Oil Shock Lashes Trend-Following Quants as ‘All Trades Backfire’
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Monday’s oil spike blindsided many investors, but in one corner of quant land the fallout was particularly punishing.
Systematic investors known as commodity trading advisors, whose strategies track price trends across assets, held record short positions in oil and gas futures before a drone strike in Saudi Arabia sent shockwaves through global markets, according to JPMorgan Chase & Co.
Brent futures soared by the most since the first Gulf War in the attack’s wake, before settling just above $69 a barrel.
The record surge is merely the latest domino to fall in a miserable month for CTAs, according to Nomura, after rising bond yields hit returns last week. The SG CTA index fell for a seventh day in eight on Sept. 13, putting it on track for its fourth-worst month this century.
“CTAs have seen essentially all of their trades backfire, what with the mass unwinding of bearish trades and the momentum crash in bond futures since the beginning of the month, along with the surge in the price of crude oil yesterday,” Masanari Takada, cross-asset strategist at Nomura, wrote in a note to clients. Even in comparison with other major hedge fund strategies, the performance of CTAs “has deteriorated remarkably,” he said.
The question isn’t why trend-followers missed oil’s record one-day spike — the commodity has been trading sideways for months — but whether the rally will be solid enough to lure the fast money onto the bandwagon.
Strategists at JPMorgan say that’s likely to happen, which could further juice prices. “A similar contract uplift can occur once signals for the energy futures trend turns positive,” Marko Kolanovic and Bram Kaplan wrote in a note.
Oil and gas contracts have soared through key moving averages, a sign there will be “significant short covering” by CTAs, they wrote. From a macroeconomic perspective, geopolitical tensions in the Middle East and recent progress in U.S.-China trade talks should add tailwinds.
TD Securities strategists led by Bart Melek also say CTAs are likely to ramp up bets on Brent and WTI futures now that the contracts have breached estimated trigger levels.
The sudden market gyrations further threaten what was shaping up to be a pretty good year for trend-chasing quants. The SG CTA Index was up 12% going into September, when the worst week for government bonds in nearly three years punished the cohort’s long positions in sovereign debt.
Oil’s abrupt reversal has been particularly cruel. Both the SG CTA Index’s beta to crude — or the portion of returns attributable to it — and official positioning data show trend-followers and macro hedge funds were betting against the commodity, according to JPMorgan.
Of course, thanks to 2019’s spirited stock and bond rally, trend-followers are still up 7% this year. Societe Generale’s index tracks a basket of 20 funds.
Further declines in government bonds sparked by Wednesday’s Federal Reserve meeting could spell more trouble for the group, though.
“If the Fed were indeed to take a hawkish turn, the situation would be nightmarish for CTAs,” said Nomura’s Takada.
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