Algorithms seem to be winning the battle against humans in financial markets, as hedge funds relying on complex mathematical models, statistical data, and technology record returns higher than the S&P 500. Trend-following strategies, known as CTAs, capitalized on major trends in oil, bonds, and the US dollar, posting gains of 15.7% over the nine-month period compared to 11.7% for Wall Street's benchmark index. Their goal is to identify and track large, sustained trends, both upward and downward, to profit from ongoing market momentum. The Societe Generale SG CTA Index, the industry's key benchmark that tracks the daily net returns of major strategies including funds managed by Man Group, PIMCO, AQR, and Winton Capital, registered a 15.7% return in the nine-month period through the end of the third quarter. By comparison, the broader S&P 500 index rose by 11.7% over the same nine-month stretch.
"Early, counter-consensus, and right"
Industry sources told CNBC that CTAs correctly predicted the sudden drop in bond prices in September by taking short positions on US Treasuries. This came on top of earlier gains from bullish bets on the dollar, as well as long positions in oil ahead of the war with Iran. "CTAs are crushing the rest of the hedge fund world this year," said Andrew Beer, managing member at Dynamic Beta Investments. As he noted, the industry was "early, counter-consensus, and right" when it began buying crude oil in January before the war with Iran, and subsequently positioned itself successfully for rising interest rates ahead of the turmoil that hit the global bond market. "They have hit the bullseye on the two major market trends: on one side, the feverish stock enthusiasm fueled by artificial intelligence and, on the other, panic over oil prices and inflation," Beer told CNBC. "Humans are far too emotional to time the markets correctly. Machines are simply much better." Nicolas Gaussel of Metori Capital Management noted that CTAs managed inflationary pressures effectively thanks to their ability to take short positions on bonds.
He added that the negative correlation between equities and oil was another critical factor boosting investment performance this year. This year has been shaped by two major structural trends, according to Gaussel: a strong positive correlation between stocks and bonds, and a strong negative correlation between energy and both equities and bonds. This environment has created significant hurdles for traditional portfolios following the 60/40 allocation model. "For traditional, long-only diversified portfolios, the positive correlation between equities and bonds has been particularly challenging. Bond performance has been weak, while fixed income provided minimal portfolio diversification against stocks. Conversely, the ability of CTAs to go short on bonds and short-term interest rates proved immensely beneficial," Gaussel added. "This serves as a reminder that one of the core advantages of CTAs is that they do not rely on the traditional defensive role of fixed income."
What comes next
Looking ahead to the end of the year, the trajectory of trend-following funds will likely depend on energy prices and interest rates, according to Yung-Shin Kung of Mast Investments. "If September is any indication, we have reached a point where the interaction between these two factors is transmitting in a meaningful way to foreign exchange and equity markets," he told CNBC via email. "The key takeaway is that CTAs are generally well-positioned to serve as a buffer for traditional asset allocations. However, risk across many CTA strategies has become increasingly concentrated in key trades."
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