Original post:
I am having great difficulty with the idea that hedge funds couldn't find a way to make money, more after the jump.
From The Economist, November 30:
Hedge funds looking to spot and ride market trends are hoping for a fresh start
IF SOMETHING has not worked for five years, most people would conclude that it was broken. Tell that to the geeks managing “quant” hedge funds, who craft elaborate algorithms to profit from market movements. Once money-spinners, their prized formulae have misfired since 2009, losing money in four of the past five years. Unless their results improve markedly, the giant funds will finish this year as the worst-performing of the most common hedge-fund strategies.HT: Business Insider
“Trend-following” involves programming computers to analyse market movements and try to infer where they might go next. Practitioners speak with reverence of “crossover levels” and “momentum speeds” leading to “breakout points”. A rough translation is that a trend that lasts a few days or weeks can profitably be invested in until it reverses, at which point a new trend may already be forming. Whether the markets are going up or down does not matter. Nor does the underlying asset being analysed—typically a futures contract linked to a commodity or a security.
After prospering through the market rout of 2008 (the prolonged slump gave even the dimmest trend-follower time to cotton on), the sector swelled from $91 billion to $215 billion, according to Hedge Fund Research, a data provider. Winton Capital, Man Group’s AHL fund, Cantab, BlueCrest and other “black box” traders, as their critics dub them, became darlings of the investing world. Unfortunately, the influx of investment coincided with the reversal in the strategy’s fortunes (see chart).
The main problem is not with the quants’ models, practitioners insist, but with the markets themselves. In the aftermath of the financial crisis, they have been dancing to the tune set by politicians and central bankers. Efforts to save the euro or stave off deflation regularly send markets into convulsions, in the process distorting the historical patterns that the algorithms are designed to exploit. The ensuing jolts and crashes have no precedent, leaving even the most finely crafted trade at risk from political meddling. Not even the world’s wiliest supercomputers can predict what the European Central Bank will dream of next, apparently.
Worse, such interference prompts stocks, bonds and commodities to move in unison. When in May the Federal Reserve hinted at a “tapering” of America’s ultra-loose monetary policy, for example, both government bonds and shares tumbled. What had started out as a good year for the trend-followers turned into a drubbing. One of the sector’s main selling-points, that its returns are uncorrelated to those of other asset classes, is at risk....MORE
The bolded bit points up one of the failures of the fund managers.
They get paid to figure out the intertemporal arbitrage, a fancy way of saying the task at hand is to understand the time period that gives the fund the greatest advantage versus the market.
The classic example is the individual investor realizing that he can't compete with HFT and looking at longer than nanosecond time periods. This opens up the possibility of not just not-competing with the traders with the lowest latency but of taking advantage of mispricings caused by their behavior. This is exemplified by one of Buffett's baseball metaphors (he has quite a few):
In investments, there's no such thing as a called strike. You can stand there at the plate and the pitcher can throw a ball right down the middle; and if it's General Motors at 47 and you don't know enough to decide on General Motors at 47, you let it go right on by and no one's going to call a strike. The only way you can have a strike is to swing and miss.The point is, you don't have to be at the market every second You are afforded the luxury of just waiting for the perfect pitch.
Now for a fund manager it get's tricky writing the quarterly report and saying "We didn't do much in Q3, we're waiting for Mr. Market to give us the high hanging curve ball" but if you've been honest with the investors that the tactic you've pulled from the toolbox is akin to the military's hurry-up-and-wait sense of time it is doable.
As a side note anyone who considers a move that is measured in weeks to be a trend is nuts. A trend is John Templeton going into the Japanese markets at 2 times earnings and catching a 40-fold move 1965-1989.
To quote myself for the second time in two days, from October's "Commodity hedge funds face bleak future":
The thing I don't get about these whiny little commod (no 'e', yet) artists is the apparent failure to understand the words hedge or macro.See also yesterday's:
Dudes, you can go long or short. And do it in multiple, disparate commodities anywhere in the world.
Unless of course the folks who were proclaiming commodities an asset class were simply full of it and were nothing more than longside trend followers charging alpha sized 2-and-20 for what was actually leveraged beta....
How to Make Big Money in Small Markets: Commodities
Small that is compared to forex or treasuries.In the recent past it was the two year decline in precious metals or the one year decline in corn that allowed folks with a feel for this stuff to recalibrate the computers and get some bets down.
There is no magic secret, just bet the multi-year trends and be right....
...The directional trade for most commodities has been down for at least two years so price action alone would have guided you....
As for the "move in unison" excuse, here's the S&P 500 ETF vs the gold ETF over the last 365 days:
Correlated markets my ass.
See also:
AQR--"Demystifying Managed Futures" (Returns and Anomalies)
UPDATED--Cliff Asness' AQR Capital: A Century of Evidence on Trend-Following Investing; Since 1903
UPDATE--More on "A Century of Evidence on Trend-Following Investing
