AHL DIVERSIFIED PROGRAMME 2014 REVIEW AND OUTLOOK

Transcription

1 AHL DIVERSIFIED PROGRAMME 2014 REVIEW AND OUTLOOK For investment professionals only. Not for public distribution. EXECUTIVE SUMMARY The AHL Diversified Programme returned 34%1 in the calendar year 2014, outperforming trend-following benchmarks which themselves outperformed the majority of asset classes and hedge fund styles. Falling levels of correlation have been beneficial for the industry, meaning that there are many opportunities to capture different trends. The AHL Diversified Programme s outperformance has stemmed from maintaining its trading style and allocations, adding new markets and from new research. Strong trends were captured in fixed income, currency, and commodity markets, but were hard to find in equity trading. With correlations continuing to fall and a pick-up in trends at the instrument level, the conditions for trend following in 2015 are arguably better than these in Instead, in light of very strong rises in both equities and fixed income assets in recent years, we would argue that AHL s enviable track record, low correlation to other asset classes, and insurance-like characteristics make it a valuable part of a client portfolio. WHAT A DIFFERENCE A YEAR MAKES Figure 2: Correlation4 between instruments typically traded by CTAs rose significantly post Credit Crisis of 8, coinciding with periods of political and central bank intervention. Since 2013, however, correlations have markedly declined, and are approaching pre-crisis levels. Figure 1: 2014 A great year for trend followers2. Average 1-y pairwise correlation 6 Trend followers have had a stellar 2014, trumping returns across the majority of asset classes, and the AHL Diversified Programme has out-performed trend-following benchmarks. In this end-of-year review, we intend to show why the environment is markedly better for trend following strategies, and where AHL s performance has been achieved. Net return Just over a year ago3, we wrote about the performance of trend following strategies post 9 a period where the Newedge Trend Index lost 2% per annum, in stark contrast to the it annualized from 0 to 9. We argued that the blame was at the door of the politicians or central bankers for two key reasons. First, interventions typically caused reversals in market direction, halting trends in their tracks. Second, they caused higher correlations across the instruments traded by trend-following managers. This is seen clearly in Figure 2, below, through the raised correlations between 9 and It is a graphical representation of the risk on, risk off environment of the previous few years when prices have tended to move in unison. Trend followers benefit from low correlations across all the instruments they trade, meaning that trends can be captured in a variety of different places QE1 4 QE2 Ends 7 Draghi Speech 2 QE1 Ends 5 Operation Twist 8 QE3 & QE4 3 QE2 6 ECB LTRO 9 Taper Tantrum AHL Diversified Programme Newedge Trend Index Source: Man database, Newedge, Bloomberg. Global Equities Global Bonds Global Hedge Funds The chart shows how 2014 witnessed a marked decline in correlations across the instruments traded by trend followers; markets are behaving in many different ways and there are more opportunities to capture different trends. This is clearly seen in the sector attributions to the AHL Diversified Programme s 34% 2014 return5 (Figure 3). 1. Past performance is not indicative of future results. Returns may increase or decrease as a result of currency fluctuations. Please note that the performance data is not intended to represent actual past or simulated past performance of an investment product. The data is based on a representative investment product or products that follow the programme. An example fee load of 3% performance fee and management fee has been applied. 2. Global equities represented by MSCI World Net Total Return Index hedged to USD; Global bonds represented by Citigroup World Government Bond Index hedged to USD; Global Hedge Funds by HFRX Global Hedge Fund Index. 3. Stick with Trend Followers, November For a copy, please contact your Man AHL sales representative. 4. Correlation is measured as the average pairwise 1-year correlations of trend-following returns of AHL s futures and FX instruments using current models. 5. Please note that the performance data is not intended to represent actual past or simulated past performance of an investment product. The data is based on a representative investment product or products that follow the programme. An example fee load of 3% performance fee and management fee have been applied. I 1 5

2 Figure 3: AHL Diversified Programme gross attribution in Trends have been captured in the majority of sectors. Gross trading return Fixed Income Currencies Commodities Stocks In the years immediately following the demise of Lehman Brothers, US politicians and central bankers were the primary drivers of fi nancial markets as all major economies sought a response to the crisis. This past year, however, has seen divergence in economic cycles globally refl ected, for example, in differing central bank policies in the US, Europe, China, and Japan. These economic themes have been the primary driver of performance of the best performing sectors, fi xed income and currencies. Europe s stagnation and the prospect of stimulus there have propelled European bond prices higher, particularly those in Italy and France (Figure 4a). This contrasts starkly with the rangebound behaviour and sharp reversals experienced in fi xed income in 2013, when it was the worst performing sector in the AHL Diversifi ed Programme. For currencies, this has manifested itself in falls in the Euro, and additional bouts of Abenomics in Japan has resulted in declines in the Yen. Both have been profi table trades for AHL (Figure 4b). Figure 4: Sample price behaviour, , normalized to 1 return volatility. a) Fixed Income 1 1 German 10y Bond Future French 10y Bond Future Swedish 10y IRS b) Currencies c) Commodities Rouble / USD Yen / USD Euro / USD d) Equities 1 1 DAX Gold Oil S&P Sugar US Energies An additional distinct theme has been the fall in the oil price and Figure 4c illustrates the strong downward trend over the second half of Of course themes manifest themselves in many ways and the decline in the price of oil also had detrimental effects on the currencies of many oil producing economies, most notably the Russian Rouble (Figure 4b). Agricultural commodities performed very strongly given their allocation, with strong upward trends in live cattle because of the structural decline over time in the US herd, and downward trends in sugar (Figure 4c) resulting from strong expectations of the Brazilian crop and also lower energy prices. Gold, on the other hand, was rangebound in 2014, in contrast to the strong downward trend from which AHL profi ted in Gross trading returns. Past performance is not indicative of future results. Returns may increase or decrease as a result of currency fl uctuations. 2 I 5

3 Equities also struggled to maintain a clear direction in Events in Argentina, Syria, and Ukraine have unsettled risk-on assets, with European equity indices in particular being affected (Figure 4d). Nevertheless despite the end of QE, the fi rmer economic footing in the US has resulted in another good year for US stocks, and AHL s index futures trend following systems performed well in that region. In addition, strong trends in the oil price have had knock-on effects in equity markets; AHL s sector trading models benefi tted strongly through being short the US energy sector and long the airline sectors, for example. WHY HAS AHL OUTPERFORMED BENCHMARKS IN 2014? The AHL Diversifi ed Programme returned 34% over the course of This compares to 19% for the Newedge Trend Index. Even accounting for differences in volatility 8, AHL has clearly out-performed. In our view, there are two key reasons for this. First, AHL has not and does not impose discretionary views on its sector allocations. At the start of 2014, with many developed market fi xed income yields at the lows of most people s memories, discretionary traders saw little value. Indeed, with 2013 proving to be a diffi cult year for trend followers in fi xed income, managers could have been forgiven for reducing allocations from the asset class. Yet AHL did not change its sector allocations, and justifi ably so, it turns out, as fi xed income has been the best performing sector year-to-date in AHL s momentum portfolios. Second, new research has born fruit, particularly research into new instruments on which AHL s momentum systems can be applied. Table 1, below, shows contributions from new instruments and new models added the portfolio in different years over the various years. For example instruments added to the portfolio in 2011 contributed 7.4% to the AHL Diversifi ed Programme in What is clear is that new instruments and new models have consistently contributed positive performance to all years. Table 1: Attributions to the AHL Diversified Programme from new instruments (top) and new models (below). Performance attribution % Instruments added to AHL Diversified Programme in Total Total Performance attribution % Models added to AHL Diversified Programme in Total Total These new instruments, many of which are traded OTC and are subject to the same liquidity constraints the rest of the portfolio, include interest-rate swaps, credit derivatives, power derivatives, and options. One example that has worked particularly well this year is Swedish interest-rate swaps (IRS), as shown in Figure 4a. We see few CTAs trading IRS, possibly because of their more involved manual nature; OTC execution requires more experienced human traders, computation of price series from multiple sources, and signifi cant operational investments. Yet AHL reaped the rewards of this additional effort in October when Sweden s Riksbank cut its main rate to zero, leading to signifi cant profi ts in long IRS positions. RESEARCH IN 2014 Most CTAs, including AHL, trade equities through country index futures such as S&P0 and Dax. In addition, as mentioned above, AHL trades equity sectors through baskets of singlename stocks which, put simply, gives the programmes many opportunities to capture trends where none might exist at the country level. Historically trading sector baskets has outperformed trading index futures, and 2014 was no different, with a like-for-like out-performance of 1 9. Much of this came this year through the dispersion in forecast profi tabilty between oil producing companies and energy consumers also saw the addition of Pan-Asian equities to the existing portfolio of US, EU, and Japanese names, and the creation of a standalone fund for this strategy. Much as the addition of new markets has been profi table over the past few years, new research has also been adding value, although we choose to apply it where we see most complimentarity to the existing trend following style, without changing this core component of our strategies. One of the key areas where this has been most evident this year is in the area of FX trading. Systematic FX trading has been dominated by both momentum and carry trading for a number of years. Trends tend to be strongest between different currencies when there are signifi cant divergencies occurring between economies, which in part explains why the dollar has had such a clear trend against other developed countries this year. When economies are not diverging so much and the world is stable, then carry trading can earn the relatively higher interest rates of one country by placing trades funded in currencies where borrowing is cheaper. Our research has focussed over the last few years away from these two styles on fi nding more economically driven triggers that can highlight when economic divergence is starting to occur and so help pre-empt trend development. Because a rich set of economic data, both public release and forecast, is available across the wide range of countries whose currencies we can trade, we have found this very effective in helping to differentiate between currencies, helping to boost the AHL Diversifi ed Programme s FX performance in 2014 by more than %. OUTLOOK Last year the positive outlook was predicated on the decline in correlations. Figure 5, below, shows that there is a strong relationship between correlation and CTA performance: Low correlation has tended to be accompanied by strong performance and vice versa. At the end of 2014, correlation is lower than it has been at any time post 8, which implies that strong performance in the last 12 months is no accident. The clear clustering with time illustrated by the chart also suggests that conditions for the industry to perform well going forward are in place and our optimism has been vindicated with correlations 7. Past performance is not indicative of future results. Returns may increase or decrease as a result of currency fl uctuations. Please note that the performance data is not intended to represent actual past or simulated past performance of an investment product. The data is based on a representative investment product or products that follow the programme. An example fee load of 3% performance fee and management fee have been applied. 8. Since 7, the monthly volatility of the AHL Diversifi ed Programme and Newedge Trend Index are 14% and 12% respectively. 9. Based on standalone trend-following funds, one trading index futures, and the other sectors, both at 1 target volatility. 3 I 5

4 continuing to fall, effectively to pre-8 levels. Further, history suggests that correlation environments are fairly stable. Figure 5: Average pairwise 1-year correlation 10 versus rolling 1-year performance of the AHL Diversified Programme 11. Each point represents one month of data. Low correlation environments tend to be accompanied by high performance, and vice versa. Correlation environments also tend to be stable with time. AHL Diversified Programme rolling 12m-performance % 4 - Pre-8. Low correlation linked to strong performance. Average = 16% Dec Move to high correlation regime was profitable. Average = 23% - Last 18m: Correlation declines Jan09 - Jun13. High correlation and performance improves - hurts performance. Average = 1% m pairwise correlation Thus the argument that low and declining correlation bodes well for the performance of trend followers holds as well, if not better, for 2015 as it did in However, as was discussed earlier in this note, a decline in correlation is only one component of an ideal environment for trend followers. To fi re on all cylinders, the industry also requires trends at the individual instrument level, and this can be investigated through average instrument Sharpe ratios, which is illustrated in Figure 6 below. Figure 6: Average rolling 1yr Sharpe ratio 12 of simulations of futures and FX instruments in the AHL Diversified Programme. Averages, shown with 1-standard deviation bounds, fell post Credit Crisis in 9-13, but in 2014 showed signs of recovery to normal levels. Average 1-year Sharpe Ratio Trends at the instrument level increased throughout 2014 As a general comment, at the instrument level, trend-following is a relatively low Sharpe game, as shown by average values of around 0.3 between 0 and A portfolio Sharpe of 0.7, which is the near two decade long value for the AHL Diversifi ed Programme, is achieved through diversifi cation across multiple instruments, which is why low correlation between instruments is so important. Figure 6 illustrates a clear distinction between average Sharpe ratios pre- and post-9, in keeping with the thesis that politicians and central bankers have interrupted trends at the single-instrument level. What is also clear, and which gives additional optimism for the future, is that average Sharpe ratios have risen signifi cantly throughout With the addition of falling correlations, it would seem that both key pieces of the trend-following performance puzzle are falling into place. Nevertheless AHL has not been sitting idly by, waiting for the environment to improve. The AHL Diversifi ed Programme is still dominated by momentum. AHL believes its investors bought into momentum s well-established characteristics long-term track record, low correlation to equities, and strong performance when equities have been in crisis and so it has not changed style. Instead, as discussed earlier in this note, it has developed its momentum models and applied these models to new and differentiating instruments which are not typically traded by trendfollowers. They now outnumber the futures and FX component of the portfolio (Figure 7a), typically have low correlations to the rest of the portfolio, and have been less affected by the interventions of the politicians and central bankers post Credit Crisis (Figure 7b). Figure 7 a) AHL has almost doubled the number of non-traditional instruments it trades since 9, and now constitutes more than % of the portfolio by number. Average number of instruments Non-traditional instruments in AHL Diversified Programme Futures/FX instruments in AHL Diversified Programme b) These instruments have been less affected by the post Credit Crisis interventionist regime than traditional futures and FX instruments typically traded by CTAs, as illustrated by their smaller correlation increases post 9. Average 1-y pairwise correlation 2 1 Both correlation metrics are approaching pre-crisis levels Futures/FX instruments Non-traditional instruments 10. Correlation is measured as the average pairwise 1-year correlations of trend-following returns of AHL s futures and FX instruments using current models. 11. Past performance is not indicative of future results. Returns may increase or decrease as a result of currency fl uctuations. Please note that the performance data is not intended to represent actual past or simulated past performance of an investment product. The data is based on a representative investment product or products that follow the programme. An example fee load of 3% performance fee and management fee have been applied. 12. Sharpe ratio is a measure of risk-adjusted performance that indicates the level of excess return per unit of risk. In this case it is the return divided by the return volatility, unadjusted for risk-free rate. 4 I 5

5 SUMMARY As we enter 2015, we feel cautiously optimistic that the environment for trend followers is better now than it has been since the Credit Crisis of 8. Further, with the number of instruments on which AHL can apply its algorithms almost doubling over the period, arguably it is even better placed to perform well than it has been in the past. With fi xed income yields in developed markets at the lows of most people s memories and equities having had six straight years of positive returns, we would be surprised if investors were not starting to worry about asset price bubbles. Unlike conventional long-only investing, bubbles do not worry a trend-follower. Quite the opposite, in fact, as bubbles can represent opportunities to capture strong trends in both upward and downward directions. Unlike investing in asset classes, where strong short-run returns are likely to be followed by weak performance, the trading nature of AHL s strategy means there is no notion of fair value. The fact last year s return was in excess of does not imply that 2015 should necessarily be good or bad. It is perhaps also worth revisiting the value of a trend follower in a portfolio context. The strong performance of fi xed income in 2014 is anti-consensus; few commentators would have predicted this at the start of the year. Nevertheless, over the medium term, the perception amongst investors seems to be that equities will likely outperform developed market fi xed income s paltry low singledigit yields. It is worth remembering then that trend followers have historically exhibited negative correlation when equity investors have needed it most; during the Credit Crisis, for example, the AHL Diversifi ed Programme returned around 4 while world stocks lost % 13. If the world s markets defy consensus again, the ability to follow the way they develop, both long and short, may be key. Not surprisingly, we feel that now is an opportune time to invest in CTAs. There are two key reasons for this. First, as we have detailed in this note, inter-market correlations are low and second, prices of individual instruments themselves have been trending more. These are the necessary conditions for strong performance of trend following, and for performance of the AHL Diversifi ed Programme has been one of the best years in AHL s history and we enter 2015 with optimism that this can continue. 13. Credit crisis defi ned as 1 July 7 to 28 February 9. World stocks given by MSCI World Net Total Return Index hedged to USD. Important information The value of an investment and any income derived from it can go down as well as up and investors may not get back their original amount invested. Alternative investments can involve signifi cant additional risks. This material is for information purposes only and does not constitute an offer or invitation to invest in any product for which any Man Group plc affi liate provides investment advisory or any other services. The content is not intended to constitute advice of any nature nor an investment recommendation or opinion regarding the appropriateness or suitability of any investment or strategy and does not consider the particular circumstances specifi c to any individual recipient to whom this material has been sent. Opinions expressed are those of the author as of the date of their publication, and are subject to change. Some statements contained in these materials concerning goals, strategies, outlook or other non-historical matters may be forward-looking statements and are based on current indicators and expectations at the date of their publication. We undertake no obligation to update or revise them. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those implied in the statements. Unless stated otherwise the source of all information is Man Group plc and its affi liates as of January This material was prepared by AHL Partners LLP (company number OC3907) which is registered in England and Wales at Riverbank House, 2 Swan Lane, London, EC4R 3AD. Authorised and regulated in the UK by the Financial Conduct Authority. This material is distributed pursuant to global distribution and advisory agreements by subsidiaries of Man Group plc. Specifi cally, in the following jurisdictions: Australia: To the extent this material is distributed in Australia it is communicated by Man Investments Australia Limited ABN AFSL , which is regulated by the Australian Securities & Investments Commission (ASIC). This information has been prepared without taking into account anyone s objectives, fi nancial situation or needs. Germany: To the extent this material is used in Germany, the distributing entity is Man (Europe) AG, which is authorised and regulated by the Liechtenstein Financial Market Authority (FMA). Hong Kong: To the extent this material is distributed in Hong Kong, this material is communicated by Man Investments (Hong Kong) Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong. This material can only be communicated to intermediaries, and professional clients who are within one of the professional investors exemptions contained in the Securities and Futures Ordinance and must not be relied upon by any other person(s). Singapore: To the extent this material is distributed in Singapore, it is for information purposes only and does not constitute any investment advice or research of any kind. This material can only be communicated to Institutional investors (as defi ned in Section 4A of the Securities and Futures Act, Chapter 289) and distributors/intermediaries and should not be relied upon by any other person(s). Switzerland: To the extent the material is distributed in Switzerland the communicating entity is Man Investments AG, which is regulated by the Swiss Financial Market Supervisory Authority. This material is not suitable for US persons. This material is proprietary information and may not be reproduced or otherwise disseminated in whole or in part without prior written consent. Any data services and information available from public sources used in the creation of this material are believed to be reliable. However accuracy is not warranted or guaranteed. Man 2015 UK/15/0062-P 5 I 5