Unfortunately, My CTA Was Diversified!

Research insights

Robert Baguenault de Viéville, Founding Partner & Fund Manager, Charles Chevalier, PhD, Research Analyst and Alison Mayer, VP European Sales, KeyQuant
Originally published in the April | May 2020 issue

Abstract 

The CTA space is now more diverse than ever. When considering an investment in CTAs for risk mitigation purposes, how to pick the right one? In this note we will take a closer look at multistrategy CTAs and analyze how they fare in comparison to their pure trend counterparts. We find pure trend CTAs offer a better protection against deep losses of traditional portfolios than multistrategy CTAs. The quest for improving their standalone profile might have come with adding convergent strategies, though complementary to trend, but in some way similar to the investors’ existing underlying portfolios.

Introduction

You probably remember the 2008 global financial crisis. Markets were upside down, trust in the system evaporated overnight. Stocks were losing more value every day. It was frustrating to see all of these long-built gains wiped out… And no hope for a quick recovery on the horizon. The situation went from bad to worse, when the panic and the desperate need for liquidity triggered waves of redemptions and deleveraging, crystallizing losses at the worst moment. Hedge fund investments were not spared by this global crisis either. Their supposed decorrelation with financial markets vanished as they were experiencing losses as well. Ironically, the only strategies that did not suspend redemptions thanks to their liquidity (like CTAs) also were the ones delivering strong positive performance.

The post-crisis years were years of success for CTAs in terms of asset raising. They had proven their value-add: they had delivered strong positive performance in market chaos, true diversification and liquidity. CTAs were the hedge fund strategy to have in your portfolio.

Time went by. Equity markets had the greatest rally ever. Central banks made a vow of never letting another 2008 happen again. Since then, at the slightest sign of a crisis, central banks have taken actions to fight market falls, providing investors with an artificial hedge. With the spectrum of a crisis fading in the distant past, the lumpy yet positive returns of CTAs over the last decade, many investors challenged their very use in their portfolio. In this context, some CTA managers diversified away from their core trend system, thus morphing from pure trend to “multistrategy” CTAs, in order to smooth their return profile.

But, what will happen when the next crisis hits the markets? Will these multistrategy CTAs prove themselves as useful as their trend counterparts in protecting your portfolio against large drawdowns? In this situation, will it matter that they had a better standalone Sharpe ratio when everything else was performing well?

In this paper, we take a closer look at multistrategy CTAs and pure trend CTAs and take an empirical approach in order to answer these questions.

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