Mark Rzepczynski, Author at IASG

There has been a strong move to passive investing tied to benchmarks by investors. The reasons for this movement are threefold. One, passive benchmark investing is cheaper than active management. Two, active management has often underperformed benchmarks. Three, passive investing provides transparency on what will be in the portfolio. Nevertheless, a survey of defined benefit consultants suggest that the choice between active and passive management is not obvious and actually asset class specific. There are some areas where consultants view that active management is important while other areas the focus is for passive investing.

A recently published Fidelity Global Institutional Investor survey suggests that more asset allocation changes will be made in the next one to two years than shown in their last two surveys in 2012 and 2014. This survey anticipates what we are all thinking – it is a new investment world with a Fed becoming more aggressive and the politics of populism sweeping many countries. The post-crisis investment world of boundless liquidity and asset performance catch-up has ended. We are entering a new period of two-way market views. There is more uncertainty on market direction so we are likely to see more divergences in asset allocation.

When asked about the top concerns for investing in their portfolios, the three top answers were all boar performance; what is past performance of an asset class, what is the expected return from an asset class, and where has there been success and failure with investments. Perhaps performance is always the top issue in the minds of managers, but the survey highlights particular focus during this period of transition.

A review of all sectors shows some clear themes across asset classes. Bonds are out of favor and US equities are preferred. International equities and bonds reflect repricing of rates and currencies while still showing lower global growth.

Key financial market trends show continuation as we enter December. Down trends in bonds and rates may show some weakening after the strong moves in November, but there are few signs of reversals. Dollar strengthening is linked to the bond moves based on expectation of increased US growth and Fed action. Energy markets show a strong uptrend on announced OPEC production cuts. The US equity rally post-election is slowing. This stock rally never occurred in global markets. There are limited trend opportunities in precious metals and slowing trends in base metals. Commodity markets are mixed based on large dispersion in supply and demand conditions.

A US equity rally after the election and a major bond sell-off highlighted the month for traditional assets. Many hedge fund strategies were able to exploit these moves and generated gains especially in fundamental value, market directional and relative value strategies. The big losers were fundamental growth and emerging markets. Global macro and CTA strategies also generated loses for the month.

A large sell-offs in bonds both domestically and around the world, a strong US equity move, and a strong dollar trend that changed perceptions on currencies, did not create an environment where managed futures were able to generate positive returns. I don’t want to be accused of hindsight bias, but a review of price trends in bonds and the dollar going into the election suggested that post-election moves, while extended, were not inconsistent with longer-term trends. Still, an early review suggests that there have been some major winners in this space who will end the year with strong positive gains. Careful CTA manager selection has meant the difference between success and failure in 2016.

For those who had a “safe” portfolio skewed to bonds before the election, it was a disaster month. For those who were stock-pickers in value and small cap, it was a dream market. The return differential between bonds (TLT) and value (IWN) was more than 20% in one month. Call it a “Trump Rally / Trump Bond Sell-off”, but the financial world changed beyond politics. This sound bite story may be getting old, but there is a lot going on in markets beyond being long stocks and short bonds.

CTA Intelligence reported the top 50 CTA’s as of September 2016 and provided some good graphics on the names and the changes over the last year. Taking a closer look at the data from the perspective of market structure and industrial organization provides some additional insights on the managed futures industry. We will focus the discussion on the top 50 managers because these are the ones that will receive the most interest from institutional investors. We can call this the relevant market.

“I made my fortune by selling too early”, a quote from Baron Rothschild used for an investment game by John Hussman. John Hussman has invented a game called “Baron Rothschild” as a teaching tool which is based on a simple process of drawing returns from a set of cards The sequence of cards can generate a performance record. Think of this as a form of Monet Carlo simulation from a return distribution. The player can call stop after any number of picks or he can continue to pull return cards to compound his performance.

There are fads and fashions in finance and business. Some statistical techniques come and go in and out of favor based on expectations of success and the realization that some tools just cannot solve certain problems. Data mining in now a hot topic in many areas of business, yet there are not clear definitions of what data mining means, what tools it represents, and how it can solve problems. Clearly, the low cost of computing and storage has made the collection of data much easier, but the problem is not with the data. The issue is how you extract the data “ore”, how it is processed, and what you do with it once it is modeled.

Being on both side of the table concerning the due diligence of managers, I can argue that there has been a significant improvement with the skill at conducting operational due diligence. Operational risks can be effectively identified and measured. There will be fund failures, but investors can do a good reasonable job of handicapping firm-specific risk. There are checklist and processes that can support the choice of managers. The operational due diligence has been effectively institutionalized.