smn Investment Services
After years of bullish markets around the globe combined with a constant decrease in volatility, some spice has come back to global markets recently. Be it the bursting bubble in China, the endless story about Greek debt or maybe the epiphany that printed money will never be able to change anything in the real world. In the end it will not make a difference to find out the trigger for the turnaround, but at some point investors will again have to face the fact that every bull market comes to an end at some point. But how to react?
In past crises there was one hedge fund strategy that really proved reliable: Managed Futures/CTAs. In the downturn of 2008 these mostly systematic strategies showed great results. The ability to benefit from rising and falling markets helped a lot in such environment with strong trends. Since then CTAs have lost a lot of their reputation. The decrease in volatility and the invisible hand of central bankers created a long, difficult environment for these strategies – and at the same time a perfect environment for other strategies, that are so much easier to explain and to feel comfortable with.
In the current scenario people may re-assess further return potential in most asset classes, and some investors do remember CTAs. This strategy is not depending on the continuing rise of equity markets nor on a further decrease in interest rates. Attractive uncorrelated returns can be generated by following market trends. Sounds good, and for sure it is a perfect diversifier in every portfolio, your risk model will like it. But there is one big BUT: be careful as these instruments are regarded as BLACK BOXES.
It is easy to understand the reservation of investors to trust their funds to computer algorithms rather than investing with an experienced fund manager. But are these fears rational? Are systematic trading models really to be regarded as black boxes or aren´t they even easier to understand than a human being, because models act completely rational? There is clear evidence that computers are a lot better than humans when it comes to pure routine jobs.
Reacting on market movements and patterns is a routine job. Definitely it is important to have a diligent look at the people who set up these rules and programmed the computers before giving money to a systematic trading system. But if the mechanism and general philosophy can be outlined to the investor, it is easy to understand the positioning and the results of a system in certain market situations. You can even get evidence by looking at the track record of the strategy in a certain market environment. If this proves consistent with the functionality of the trading model, the system will definitely act similar in a similar situation in the future. Is this also the case with a discretionary trader? I have my doubts.
If such a trader believed that it was good to always act along a given set of rules, he would rather set up his own system. If he does not believe in the merits of such discipline, he might apply a good portion of flexibility to add value through trading talent and experience. To me this is the real black box approach to investing.