CTAs vs Central Banks: The QE Effect

After running the CTA index through the drawdown analysis tool we notice that the CTA industry continues to struggle. Almost as soon as the previous drawdown ended in January 2015, the longest drawdown in CTA index history, a new one began three months later (see table below).

These two drawdowns account for almost seven years of under-water performance for the industry, and their length is unprecedented, both individually and combined.  

Before we scare all the existing and potential investors away from the CTA space, it should be noted that despite the severity of the CTA drawdown as viewed by the alternative industry standards, it was just a fraction of the largest drawdowns in equities — roughly one third in depth and half in length — even after adjusting CTAs to match equity volatility. Using AlphaBot it is easy to put the S&P 500 and CTA indexes together to produce a telling drawdown chart (see chart of drawdown comparison,below). To make a fair comparison, we matched CTA volatility to that of equities (14.2% annualized for the period), using AlphaBot’s easy to use Volatility Adjustment feature.

So what exactly is happening in the CTA space? It would be difficult to believe that with so many talented portfolio managers, programmers and traders, they have massively forgotten their skills. It would be much more feasible to look for an external factor (or factors) that may influence the performance in the space and this is exactly what we are attempting to do.

Right about the second half of 2014 the Fed has begun implementation of the tapering program, and the outright held securities balance sheet growth has begun to slow down. Miraculously, for a brief few months around the same time, CTAs sprang back to life, generating 12% in the 12 months from April 2014 to March 2015. This was the second strongest rolling 12-month result for CTAs in more than 10 years, bested only by the 17.5% return from April 2007 to March 2008 (see CTA 12-month performance charr below).

But the joy did not last long, and in a few short months CTAs in general have hit another prolonged drawdown. With the Fed out of the picture, many have wondered what is happening and why? The potential cause is not difficult to spot, at least for those of us who accepted the idea that Central Bank activity can distort markets. This time it was the European Central Bank, not the U.S. Fed causing problems.

Page 2 of 4