Sunday, January 17, 2010

The End of Trend Following

After a period of underperformance, trend following CTAs are under the gun again. See the WSJ and their article "Is the Black Box Broken?"

The End of Trend Following

A “black box” trading program called AHL helped Man Group become the biggest hedge-fund group in the world. But the fortunes of both its AHL flagship fund and Man itself have taken a turn for the worse.

AHL lost 16.9% last year as unpredictable market shifts hurt its computer-generated bets on managed futures. That was far worse than an average 4.7% loss at managed futures funds tracked by BarclayHedge Ltd., and has sparked concern that the black box could be broken.

If it were, Man Group could expect its assets to shrink even further from the $79.5 billion it had in June 2008 to $42.4 billion now. Many of its products, including structured notes popular with Japanese and Australian investors, are linked to AHL’s performance, and future sales rest on the $22 billion fund’s revival.

AHL’s decline also means the company doesn’t collect the hefty performance fees it gets when the fund is doing well.

In the three months to Dec. 31, Man lost about $1.2 billion in assets from the poor performance at AHL and some of its other funds, helping to spark a 6% decline in its shares today.

Analysts say the box probably isn’t really broken, just a victim of sharp swings last year in stock, bond, currency and metals markets that were hard to keep up with. The company is looking to other areas of its business for growth, though, aware that its sales pipeline is already damaged by the underperformance.

One bright spot in Man’s fiscal third-quarter trading update points to the future: managed accounts. A major pension fund is giving the group up to $1 billion over three years to put into managed accounts, a format that is increasingly popular with investors because it lets them control the cash they put in hedge-fund strategies.

After the Madoff scandal and the common practice throughout the financial crisis of hedge funds slamming down “gates” and refusing to immediately meet investors’ redemption requests, industry analysts say managed accounts can only gain more traction.

It’s a business Man has been in for 12 years but it’s only now picking up steam. At Dec. 31, it had $7.3 billion in managed accounts, compared to $4.1 billion nine months ago.

The black box won’t stop being Man’s earnings driver any time soon, but it’s encouraging to know the company has some sure bets in the mix.

This reminds me of Merrill Lynch's decision to pull $600 million in assets from John W. Henry right at the bottom of a drawdown.

May 29 (Bloomberg) -- John W. Henry & Co., a U.S. investment firm that's performed badly for more than a year, will lose $600 million from Merrill Lynch & Co. this week, leaving it with $500 million under management, the Wall Street Journal said in its ``Heard on the Street'' column. Only a year ago, the Florida-based firm, founded and led by the man who also owns the Boston Red Sox baseball team, managed more than $2.5 billion, the newspaper said. John Henry's biggest investment fund, the Strategic Allocation Program, has dropped 24 percent in the past year and more than 9 percent so far in 2007; six other programs have fallen more than 20 percent, the Journal said. Henry is a so-called trend follower, who gambles on significant market moves continuing; however, limited volatility and a dearth of prolonged trends have hurt him badly, the newspaper said. The firm has had talks about affiliating with another investment manager, but no transaction is imminent, the Journal said, citing a person close to the matter; Henry, meanwhile, says he has no plans to abandon the trend-following strategy or to close the firm, the Journal added.

JWH went on to produce a 78% return in 2008 following Merrill's "wise" decision.

Trend Following has these cycles of drawdown where journalists and analysts declare trend following dead. I declared in August of 2008 that it was time to invest in CTAs following large drawdowns at several CTAs. 2008 ended up being one of the best years in the history of managed futures. I would argue that we are seeing this type of sentiment again and that investing in CTAs and trend following companies is as good a value as any other investment today.

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