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The idea that hedge funds are getting 2/20 for management fees is becoming a myth. Dynamic pricing is being used more aggressively by hedge funds with a wide range of management and incentive fee options. For example, in the managed futures space, there seems to be a willingness to offer beta products as low-cost alternatives as well as traditional alpha plus beta products. The low cost products are being marketed as trend-following beta at low cost while higher priced products are being offered as alpha generators relative to trend-following beta. Of course, there is not a clear definition for what is trend-following beta so there is something more going on with this pricing. (The beta may be associated with a peer index, so the beta firms offer a low cost product to match a bundle of competitors.) This approach is being used by a number of larger firms.

We have learned from behavior finance that one of the key thing that investors do not want to suffer from is regret. From prospect theory, there is a desire to sell winners and hang onto losers in order to avoid regret not suffer from loss aversion. Loss aversion tied everywhere to the decisions we make. Picking the wrong manager. Picking the wrong strategy. Picking the wrong time to enter or exit a trade. Investors do want to make a decision only to find out that ex post it was a poor one.

It is hard to determine whether one manager is better than another when looking at performance numbers. The sample sizes are often too small to distinguish return differences, so investors often looking for other signals that can be used to suggests one manager is better. One that is often used is growth of AUM. Call it the “wisdom of crowds” signal. If an investor cannot distinguish the return performance between two managers, he will place weight on the dollar opinion of others. If the herd is investing in manager X, perhaps they know something that others don’t. The investor will free ride on the due diligence of others and invest with the manager who is growing faster.

Consistency is critical for any investment style or factor, and it seems that trend-following seems to show it better than most other alternative strategies. It is now almost amusing that when efficient markets ran supreme as the paradigm of choice for market behavior no one was able to find these results, but now that there […]

What is needed is volatility coupled with price trends, which Ivarsson refers to as “directional volatility”. “What we at RPM look for is ‘directional volatility’, meaning volatility that drives markets in a certain direction”. – RPM’s executive Vice President Per Ivarsson

The concept of directional volatility is elusive. It combines two concepts, the path of prices with the price spread away from the average. The quote is focused on the critical need for a trend with volatility for trend-follower to profit. Volatility is necessary but not sufficient for strong trend-following profits. It is necessary to have prices move across a range in a discernible path, but a wide price range can still be without trends. Trends may occur if there is low volatility but the level of profits will be smaller and the trends will be harder to identify.

The depiction of trend following as a look-back straddle is based on volatility and the ability of the trend follow to capture the range. The look-back option is the potential max that a trend follower may achieve for a single trade within a time span. Nevertheless, if we think of a stochastic process for a price series, we want a mean change plus wide dispersion. It is not enough to just have volatility, the journey expressed in the volatility is critical.

Don’t worry, be happy and without stress. The ECB Composite Index of Systematic Stress (CISS) measures declining stress in the EU. While there is a big disclaimer with the ECB risk dashboard that this is not an early warning system, the declining trend tells a story of stability. This index serves as a European equivalent […]

Most stocks do not do well over their lifetime. If you randomly pick a stock or set of stocks there is a high likelihood you will not do better than T-bills and you will likely not survive for a long time. This should be well-known, but a new research paper really present some stark conclusions. This is a paper that is insightful and sobering for most investors. See “Do stocks Outperform Treasury Bills” by Hendrik Bessembinder.

The equity focused HFR hedge fund indices produced positive returns for the month of June while those indices focused on broad-based macro trades declined. Equity focused hedge fund managers will often do better when there is more dispersion across industry sectors and when there is stronger performance in broader-based indices like the Russell 2000. The market saw strong gains in both growth and value indices and less emphasis on large cap names. The fall in tech stocks which have been at elevated levels may also have been a contributor to some hedge fund gains.

The managed futures index from SocGen was down over 2% for the month with price declines in many major financial markets over the last week. Similar performance has been found with other indices; however, those managers with more commodity diversification have fared better.

Trend traders were hit with a number of significant reversals in major asset classes near the end of the month. Bonds were rocked with a possible ECB “taper tantrum” albeit it is early to say that this will be like what was seen in the US. No two market tantrums will ever be the same. Equities are in a trend decline in Europe and the US has started to trend lower although the month still generated positive gains for many investors. There is an equity rotation away from large cap indices, but it is hard to take advantage of in futures. The dollar also trended lower near the end of the month only to see some gains in the last two trading sessions. Many commodities moved higher on weaker supply reports and oil products has bounced off the declines from the past few weeks. Last week was the major reversal period.