Quantitative funds, known for capitalizing on market momentum, are currently facing significant setbacks as their bets across various asset classes reverse sharply.
Entering July, these trend-following funds were heavily invested in major market trends: increasing equity positions, shorting developed-nation government bonds, and betting on a weakening yen, according to Societe Generale SA.
However, these markets experienced abrupt reversals, leading to substantial losses for these funds. One broad measure indicates that nearly all gains made this year have been erased.
“Everything went wrong simultaneously,” remarked Andrew Beer, founder of Dynamic Beta Investments. His iMGP DBi Managed Futures Strategy ETF has dropped about 7% in August, reducing its annual return to approximately 5%. “This is a classic cross-asset reversal,” Beer added, noting that many funds have relinquished between half and three-quarters of their year-to-date gains in recent weeks.
This turn of events highlights the risks inherent in a strategy that thrived during recent market stability but now contributes to increased volatility as investors unwind crowded trades. The trend-chasing approach, naturally susceptible to rapid sentiment shifts, had benefited for months as the US economy defied Federal Reserve rate hikes, AI optimism propelled stock markets, and the yen depreciated under the Bank of Japan’s accommodative policies. However, this strategy was disrupted as the yen appreciated, the BOJ raised rates, and concerns over the US job market sparked recession fears.
Despite a partial recovery from Monday’s downturn, these developments have significantly impacted returns. The Societe Generale CTA Index, which tracks these funds, showed a stark reduction from a 12% gain at the end of April to just 0.2% for 2024.
“The growth and interest-rate outlook repricing at the end of June, along with recent US economic concerns, triggered a sharp reversal,” explained Sandrine Ungari, head of cross-asset quant research at Societe Generale. “Strong early-year performance was driven by rising equity and commodity prices.”
Commodity trading advisers (CTAs), a diversified group within the quant fund space, typically leverage momentum across futures markets to capture collective market wisdom. Those with long- and mid-term investment horizons have suffered the most in the recent upheaval, according to Beer. Short-term funds, focusing on trends over a few days, have only declined by 2.7% since April’s end, compared to a 10.4% drop for the broader cohort, based on the SocGen index.
Systematic funds have been compelled to sell equities and purchase bonds rapidly during this market turmoil, likely intensifying the market movements. Nomura Securities International analysis revealed that these funds have offloaded $61 billion in global equities and acquired $205 billion in bonds from major developed nations in just the past two weeks.
Although market volatility eased on Tuesday and Wednesday, the recent turbulence exposes vulnerabilities in the Wall Street consensus and poses challenges for funds attempting to capitalize on clear market trends.
“By definition, they need trend,” stated Charlie McElligott, cross-asset strategist at Nomura. “They are built to profit from clear trend breaks, but choppy trend reversal markets reduce their opportunity set.”
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