Trend-followers’ fallout ensnares Winton Capital

by | February 7, 2018 4:34 pm



Trend-following quantitative hedge funds were among the biggest victims of the current market turmoil, wiping out much of their 2018 gains in two torrid days of trading and undercutting their status as risk-mitigation tools.

Surging global share prices during January lured in more money from computer-driven hedge funds that ride market momentum, but the sudden eruption of volatility triggered abrupt losses for many of the industry’s biggest players.

“The rally had accelerated, and we kind of knew an accident would happen, but it’s never pretty when it does,” said David Harding, the head of Winton Capital, one of the biggest such funds in the industry. “We’ve had a couple of painfully bad days . . . This will go down as one of the weeks one remembers.”

Mr Harding said Winton’s funds were down 3 per cent to 4 per cent over Monday and Tuesday, their worst short-term performance in five years, according to the hedge fund manager. Yet Winton’s funds use relatively little leverage and the pain is likely to have been more intense elsewhere.

A Société Générale index indicated that trend-following funds lost 1.4 per cent on Monday, extending their tumble since late January to nearly 5 per cent. Even this may understate the damage, given that many European funds closed their books before the US turmoil worsened late on Monday, and for them Tuesday could have been even worse.

“The last two days have been pretty uncomfortable for us and a few other people,” said one European hedge fund manager, who declined to be named. He estimated that most trend-followers would be down 4 per cent to 10 per cent over the week, depending how much leverage they used.

Trend-followers, often called commodity-trading advisers after their US regulatory label, ride the waves of markets using sophisticated computer models and automated trading strategies. They did particularly well during the financial crisis when they surfed the downward trend in stocks and the rally in bonds.

Billions of dollars of institutional investor money has flowed into CTAs in recent years because they are viewed as a good ballast for a portfolio at times of stress. But even some industry insiders — most prominently Mr Harding at Winton — have argued that is a fallacy.

The jarring performance of most trend-followers over the past week “serves to remind us that using CTAs to hedge against market moves is a bad idea”, he said. “I’ve said it a million times . . . In a long bear market it is a hedge, but in a crash it is not.”
Indeed, some analysts argue that trend-followers worsened the recent sell-off, because most use some kind of “volatility target” as a risk-management tool. When volatility is low they tend to add to their exposure, and when it resurfaces they sell down — potentially worsening pressures on an already falling market.

One trend-following fund executive admitted its stock market exposure had been sliced by almost a third over the past week, while analysts at Bank of America and JPMorgan estimate that the turbulence would have been enough to trigger roughly $200bn of equity selling. However, the CTA industry argues that their de-risking is far too modest and gradual to rock global markets.

“People always want to blame the quants,” the European hedge fund manager said. “But if you’re always buying and selling on market choppiness then you’d be killed by the trading costs.”

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