While it may take years to correctly assess the abilities of a program to react in both good and bad periods – the current condensed volatility cycle with a nicely defined up move, and near mirror image down move is giving us the rare opportunity to evaluate programs in both environments.
You can see in the chart below that managed futures as a whole, as represented by the SG CTA Index index – has returned roughly to where it was about 6 months ago, after running up a little more than 10% and then proceeding to give back -9% (the fact that you can earn 10% and give back 9% and be in the same place is a mathematical oddity we’ll cover another day).
The naysayers will point to the give back of all the profits as proof that systematic strategies don’t react when they should, to lock in gains quick enough. The believers will point out that it showed up when it needed to (when stocks were selling off heavily). Whatever your take on where things ended up – it is quite clear that there were two distinct market environments at play here – one a beneficial period for systematic global macro/managed futures type strategies and one a not so beneficial period.
What we’re more interested in is how specific programs performed in each of these periods. In short, this is a great time to benchmark your particular brand of managed futures/macro. If they didn’t quite catch the up move, or underperformed their peers – you likely heard sound bites like the following from the managers:
– Our portfolio didn’t have exposure to the markets that moved
– We risk a fraction of others, so don’t expect to make as much as they do when things move
– Our models are longer term, and don’t necessarily capture shorter term moves like those
– The moves were based on quick, binary outcomes driven by the Fed, Draghi, etc. – which are hard to capture
Essentially, their argument is – we missed some of the up move but that’s by design – and the benefit of missing some of that up move will show up when and if there’s a poor environment, where we’re likely to outperform.
On the flip side, is the down move – where managers are now explaining why their funds may be underperforming the rest of the industry in the current environment; with sound bites like the following:
– Our portfolio was over exposed to the markets that reversed heavily
– We risk more than others, so expect to lose a bit more than they do when things move
– Our models are longer term, and these short term moves are chopping it up
– The moves were based on quick, binary outcomes driven by the Fed, Draghi, etc. – which are hard to avoid
The underperformance on the downside argument – it’s been worse on the way down, markets are behaving badly and not providing the directional volatility that’s needed.
These aren’t lame excuses. It is hard for systematic programs to capture moves that materialize out of nowhere based on the comments of this Fed governor, etc. It has been an incredible three months in terms of volatility contraction. Just look at the 10 yr Note chart where it looks like a sawtooth blade ///// and is essentially right where it was three months ago despite the sometimes sharp moves up and down.
But these excuses do give us a chance to benchmark managers and see if their models are performing as they say they would and as we would expect them to perform. In essence, this is a chance to pull out the B.S. detector. If a manager told you they didn’t make as much on the way up because they risk less, and is now down more than his/her peers when the environment is bad – something doesn’t line up. Similarly, you can’t say you didn’t have exposure to the markets that moved and then follow-up with a line about too much exposure to those markets.
In short – you shouldn’t underperform on the way up, AND underperform on the way down. Whatever caused the underperformance on one side, should cause overperformance on the other side, and vice versa. In technical terms, your down capture being larger than your up capture is bad. You want to exist in the top right quadrant of the performance box below, not the bottom left.
Being good on one side and bad on the other is ok. That may be, as the managers tell you, by design. So take this ‘Lonely Mountain’ pattern as the chance it is. Take it as an opportunity to review the alternatives in your portfolio and see where they land in the performance box. Or call us at 855-726-0060 and we’ll do it for you. That’s what we’re here for, after all. And bonus – we just happen to know who the guys are in the top right corner, as well.