Managed futures performance can be frustrating for investors. After strong performance in 2014 and into Q1 2015, many may be wondering why the strategy has lost some luster in Q2. The reality is that some of the very strong trends from last year have seen changes in direction. The key to understanding what might happen next is in trying to assess whether those trend changes are corrections against the previous trend or have graduated into full-blown trend reversals.
There were price corrections across all four major market sectors in Q2—the US dollar, interest rates and equity indices (especially in Europe) all sold off while commodities (particularly energy) have rallied. The result was that no single market or sector was the cause for negative performance. Rather, each sector or even sub-sector therein, lost a small amount. Add these up and you get negative performance for many managed futures managers in Q2.
Below is a brief summary of some of the major drivers in each sector:
Currencies. In 2014 short positions in the euro, yen, and most other currencies versus the US dollar proved to be a very successful trading strategy for managed futures managers as central bank policies began to diverge. In Q2, expectations have shifted due to early signs of QE success in Europe. The EUR/USD trade has corrected and is heading back towards where it started the year. Short euro trades have logically resulted in losses. Most trend following managers remain short euro, betting that the trend of a stronger US dollar will resume.
Commodities. Short crude oil was, by far and away, the most successful trading strategy in the second half of 2014. Since the downward price trend was so strong, most trend following systems have regarded the price appreciation in 2015 as a correction within the overall downtrend, rather than a trend reversal. However, as the months roll forward without a resumption of the downtrend most managers have reduced short exposure to crude, and a few have begun to reverse their positioning to long. The longer the crude oil price holds above $60 per barrel and continues to tick higher, we expect more managers to view the market as having reversed.
Fixed Income Futures. Fixed income has been volatile—especially in Europe. German bond yields rose and prices fell quickly as market participants wised up to negative yields. Managed futures managers were largely long the bund and other European fixed income contracts, thus incurring losses (albeit most somewhat minor). Fixed income positioning has been reduced across the board as the market determines whether a new uptrend in bond yields has indeed begun. Some managers have begun to establish short futures positions.
Stock Index Futures. Long stock index futures positioning—both domestic and globally—have been a mainstay of portfolios for many quarters. Corrections in some of the strongest upward price trends such as Eurostoxx 50, the DAX and even S&P 500-miniFutures caused losses in Q2. Most trend following managers remain long in anticipation of an ongoing uptrend.
Will it Get Better?
Managed futures managers, particularly medium- to long-term trend following managers, do not reverse positions overnight. Timing depends on the parameters of their underlying trend identification algorithms. In general, most trend following managers require a sustained price movement before reversing positions from long to short or short to long. Even in 2008, a banner year for managed futures strategies, many trend following managers suffered several months of negative performance before their systems identified whether corrections were new trends. After a prolonged period of strong trends, it is very common to see markets experience reversals for either technical or fundamental reasons (or both). In today’s market, there is no unifying reason for these moves—markets appear to be simply retracing some of their price trends over the last 12-plus months. We believe these price reversals represent “normal” market behavior, particularly after a long trending period. Similarly, it is normal for managed futures managers to have periods of drawdown after a strong winning sequence like the one we saw beginning in mid-2014. Investors might be nervous that we are entering another extended period of stagnation in the strategy, but we believe the underlying market conditions of expanding volatility and central bank policy divergence remain supportive of the opportunity sets in managed futures, regardless of whether you view current price moves as corrections or new trends.