreasing beta exposures across most geographic Long/Short peer groups, especially in the second half of the year. All geographically focused peer groups and all sector specialists posted positive results with the exception of the Energy specialists. Long/Short alpha generation was strong across all geographic regions, with mixed results across sector specialists.”

A Review of CTA Performance in 2017
Snapshot View

A very strong run of returns in the second half of 2017 led to positive returns for CTAs over the year and represented a significant turnaround from the mid-year drawdowns experienced by our CTA indices. Equity indices were fertile grounds for trend following, with only a limited number of other markets offering opportunities. Short-term strategies struggled, especially at the start of the year, and on average non-trend strategies outperformed. This snapshot analyses the performance of managed futures strategies during 2017 using the SG CTA Indices, attribution data from the SG Trend Indicator, and simulations designed to show the market environment and opportunity set for momentum trading across varying time horizons and markets.”

CTA Assets under Management Evolution in 2017
Snapshot View

CTAs are attracting significant interest from institutional investors, and since 2006 industry assets have more than doubled to approximately $344b1 at the end of 2017. The annual rebalance and reconstitution of our SG CTA indices provides an interesting perspective of the assets under management (AUM) in the CTA industry each year. This snapshot will examine the recent changes in the CTA asset landscape, in particular the share of assets managed by the largest managers represented in our indices, as well as the median AUM cutoff required to be a constituent of our indices.”

2017

Name
Type
Details
Equity Hedge Fund Alpha in Various Dispersion Regimes
Snapshot View

Hedge funds’ ability to produce strong alpha depends on many variables, including manager skill and experience, quality of the team, infrastructure and the ability to navigate various marketregimes. One of the metrics that could be used to gauge the conduciveness of a market environment to alpha creation in the equity hedge fund space is equities return dispersion. The key premise underlying this assumption is that divergence of single-name equities within and across sectors can create a better opportunity set for selecting the winners and losers on both the long and short side of the portfolio. In this snapshot, we review the historical and current dispersion environments and investigate how the levels and changes in equities dispersion impact the alpha component of Equity Long/Short and Market-Neutral hedge fund returns. The key findings demonstrate that higher levels of dispersion were generally conducive to improved alpha production for Long/Short funds, while these relationships were not as obvious for the Market-Neutral peer group. Additionally, high but declining levels of dispersion were generally more favorable for Long/Short manager alpha creation than spiking levels of dispersion.

Overview of Multi-Asset, Multi-Risk Premia Investment Program Universe
Snapshot View

There is an expanding universe of investment programs that are focused on capturing the returns of specific and well known market-related risks: commonly referred to as "risk premia." In this snapshot, we explore the key characteristics of the growing universe of multi-asset, multi-risk premia investment programs, where investor interest appears greatest. We observe a proliferation of low-fee programs for this strategy concurrent with growing demand, and as of June 2017 we can measure approximately $35 billion allocated to the strategy.

Review of Equity Hedge Fund Performance First Half of 2017
Snapshot View

In the first half of 2017, global equity investors enjoyed one of the strongest first-half rallies in recent years, especially in Emerging Markets and Asia geographically, the Technology and Healthcare sectors and growth stocks from a style premia perspective. Performance of Equity Long/Short and Market-Neutral strategy peer groups constructed using our hedge fund database posted mixed results. While underperforming on absolute basis from most perspectives, the Long/Short peer group managed to generate positive alpha in selected geographies and sectors. After a turbulent year in 2016, equity style premia performance began to stabilize, recovering from one of the most significant factor rotations in a decade. Concurrently, Equity Market-Neutral strategy alpha remained relatively flat, while absolute performance continued to be slightly disappointing.

Revised ACF Adjustments for the SG Manager Evaluation Report
Snapshot View

In our prior work we demonstrated that the presence of autocorrelations in a manager’s return time series can have a large impact on the manager’s risk profile and on drawdown behavior in particular. Investment strategies with positive autocorrelations tend to have higher effective risks than conventional volatilities would indicate under the assumption of independent and identically distributed random variables (IID), whilst negative autocorrelations would lead to a lower effective risk. In order to properly measure the effective risks, we have, since 2012, incorporated autocorrelation factors (ACF) when translating single-period to multi-period risk in our SG Manager Evaluation Reports. Our experience of incorporating these ACF adjustments has led to some interesting situations over the years, including violations of theoretical bounds when using real manager data. In this snapshot we present our revised methodology for including these risk adjustments, which tackles some of these issues head on.

CTA Performance in 2017 H1
Snapshot View

By most accounts CTA performance in the first half of 2017 was disappointing. However, returns were not negative throughout and there were opportunities for trend followers and other CTA strategies. The last four days of June were challenging for managed futures, but despite large market reversals leaving many strategies in the red, a number of non-trend and short-term managers were able to generate positive performance. This snapshot analyses the performance of managed futures strategies during the first half of 2017 using the SG CTA Indices, attribution data from the SG Trend Indicator, and simulations designed to show the market environment and opportunity set for momentum trading across varying time horizons.

Don't Worry, Fee Happy
Note View

Unless you have been living under a rock for the last decade or so you will no doubt be aware that there has been increasing pressure on fees in the hedge fund industry. Fees are one of the most commonly raised topics by institutional investors with our Capital Introductions team, and the hedge fund industry has started to respond with a raft of lower-fee products in recent years. In this paper we use simulated data to show the effect that fees have on the gross returns produced by any type of hedge fund strategy, in particular reviewing the effect of different leverage levels and different interest-rate environments. We provide a framework for evaluating fee levels, with a practical example of trend-following CTA alpha strategies, to see whether these managers deserve their fees relative to a simple alternative beta strategy.

What's Driving Global Macro? Uncertainty, Surprise and Inflation
Snapshot View

There is a current train of thought that uncertainty leads to an interesting environment, typically for Global Macro performance. From our conversations with institutional investors there is anecdotal thinking that uncertainty, surprise or higher inflation should provide greater trading opportunities for discretionary global macro managers. Macro managers have some of the broadest investment mandates, taking holistic views on global markets, and they can capitalise on themes or dislocations through directional or relative value strategies. Global economic policy uncertainty, has been elevated since 2015 and reached an all-time high at the beginning of 2017. There are many macroeconomic question marks, and levels of global economic surprise have been consistently positive and G7 inflation has ticked back up above 2.0%, with both metrics at recent highs in 2017.

A Review of Equity Hedge Fund Performance in 2016
Snapshot View

Last year saw a significant dispersion of performance across equities-focused hedge funds. While performance was choppy during the year, equity Long/Short strategies finished the year up +4.91% on average. In contrast to last year’s strong performance, Market-Neutral strategies witnessed their largest drawdown since 2008 before a moderate recovery left the peer group down -0.36% in 2016. In this snapshot, we look at the performance of Long/Short and Market-Neutral equity strategies. We show a high level of variability in performance for both strategies during the course of the year, as well as significant return dispersion among both sector- and geography-focused managers overall. Additionally, we analyse the performance of six long/short equity factor models highlighting the significant factor rotation that occurred last year.

A Review of CTA Performance in 2016
Snapshot View

Managed Futures strategies experienced an up-and-down year in 2016 and, despite positive performance in December, finished the year in negative territory on average. Conditions for trend-following strategies were challenging, and the strategy experienced both significant runup and run-down periods as developing trends broke twice with no strong individual theme able to develop. It wasn’t all doom and gloom, however, as non-trend strategies, in particular short-term CTAs, were able to eke out a positive return. This snapshot analyses the performance of managed futures strategies during 2016 using the SG CTA Indices, attribution data from the SG Trend Indicator, and simulations designed to show the market environment and opportunity set for momentum trading across varying time horizons and markets.

2016

Name
Type
Details
Revisiting the Heterogeneity Within the Global Macro Universe
Snapshot View

In this snapshot, we review the correlations between strategies within the discretionary Global Macro universe. Our previous snapshot on the subject proposed that Macro hedge funds are on the whole uncorrelated to one another. We show here that the total universe continues to be on average, highly uncorrelated. Furthermore, we segment the universe using strategy styles from our classification framework and by assets under management to show that even in more focused segments of the universe, correlations continue to remain low. Finally we use hierarchical clustering to group strategies by correlation and analyse the constituents. We show that there are instances where strategies do exhibit high pairwise correlation to each other and that asset class exposure might offer some explanation to the higher correlations across the universe.

A Review of Equity Hedge Fund Performance H1 2016
Snapshot View

In this snapshot, we look at the recent performance of Equity Long/Short and Market Neutral strategies using hedge fund data from our database. We show that first-half performance of Equity Long/Short strategies struggled across the board with the exception of Emerging Markets, North American and commodity focused managers. Market Neutral strategies performed similarly, April was one of the group’s largest negative months since 2008. We analyse the performance of Long/Short factor indices highlighting quality and momentum as the performers while growth and value suffered substantially. Finally, we discuss the recent increase in European stock loan fees from a market capitalisation and sector-level standpoint.

CTA Performance in 2016 H1
Snapshot View

CTA strategies have been one of the better performing hedge fund strategies this year, with the SG CTA Index returning 4.17% to the end of June 2016. The Index weathered Britain’s EU referendum result well, recording the largest daily gain since 2000 on the 24th of June, with 18 out of the 20 constituents producing positive returns. This snapshot analyses the performance of managed futures strategies during the first half of 2016 using the SG CTA indices, attribution data from the SG Trend Indicator, and simulations designed to show the market environment and opportunity set for momentum trading across a variety of time horizons and markets.

Overview of the CTA Mutual Fund Universe
Snapshot View

In recent years there has been a significant increase in the availability of managed futures products through alternative structures such as 40 Act mutual funds, UCITS, and even ETFs. The largest growth has been seen in the United States, which has witnessed an approximately five-fold increase in assets over the last five years alone, with a similar increase in the number of products. This snapshot describes the growth in the space and details the types of CTA strategies that are available in a mutual fund format. It also provides an evaluation of the performance of these new products in comparison to our newly created SG CTA Mutual Fund Index.

A Review of Equity Hedge Fund Performance in 2015
Snapshot View

Last year was a game of two halves for equity hedge funds. In the first half of 2015, Equity Long/Short strategies returned on average +4.21%, while Market-Neutral strategies gained +2.88%. The second half of the year presented a challenge for Long/Short strategies, which ended the year down -1.11% as global equities retreated. Market-Neutral strategies, however, continued to perform well, returning on average +5.35% over the year. In this paper, we look at the recent performance of Long/Short and Market-Neutral equities. We demonstrate significant return dispersion among both sector- and geographic-focused managers in light of both the increased market volatility and the rising correlation between global equities. Additionally, we analyse the performance of six Long/Short-factor indices and provide an analysis of the stock-loan environment for European equities in 2015.

Frustration Factor - A Review of CTA Performance in 2015
Snapshot View

Managed Futures strategies managed to eke out a positive performance in 2015 despite the environment for trend-following becoming progressively tougher throughout the year. The strong gains seen in Q1 were eroded in Q2, and this was then followed by a frustrating series of alternating positive and negative returns. This snapshot analyses the performance of managed futures strategies during 2015 using the SG CTA Indices, attribution data from the SG Trend Indicator, and simulations designed to show the market environment and opportunity set for momentum trading across varying time horizons and markets.

2016 High Water Mark Bias for SG Prime Services Indices
Snapshot View

In 2014, we highlighted a new hedge fund index bias that we termed High Water Mark Bias (HWM Bias). In our note, we showed how this occurs during the reconstitution or rebalancing of any index that includes investment vehicles (such as hedge funds) with fund equalisation. This snapshot details the HWM Bias that existed in our various indices during 2015 and the maximum HWM Bias possible for 2016 as a result of our rebalance process that occurred 1st January 2016.

2015

Name
Type
Details
Re-Evaluating Two Trend Indicator Assumptions
Note View

We initially launched the Trend Indicator in August 2010, and following feedback from the industry we released a set of updates in January 2012; since then the methodology has remained unchanged. There are a couple of items that have been bothering us with the way we calculate the Trend Indicator: the outdated transaction cost assumptions and the way that we allocate the weights to different sectors. This paper looks at both of these items in turn and proposes frameworks for evaluating both on an ongoing basis. We report the results that were produced when we recently ran these analyses and detail the improvements to the Trend Indicator that will be implemented on the first business day in January 2016.

Same Same, But Different - Heterogeneity within the Discretionary Global Macro Universe
Snapshot View

We have recently been discussing the diversity of strategies available within the discretionary global macro universe with a number of investors. Macro managers have some of the most flexible investment mandates. As such, they have the ability to trade a wide range of markets using a variety of strategies, which can lead to managers being very different from one another.

A Correlation Conundrum - Trend Indicator Performance Divergence in July 2015
Snapshot View

July 2015 saw an interesting contrast between the returns of the Trend Index and Trend Indicator. The Trend Index ended up +3.82% in July and back in positive territory for 2015 +2.03%; by contrast the Trend Indicator, our moving-average crossover model, was down -2.37%, slipping further underwater for the year -6.66%. This snapshot will analyse the Trend Indicator’s returns and correlation to the Trend Index, in particular in July 2015. Additionally, we examine how different model time frames in the portfolio alter the correlation to the Trend Index, as well as performance attribution differences of a longer-term model.

Equity Hedge Fund Performance Review H1 2015
Snapshot View

The first half of 2015 saw Equity Long/Short hedge funds return +4.21% while Market Neutral strategies also continued to perform well, returning +2.88% through to the end of June. In this paper, we look at the recent performance of Equity Long/Short and Market Neutral strategies using hedge fund data from our database. We show that the first-half-year performance of Equity Long/Short strategies was strong, with all of the geography- and sector-focused peer groups adding positive alpha. Additionally, we analyse the performance of Long/Short factor indices highlighting value and growth as the standout performers. Finally, we discuss the ongoing reduction in European stock loan fees across both market capitalization and sector levels.

CTA Performance in H1 2015
Snapshot View

Managed futures have weathered two distinct periods of returns so far in 2015. The strategy was buoyed up by the presence of strong trends through the end of 2014 and 2015 Q1, and the CTA Index peaked on the 13th of April. Q2 was harder to navigate, with a number of established market trends coming to an end, eroding the gains made in the first quarter, and the CTA index ended in negative territory. This snapshot will analyse the performance of managed futures strategies during the first six months of 2015 using the CTA indices, attribution data from the Trend Indicator, and simulations designed to show the market environment and opportunity set for momentum trading across varying time horizons and markets.

The Life Outside of Trend
Snapshot View

The CTA industry is dominated by large medium- to long-term trend following managers, and this leading position is increasingly resulting in institutional investors using the two terms interchangeably. Despite this dominance in assets under management, trend following represents just a small part of the industry by the number of firms. This snapshot will take a closer look at the CTA landscape, strategies, and performance characteristics of the 75% of the industry that is not represented by trend-following managers.

An overview of Commodity hedge funds
Snapshot View

The year 2014 witnessed dramatic declines in the major commodity markets with the crude oil market recording a -47.36% down move from a 2014 high of $106.83. In contrast, the Commodity Trading Index produced its first positive return since 2010, returning a modest +1.47%. In this paper, we will review the environment for commodity trading strategies, dissect the recent performance of commodity hedge fund strategies, and provide an overview of the current commodity investing landscape.

A Review of Equity Hedge Fund Performance in 2014
Snapshot View

In 2014 Equity Long/Short strategies completed their third consecutive year at an annual high water mark, having returned +33.1% since the beginning of 2012, although 2014 saw a plateau in performance. In this paper we look at the recent performance of Long/Short and Market Neutral equities strategies using hedge fund data from our Research Database (NERD). We show the performance at overall strategy, sector, and geography levels, as well as look at the dispersion of individual manager returns. Additionally, we analyse the performance of six long/short factor indices, and provide an analysis of the stock loan environment for European equities in 2014.

Back in Black 2 - Opportunity set for trend following
Snapshot View

In the first snapshot of this series, we discussed the performance of the wider CTA space in 2014 using our CTA Indices and attribution data from the Trend Indicator. In that paper, we highlight how trend-following strategies were the best performing of the CTAs, returning 20% for the year following a strong run since March. Given the recent rise in returns, we thought it would be worthwhile to look at the opportunity set for trend followers in greater detail. While there are many factors that may affect the performance of these strategies, we focus on changes in market correlations, volatility, and the strength of recent market trends using the 55 futures markets of the Trend Indicator. In this paper we show that inter-market correlation has dropped back to pre-2008 levels, market volatility has been at historic lows, and the ‘trendiness’ of many of the underlying markets has improved significantly. These changes contributed to what was a good environment for trend followers during 2014.

Back in Black 1 - A Review of CTA Performance in 2014
Snapshot View

In our paper “The Seeds of a Recovery” that we sent out in July we suggested that managed futures may have been emerging from their recession that had lasted since 2011. The strategy went on to post the strongest six months returns since 2008 and finally emerged from this difficult period reaching a new high water mark on the 13th of November. The strategy extended its positive run further, and ended the year at daily, weekly, monthly, and annual all-time highs. This snapshot is the first in a two-part series that looks at the performance and opportunity set for CTAs. In this paper we analyse the performance of managed futures strategies during 2014 using the CTA indices, attribution data from the Trend Indicator, and simulations designed to show the market environment for momentum trading across varying time horizons and markets.

2014

Name
Type
Details
Changes in Global Macro Performance: Observations from the Macro Trading Index
Snapshot View

Global Macro returns appear to have undergone a change since 2009. In this snapshot we will use the performance data of both the Macro Trading Index and a wider Macro dataset, to look at the returns of Macro managers, and ensure that our indices are representative of the investor experience in Macro strategies. Despite a change in performance Macro continues to be a popular hedge fund strategy with investors. The number of funds has increased, and Macro continues to be a diversified strategy with average correlations between managers remaining low. We do observe however that both the returns and volatilities of these managers have fallen since 2009, resulting in lower Sharpe ratios for both our indices and the individual funds. There is a light at the end of the tunnel however, the second half of 2014 has seen a pick-up in performance for Macro. Risk-adjusted returns have returned to positive territory, and the Macro Trading Index has posted a new high watermark at the end of November 2014.

High Water Mark Bias
Note View

With the increased institutionalisation of the hedge fund industry, we are often asked by investors to help explain the risk/return characteristics of different alternative investment strategies. As with all investments, the identification of an appropriate benchmark is a key tool in order to be able to discern whether the returns of a manager are due to their individual skill, or simply the implementation of a particular investment style. There are a variety of different approaches to benchmarking hedge fund strategies, however peer-based or manager aggregate indices remain the most widely used. In this paper we add to the existing literature on hedge fund indices by documenting a new index bias – High Water Mark Bias (“HWM Bias”) – which we illustrate with an empirical study on the CTA Index. As this bias is not just peculiar to the CTA Index but affects all hedge fund indices, the methodology can be applied to other indexes when high water mark based fees are involved.

CTA Performance in H1 2014
Snapshot View

Managed futures strategies may be finally emerging from their recession that has lasted since April 2011; but critics claim confidence is premature, we have been here before, and there are still potential headwinds for the strategy. Despite low trading volumes in some of the instruments that they focus on, particularly FX, a close look at the performance of the CTA Index since March reveals a glimpse of the green shoots of recovery. No doubt CTA managers and investors are hoping that mighty oaks from little acorns grow. This snapshot will analyse the performance of managed futures strategies during the first six months of 2014 using the CTA indices, attribution data from the Trend Indicator, and simulations designed to show the market environment for momentum trading across varying time horizons and markets.

Yield Curve Carry
Note View

Carry in various forms is one of the mainstays of the financial world. The idea of borrowing at low interest rates and investing in assets that yield more is applied especially to yield curves within a country and to yield curve spreads between countries. Both of these trades – yield curve carry and currency carry – can be effected using futures and forwards. These are markets in which we are both well informed and highly experienced, and so we are in a position to use readily available market instruments and market prices to construct and publish benchmarks for both trades. This note focuses on yield curve carry. To be sure, we embarked on this piece of work fully expecting that the resulting benchmark could be used to explain the performance of a wide class of hedge funds that focuses on fixed income markets in general, and fixed income arbitrage strategies in particular. What we found, however, was very different.

Historical AlternativeEdge Papers

Name
Type
Details
Capacity in the managed futures industry
Note View

Our purpose in writing Managed Futures for Institutional Investors in 2011 was to help clear the way for the possibility of doubling the size of the industry. While ambitious, the goal seems well within reach. Since then, the industry has grown somewhat and now manages roughly $330 billion. At the same time, the industry finds itself in a drawdown that is, by the industry’s standards, relatively deep and relatively long. The current drawdown at this writing is two years long. And at its worst (so far), the drawdown was -9.3%. The growth in assets combined with the current drawdown has prompted investors to ask three related questions. What is the industry’s capacity to deliver uncorrelated returns with a reasonably high Sharpe ratio? How large can an individual manager be? And, a truly interesting question for a large institutional investor, how large an investor can I be? This note mainly addresses the first question, although the framework we work with allows one to think about the second two questions as well. To do this, we explore the position sizes that an industry dominated by trend following would require to meet a return volatility of 15% and compare them with open interest in a wide range of markets.

It's the autocorrelation, stupid
Note View

Drawdown – the money you’ve lost since reaching your most recent high water mark – could well be the single most discussed aspect of risk in the world of investing – especially in the world of active asset management. It represents money that once was within the investor’s grasp but now is gone. The active manager can be in drawdown 80 percent of the time. It causes active managers to wonder if their approaches to trading are flawed. It causes investors to wonder if their active managers will change the way they trade in an effort to protect themselves. And, several years ago, when we polled the investors at one of our early gatherings about what they considered the most important measure of risk, drawdown topped the list. In fact, it was the results of this informal poll that led us to publish Understanding drawdowns in 2004, and the model we developed there has served us well for eight years. Even so, the work of trying to understand drawdowns can reveal astonishing insights into the way we think about risk. In this case, we have learned that failing to account for autocorrelated returns can lead to serious biases in our estimates of return volatilities. Here is a case in point. While doing some work on pension fund investments, we raised the question about why drawdowns in equities can be so much deeper and last so much longer than one would expect given their volatility.

Improvements in the Trend Indicator
Note View

When we first began publishing the Trend Indicator (Trend Indicator), we recognized opportunities for improving both its return volatility and its correlation with the CTA Trend Sub-Index (Trend Sub-Index). In particular, our choice of 2-year look back and 1-year rebalancing period produced hugely volatile returns in 2008 and 2009, whereas the CTAs whose returns make up the Trend Sub-Index managed volatility extremely well during these crisis years. We also reported that early comments on our research suggested that we should weight commodities more heavily and equities less heavily then we did. The purpose of this note is to report on what we believe are significant improvements in the Trend Indicator that will take effect as of the first business day of January 2012.

How many trades are there currently?
Snapshot View

Using the positioning data available to us through the Trend Indicator it appears the answer to this question is “Not Many.” We observed that for the period 3rd February 2011 to 28th February 2011 there does not appear to be any difference in the direction of positions within each of the asset class sectors for our proxy of long term trend following. Depending on how one calculates the number of trades, this could range from one to four namely; long risk assets (equities and commodities), short the dollar, a yield curve steepener, and short natural gas. Although people comment that markets may become this binary fairly frequently, the extent of this struck us as being highly unusual and further begs the question: How frequently does this actually happen?

Two benchmarks for momentum trading
Note View

Returns in the CTA sector probably can be best understood as the combination of two powerful forces. One is the influence of trend following or momentum trading, which appears over long stretches of time to be profitable. The other is the presence of uncorrelated trading strategies that are also profitable and whose diversifying effects greatly improve the risk/return profiles both of individual CTAs and of portfolios of CTAs. Given its comparatively high and stable correlation with actual trend following CTAs, we believe that this particular trend following model and parameter combination – which we will publish as the Trend Indicator – has a useful role to play for both investors and managers. Investors will have a benchmark that provides position level transparency in all of the markets that it employs, which in turn allows ready access to information about sources of returns. For their part, managers will have an independent, no-ax-to-grind, standard of comparison that they can use in conversations with their clients.

A new look at building teamwork portfolios
Note View

The original Superstars versus teamwork (Nov. 8, 2007) was the first in a sequence of research pieces that have persuaded us that the best way to build portfolios of CTAs is to look for low correlation and place your bets there. Correlations appeared to be predictable, especially for portfolios, while Sharpe ratios did not. We found that choosing managers to maximize the portfolio’s Sharpe ratio yielded better results than did choosing managers based on their individual Sharpe ratios, and the difference was statistically significant. The teamwork portfolios in that research were constructed, however, using conventional mean/variance analysis that was based on estimated means, volatilities and correlations. And, when we applied it to the construction of a teamwork index, we found out, quite by accident, that it was unusually sensitive to minor changes in the eligible set. Too sensitive, for that matter, which led us back to the question of just how one should approach the selection of managers for a teamwork portfolio.

Superstars versus teamwork
Note View

One of the most powerful tensions in the world of money management is in the pull between assets that perform well on their own and portfolios that perform well. Even the most casual students of finance know about the importance of diversification. But as soon as any one asset turns in a bad performance, the temptation to dump that asset and replace it with something that performed better is nearly irresistible. What we found in this research is that team players outperformed superstars. We found that the difference was statistically significant. We found that in most cases replacing “underperforming” managers with someone who would have been better did little or nothing to improve overall portfolio performance. We did find, though, that firing team players for poor individual performance and replacing them with managers with higher Sharpe ratios seriously degraded the performance of the portfolio.

Understanding Drawdowns
Note View

Within the universe of hedge funds and commodity trading advisors (CTAs), one of the most widely quoted measures of risk is peak to trough drawdown. Our experience suggests, however, that investors do not have a widely accepted way of forming expectations about just how much managers who are in business over long periods of time might be expected to lose. Rather, we find that investors tend to monitor a manger’s worst or maximum drawdown with only informal or anecdotal information about the manager’s average annual or previous year’s returns. Drawdown as a measure of risk has failed to attract the same kind of research and attention that are devoted to other common measures such as return volatility, VaR, or Sharpe ratios. Our purpose here is to show that it is possible to get a reasonable fix on what drawdown distributions should look like. This is no trivial problem. Any manager for whom the standard deviation of returns is large enough to produce a loss in any given investment period will experience drawdowns. Most managers are in drawdown most of the time. And managers who have been in business a long time may well have experienced more and bigger drawdowns than those with short track records.


This material is a product of the Alternative Investments Consulting Prime Services Group in the Global Markets Divison of Societe Generale (SG). This document is not a product of Societe Generale’s research department and should not be regarded as a research report. It is only directed to Institutional Investors (as defined under Rule 2210 of the Financial Industry Regulatory Authority, Inc.) and available only to such Institutional Investors who have received the proper options risk disclosure.