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CTAs Ask Investors to Be Patient

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A 9-sigma drop in the SG CTA index on March 13, 2022, coincided with a 10-sigma rise in the 2-year U.S. T-Note and caused significant losses to some managed futures CTAs.

The SG CTA index is down about 5.3% year-to-date and about 12% below the 2022 highs.

After a lost decade with flat performance from 2009 to 2019, managed futures CTAS had their best year in 2022, due to a combination of random events: a pandemic and the supply shock that followed. The index gained 20.2% in 2022.

Last week, another random event related to the collapse of a regional bank caused a flight to quality, and some CTAs were caught short on the 2-Year Note. Based on the data we have since 1990, there was a 10-sigma event in the 2-Year Note futures of more than a full point.

Continuous backadjusted 2-Year Note Futures. Source: Norgate Data

The extreme change in prices on March 13, 2022, caused an extreme drop in the SG CTA Index of 4.5%, or a 9-sigma event based on the available sample since 2000.

All this boils down to the fact that investors in managed futures near the top of last year are down about 12% this year. Although drawdowns are frequent with all trading strategies, passive or active, and with all allocations, strategic or tactical, an attempt to blame investor behavior for the losses avoids dealing with the main problem, which is the fact that most CTAs use relatively the same simple strategies that chase market outliers. When there is a significant reversal in the markets, losses can accumulate fast, and when there are no outliers, you get those long periods of flat returns, as during the Lost Decade.

Blaming investor herd behavior is not a good excuse. At the same time, CTAs maintain a low to no correlation with equities and have the potential of providing convexity during bear markets. The CTA programs may provide diversification to capital preservation strategies, but it appears they have lost their absolute alpha generation potential after the 1990s and especially after 2008. Obviously, not all CTAs are the same, and indices conceal the high dispersion due to different programs. However, identifying the CTA program that will outperform in a year is equivalent to identifying a stock that will generate large returns: it is all about the speculation of chasing outliers.

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