Hedge funds: Follow the trend

Hedge funds have had a tough year so far. But one subset of the market – trend-following funds – have beaten their more traditional rivals by a wide margin.

Hedge funds in general have had a tough year so far (so much for their raison d'etre: to outperform in any market). However, one subset of the market "trend-following" funds have beaten their more traditional rivals by a wide margin. Trend-following funds also known as commodity trading advisers (CTAs) do exactly what they say on the tin: they follow trends using computer programs. In effect, it's a momentum strategy. It doesn't matter which direction a market is going in. As long as it is rising or falling in a clear manner, a trend-follower should be able to profit, simply by betting that the trend will continue.

"If you believe we are going to have a bear market, CTAs will have a chance to make money, and in the meanwhile they offer non-correlated returns," as Troy Gayeski, a partner at hedge-fund specialist SkyBridge Capital, tells the Financial Times. In the torrid first two months of 2016, trend-followers were very profitable indeed, climbing by an average 5% or so, compared to a 3% average fall for hedge funds in general.

However, trend-followers have been through hard times too. The funds attracted huge inflows after the financial crisis. One attraction of CTAs is that they should be able to offer portfolio diversification (ie, they will go up when the market is going down), and indeed, they performed well both in 2008, when the market crashed, and in 2014, when oil prices slid and the US dollar soared. As a result of this diversification potential, the assets under management in the sector peaked at around $270bn in 2014.

But when markets are unable to make up their minds, trend-followers tend to suffer 2011 and 2015 both saw the average fund lose money, and 2012 was particularly bad, with the typical fund in the sector down by nearly 8%. You can, of course, argue that it doesn't matter as long as it's serving its purpose of diversification and only goes down when most other things in your portfolio are going up but the point to remember is that no strategy works all the time, and as we'll note in a moment, getting exposure to this one doesn't come cheap.

With that caveat in mind, trend-followers have certainly made impressive returns so far this year. The FT cites the examples of the Conquest Macro Fund up by almost 26% in 2016 already and the Progressive Capital Partners' Tulip Trend Fund, which is said to be up 24% by those familiar with the portfolio. This is all at a time when the S&P 500 is slightly lower, having had one of the worst starts to a year ever.

So can you access the strategy? Most of the money in trend-following funds is institutional, and the funds also tend to have restrictively high investment minimums. The Man AHL Diversity Alternative is one potential option for investors with large portfolios. The fund, managed by Tim Wong and Matthew Sargaison, has a minimum investment of £100,000 (although you may be able to access it for less through a financial adviser). The ongoing charge of 2.12% is high, but this is a specialist asset class. Returns have been modestly negative in four of the past five calendar years, but when it works, it does very well rising by more than 30% in 2014, for example.

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