August 12, 2009 / 5:01 PM / 10 years ago

Clear market trends to boost black-box funds

ZURICH/LONDON (Reuters) - After a stellar 2008, trend-following hedge funds have struggled this year with many finding thinly traded markets hard to negotiate, but say a resurgence in market trends is set to improve their fortunes.

Commodities trading advisers (CTAs) are “black-box” funds that use computer programs to exploit trends in asset classes ranging from interest rates to equities indexes. These trends have been too short-lived in recent months for investors to identify and profit from them.

Managers are now turning bullish as stronger trends show signs of re-emerging in certain markets, said Umberto Loschi, a CTA manager based in Padova, Italy: “Things will take off again in the fourth quarter on increased volatility in energy and agricultural commodities.”

Hedge fund executives compare CTAs — sometimes called managed futures as they usually invest in futures markets — to surfing. Many funds can make money by riding a large wave, or market trend, such as a long-term rise in oil prices.

Managed futures took advantage of strong trends in 2008 to top hedge fund performers with returns of 18.3 percent, while most strategies lost money, Credit Suisse/Tremont data show.

However, after further gains in the first quarter from continuing market trends, CTAs lost 8.2 percent in 2009 to July, while the average hedge fund returned 9.7 percent, preliminary CS/Tremont data show.

“From April to June it wasn’t that there was no trend, but trends were too short-lived for our purposes,” said Tim Wong, Chief executive of Man Group’s (EMG.L) $20.4 billion AHL, the world’s largest managed futures strategy.

A turnaround is not here just yet. The CS/Tremont data showed managed futures lost 0.8 percent in July, one of only two losing hedge fund strategies in a very strong month for equities markets, and Tremont observed that “in general, trend followers in Global Macro and Managed Futures struggled” during the month.


One advantage of CTAs over other trend-followers like statistical arbitrage (stat arb) funds, which use programs to exploit tiny market inefficiencies, is that crowded trades are not generally a problem.

At many stat arb funds, sell orders kick in when prices move far enough against them. Moves can be accentuated if continued price falls trigger sell orders at other funds, and an exit from a position can turn into an exodus.

This happened in August 2007, when funds from JP Morgan, Goldman Sachs and others lost up to 30 percent in just days.

However, CTAs are less prone to this peril because of the type of leverage they use, said AHL’s Wong.

Fund managers say that managed futures funds can be leveraged without external borrowing, and that is a key difference compared with stat arb funds. Hence there is little danger of being forced to liquidate positions.

In futures markets, participants enter contracts to buy or sell assets at a certain future date, and pay a deposit, usually a small fraction of the asset value, as a guarantee.

Parties may have to increase their deposit if prices move against them, but there is no borrowing involved, so a lender cannot force them to close the position.


Some investors are wary of investing in CTAs because returns can be very unpredictable.

“Even prior to the summer there was reticence from people to participate in the market,” said Nick Hannan of Oakley Absolute Return, a UK-based fund of funds which manages $175 million. “Most people sat on the sidelines. This fund opted not to invest in CTAs because of the irregularity of returns.”

Investors need to worry less about volatile short-term returns and analyze CTA performance over a three- to five-year timeframe, said Wong.

Managers believe clear market trends are now developing, and are gearing up to get on board.

Juerg Buehler, chief investment adviser of Switzerland-based Dynamite CTA Fund, said he was looking to bet on prolonged euro weakness, and on the short side in the stock market, but would take the opposite trades if the strengthening trends of equities and the euro remained intact.

“There are some nice trends coming up and we don’t care which side we invest on, long or short,” Buehler said.

Editing by Sitaraman Shankar

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