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What selectors need to know before investing in CTAs

What selectors need to know before investing in CTAs

With the role of quant-led strategies becoming ever-more prevalent, fund selectors must understand the nuances of these investment approaches to deliver value to clients.

Here, SEB’s head of quant-led strategies and portfolio manager, Hans-Olov Bornemann, highlights three key things fund selectors need to know before investing in CTAs/managed futures.

#1 Loss and gain

Bornemann said the first thing investors need to understand is when they will make money from CTAs and also when they are most likely to lose money.

'You need to know what you are buying into, you will always lose money when the market reverses. When a trend breaks and it goes in the other direction CTAs will lose money at the point of trend reversal – the inflection point.

‘For example, if you are long equities in an upward sloping market, you will start to lose money in equities. If the model starts to believe that the equity market is not only going to be seeing a few days of a drop in the price level – but a sustained continuation of negative trends, then a CTA will reduce its equities down to zero.’

Bornemann said it takes around 4-to-6 weeks for medium-term trend followers to turn around from a maximum long exposure to equities, but said this would take a short-term trend follower around two weeks.

‘At the reversal point every trend follower is losing money and when does a trend follower make money? As the name indicates, when the trends becomes longer and longer, trend followers will be making more and more money.

‘Whether the trends are positive or negative it doesn’t matter,  as long as they go in one direction for an extended period of time they will make money.'

#2 Don’t try and time CTAs

Bornemann said selectors also need to know that there is no point trying to put time constraints on CTA products.

'If the CTA managers knew how to time their own funds then they would put it into their models, there’s not a high chance of being successful in trying to time CTA funds. Timing the market is easier than that.

‘For that reason, the recommendation is that if you believe that CTAs can generate excess returns over time, which a lot of people do.

'If you think they will have an average correlation between equities and bonds which are quite low, then you should be owning CTAs in your core portfolio alongside equities and bonds.'

Bornemann said he has been recommending fund buyers to use CTAs in their allocations.

#3 Don’t use bucket thinking

According to Bornemann, it’s human nature to conduct bucket thinking, but he said this shouldn’t be applied to CTAs.

'If you look at equities they go up and down. When they go down investors tend to say: "Well the equity market goes up all the time so I’m just going to hold onto my equities".

'When a CTA fund goes well people say: "That's exactly what it should be doing". But if it doesn’t go well you start to worry.

'You worry because you don't fully understand the strategy and you don't fully understand why it has lost money at that point. If you are not comfortable with the strategy, what tends to happen is you tend to sell.

'If you consistently sell an asset whether it’s CTAs, equities or bonds then you won’t get good performance. Holding onto an asset like equities, bonds, and CTAS over the long term is the best way to create value,’ he added.

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