CTAs vs Central Banks: The QE Effect

In January 2015 at a Managed Funds Association conference I presented findings on the apparent relationship between commodity trading advisor (CTA) drawdowns and the Federal Reserve balance sheet, specifically the outright held securities part of it). The theme of the panel, and a subsequent research paper was: “Managed Futures and CTAs — Where are We and What's Next?”

The CTA industry was undergoing one of the worst and most prolonged drawdowns in its history at that time, and many people were looking for a feasible explanation. Some have suggested that quantitative easing in all its phases: QE1, QE2, operation twist and QE3 — which was in the ending of phase — could have been the reason due to distortion of asset prices it caused. There was a lot of anecdotal evidence of this, but this possible relationship has not been studied in depth.

Using HFRI Macro Systematic Index as a proxy for CTAs and S&P 500 for equities, we plotted a few charts and ran some numbers, which revealed very interesting findings:

  • There is strong correlation between depths of the drawdowns and Fed balance sheet amount;
  • Equities benefit in months of active quantitative easing (QE) and suffer otherwise; and
  • CTAs suffer when QE is on and do well when QE is off.

In other words, during the QE 1, 2 and 3 periods, CTAs lost money on average, and equities made money hand over fist. Between the periods the picture reversed, equities were losing and CTAs winning (see chart below). The effect was so strong, that if measured via so called statistical hypothesis testing approach, then the neutral hypothesis of no relationship between Fed activity and CTA performance would have to be rejected at 5% significance level, a very strong result for a finance-related analysis, and at 1% for same relationship with equities – an even stronger result, which is quite unusual in financial data.

The presentation and the article have generated considerable interest. And if you accept the findings that QE had a direct effect on CTA and equity performance, it is worth following up now that the Fed is preparing to unwind its huge balance sheet. 

So we ran the numbers again, with a few small changes. First, I have used AlphaBot for performance and drawdown analysis. AlphaBot is designed for a quick evaluation of performance across different providers (funds, platforms, funds of funds, databases, etc.) and asset classes, from hedge funds and CTAs to equities and even cryptocurrencies. Second, instead of HFRI Macro Systematic Index we use the BarclayHedge CTA index. The indexes are very close, but BarclayHedge makes their indexes available on AlphaBot free of charge.

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