One Analyst Suggests CTAs Face Existential Crisis After February Quant Quake

I don’t know this for sure, but I’d be inclined to think that the quant community would be just fine with it if JPMorgan would go a day or two without weighing in on what happened earlier this month to CTAs, risk parity, and other systematic strats.

To be sure, the commentary hasn’t been all bad and indeed, both Marko Kolanovic and Nikolaos Panigirtzoglou have taken the lead when it comes to suggesting that the forced deleveraging from the programmatic crowd is likely out of the way. For instance, in his latest piece, Kolanovic noted that according to his models, “volatility targeting strategies may now start very slowly rebuilding their equity positions.”

For his part, Panigirtzoglou might well have helped supercharge the late afternoon rally on Friday, February 9, that set the stage for the best week for U.S. equities since 2013, with a note that for all intents and purposes gave the all-clear on the CTA/risk parity unwind.

All in all, I’d say JPM’s coverage has been pretty balanced. Still, I think it’s entirely fair to say that the quant community doesn’t much care for the attention. If you follow that crowd, you know they’re not big on the idea that “all publicity is good publicity” and to be sure, a lot of the publicity they get tends to be of the negative variety. Simply put, lots of folks like to point fingers after acute risk-off episodes because, well, honestly because when you’re running rules-based strategies, it stands to reason that people will ask you if you might have sold indiscriminately.

So that brings us to Panigirtzoglou’s latest piece which finds Nikolaos asking simply this: “[Is] this a turning point for CTAs?”

First, he notes that “the struggle by CTAs to recover from the recent slump is reflected in their recent performance [as] despite the market rebound, less than one third of the previous drawdown has been recaptured over the past two weeks.”

You might recall that on February 8, we posted something called “Did ‘The Market’s Boogeymen’ Just Suffer Their Worst 5-Day Loss On Record?” Here was the chart that accompanied that post:

We wrote that on the evening of Thursday, February 8, and that chart did not include that day’s action. Of course that day saw the Dow plunge 1,000+ points for the second time in four sessions. Well here are the numbers for that full week via Panigirtzoglou:

Pure Trend Following CTAs, which lost almost 11% in the week ending Feb 8th. This 11% is the second highest recorded weekly loss since the 12% Pure Trend Following CTAs lost in the week ending 5th March 2007. For overall CTAs though, the weekly loss of 8% in the week ending Feb 8th is the worst weekly loss ever recorded since data began in 2000 (Figure 2).

Then Panigirtzoglou starts to ask some tough questions about CTAs. Specifically, he notes that “abrupt de-risking and severe underperformance is raising questions about the future of the CTA universe as it compounds a previous two-year trend of already significant underperformance.”

That underperformance actually doesn’t look very notable on a longer-term chart, but suffice to say that since the end of January 2016, CTAs have lost 3.7% compared to a 19.5% gain for the overall HF universe.

Next, he basically posits an existential crisis. To wit:

But the most recent underperformance during February is more problematic for the CTA universe because it casts doubt on the idea that Quant funds such as CTAs exhibit higher convexity and lower beta during market corrections. In other words, it casts doubts on the idea that during market corrections, Quant funds such as CTAs tend to outperform as their drawdowns are contained. In fact, the opposite happened during February’s correction. In our mind, February’s correction shows that CTAs can become victims of even modest profit taking when momentum or trend following signals become too strong and momentum positions become too crowded.

Hmmmm. Finally, he connects the dots by suggesting that institutional investors and sovereign wealth funds might decide to simply pull their money, which could cause CTA’s share of the hedge fund universe to contract.

Panigirtzoglou’s assessment of that visual reads as follows:

At 9.2% currently, the share of CTAs in the total HF universe appears to be downshifting and a return to the 2014 lows seems more likely than not.

I’m sure the quant crowd would contest a lot of that, especially the part about February casting doubt on the viability of the model.

Be that as it may, the numbers are the numbers – and no one knows that better than a quant.

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