2013-12-05 12:39:36
Hedge funds looking to spot and ride market trends are hoping for a fresh start
IF SOMETHING has not worked for five years, most people would conclude that it
was broken. Tell that to the geeks managing quant hedge funds, who craft
elaborate algorithms to profit from market movements. Once money-spinners,
their prized formulae have misfired since 2009, losing money in four of the
past five years. Unless their results improve markedly, the giant funds will
finish this year as the worst-performing of the most common hedge-fund
strategies.
Trend-following involves programming computers to analyse market movements
and try to infer where they might go next. Practitioners speak with reverence
of crossover levels and momentum speeds leading to breakout points . A
rough translation is that a trend that lasts a few days or weeks can profitably
be invested in until it reverses, at which point a new trend may already be
forming. Whether the markets are going up or down does not matter. Nor does the
underlying asset being analysed typically a futures contract linked to a
commodity or a security.
After prospering through the market rout of 2008 (the prolonged slump gave even
the dimmest trend-follower time to cotton on), the sector swelled from $91
billion to $215 billion, according to Hedge Fund Research, a data provider.
Winton Capital, Man Group s AHL fund, Cantab, BlueCrest and other black box
traders, as their critics dub them, became darlings of the investing world.
Unfortunately, the influx of investment coincided with the reversal in the
strategy s fortunes (see chart).
The main problem is not with the quants models, practitioners insist, but with
the markets themselves. In the aftermath of the financial crisis, they have
been dancing to the tune set by politicians and central bankers. Efforts to
save the euro or stave off deflation regularly send markets into convulsions,
in the process distorting the historical patterns that the algorithms are
designed to exploit. The ensuing jolts and crashes have no precedent, leaving
even the most finely crafted trade at risk from political meddling. Not even
the world s wiliest supercomputers can predict what the European Central Bank
will dream of next, apparently.
Worse, such interference prompts stocks, bonds and commodities to move in
unison. When in May the Federal Reserve hinted at a tapering of America s
ultra-loose monetary policy, for example, both government bonds and shares
tumbled. What had started out as a good year for the trend-followers turned
into a drubbing. One of the sector s main selling-points, that its returns are
uncorrelated to those of other asset classes, is at risk.
The quants are remarkably sanguine about their recent record. Performance
since 2009 in traditional strategies hasn t been great, but it s no disaster
either, says Sandy Rattray, AHL s boss. Many of the stock-picking hedge funds
that had been lionised for making money in the crash suffered large losses in
subsequent years, he points out. Low interest rates, which depress returns on
the safe assets quants hold as collateral to back their trades, have not
helped.
The big unknown is whether trend-following will ever work again. The quants are
adamant that the models are simply in hibernation. Profits will return, they
say, as soon as prices revert to being dictated by investors rather than
policymakers. Imagine where bonds would be trading if it weren t for the
interference, says Leda Braga of BlueCrest.
Some wonder whether the growth of quant-fund investing has irreparably harmed
returns. Decent trend-following algorithms can be bought online. Some of the
funds are adapting in response. Winton, the biggest, now invests some of its
cash in equities; it is among the few to have risen in value this year, albeit
modestly. AHL is focusing its energies on trading in more esoteric markets,
like German power or iron-ore futures, which it hopes are less crowded. Yet it
is hard to find markets that are immune to political meddling, or politicians
who are inclined to let the forces of finance be. Trend-followers may yet
prosper again, but the breakout point, as it were, may be some way off.