Hedge funds that use powerful computers to run their portfolios are making huge profits in this year’s market turmoil, marking a resurgence for a sector trying to recover from a long stretch of weak performance.
Trend-following hedge funds, which use mathematical models to try to predict market movements, had struggled for years in an era dominated by central bank bond-buying — a stimulus tool that suppressed much of the volatility on which they thrive. But the $337bn industry is now making its biggest gains since the 2008 financial crisis, according to data provider HFR.
These quantitative funds have profited in particular from bets against government bonds, which have been shaken by expectations that the Federal Reserve will keep raising interest rates aggressively to fight high inflation.
They have also capitalised on a surge in energy and commodity prices, fuelled by supply chain bottlenecks and Russia’s invasion of Ukraine.
“Now is one of those 2008 moments where everyone [in trend-following] is doing well again. The trends are clearer”, said Leda Braga, founder of Systematica Investments and former head of systematic trading at BlueCrest.
“The one underlying theme has been the end of the benign decade we’ve experienced”, added Braga, whose BlueTrend fund is up 26 per cent so far in 2022, its best performance in 14 years. “Now there’s more volatility.”
Among the winners lies BH-DG Systematic, a joint venture between David Gorton and hedge fund Brevan Howard. It has gained 32 per cent so far this year. Aspect Capital, co-founded by Martin Lueck, one of the three original founders of Man Group’s AHL unit, has gained 29.2 per cent in its Diversified fund, its second-best calendar year since launch in 1999.
Such quantitative funds on average gained 15.1 per cent in the first four months of the year, according to HFR data, ranking them as the best-performing category of hedge fund during a period in which many big-name managers posted double digit losses and the S&P 500 dropped 13 per cent. The hedge fund industry overall is down 1.9 per cent for four months to end of April.
These quant funds — also known as managed futures funds — can make money from latching on to persistent price trends in both rising and falling markets, which has often allowed them to profit during periods of market stress. In 2008, for instance, they profited from both a steep rise and then a subsequent collapse in oil prices, and from a rapid sell-off in equities as the financial crisis reached its nadir.
This year’s sharp upturn in performance comes after years of often-lacklustre returns, with trend followers losing money in the six of the eight calendar years between 2011 and 2018, according to HFR. The period after 2010 “was a dead decade” for trend-followers, said one senior industry executive.
The wait for a comeback proved too long for some funds. Billionaire David Harding, another former co-founder of AHL who set up quant firm Winton in the 1990s, caused controversy in the sector several years ago when he moved his main fund away from trend-following, arguing that the strategy did not make enough to justify running a big hedge fund.
“It was impossible to raise money then” after Harding’s move, said one fund manager who continued to back trend-following. GSA Capital last year shut its Trend fund after finding that meeting the fund’s investors had become a distraction for its researchers.
However, a steep acceleration in US inflation last year, initially underestimated by central bankers, has catalysed interest rates rises and the withdrawal of quantitative easing. That has removed a support for asset prices in traditional markets, sending bonds and equities tumbling.
“Central banks have to focus on fighting inflation despite the cost to asset prices,” said Philippe Jordan, president of Paris-based quant hedge fund firm CFM, whose IST trend fund is up 16.5 per cent this year. “This is a positive backdrop for trend because it creates momentum”.
The 10-year US Treasury yield has risen from 1.51 per cent to a peak of 3.2 per cent this year, while the Bund yield, which turned negative in 2019, has jumped from minus 0.18 per cent to as high as 1.19 per cent. Yields move in the opposite direction of prices.
“If you look at the German 10-year, there’s been a staggering move for something that’s been doing absolutely nothing for a long time,” said Kenneth Tropin, chair of Connecticut-based Graham Capital, whose K415 fund is up 41.7 per cent this year, while the Tactical Trend fund has gained 33.4 per cent.
“Given what’s happened in rates, commodities and currencies, managed futures funds are like pigs in mud,” said Andrew Beer, managing member at US investment firm Dynamic Beta Investments, whose DBMF fund is up 22.4 per cent this year.
After a relatively lean period for the sector, managers now think the change in market regime means trends could last for some time.
“The change in inflationary expectations feels like a large barge and is going to take time to turn around,” said Systematica’s Braga, pointing to decarbonisation and changes in supply chains as inflationary forces. “It seems to be a longer cycle ahead and I suspect trends will persist for a while.”