by Michael McClain, Alternative Investment Research Analyst and Due Diligence, LPL Research
Managed futures strategies, also known as Commodity Trading Advisors (CTAs) or trend-followers, are designed for environments where macro shifts drive persistent price trends across equity, bond, commodity, and currency markets. As geopolitical risk has spiked due to the conflict with Iran, the current backdrop will present a unique test for investment strategies.
Current Positioning
Using the SG Trend Indicator from Societe Generale Prime Services as an industry proxy, the most recent positioning by asset class is below. Note, depending on a manager’s individual contracts traded and portfolio construction process, exposures will differ from this. The SG Trend Indicator uses a 20-day/120-day moving average crossover for signal generation. The longer this signal is intact, the larger the position size, however, scaled for expected volatility.
- Equities: Except for a short NASDAQ futures position, there is long exposure across domestic and international developed equity markets.
- Commodities: Long exposure across precious/base metals, crude oil, and livestock contracts. Short exposure within agricultural contracts such as coffee, cocoa, and cotton.
- Bonds: Mixed long and short exposure depending on region and maturity levels. Short middle of the U.S. Treasury curve, however, limited directional exposure overall.
- Currencies: Long euro, British pound, Canadian dollar, and peso versus the U.S. dollar. Long U.S. dollar versus the Japanese yen.
Potential Impact of Rising Geopolitical Risk
Historically, similar periods have caused a rush to safe-haven assets, the selling of risk, and a sharp increase in energy prices. Below, we have the potential impact based on the positioning described above:
- Equities: If equity markets continue to sell off, there may be a short-term drag on overall performance due to current long exposure. However, as signals are moderate, a sharp or extended decline could lead to outright short positioning.
- Commodities: Crude oil prices have already experienced a sharp increase, supporting existing long exposure.
- Bonds: Increasing demand for Treasuries is expected during periods of market volatility. As current Treasury exposure is mixed, investor demand across the yield curve may drive any shifts in exposure.
- Currencies: A flight to safe-haven currencies would negatively impact existing short U.S. dollar exposure over the short-term.
LPL Research Takeaway
The Iran conflict has introduced significant macro risk and volatility into global markets. For managed futures, this environment underscores their purpose of providing dynamic diversification by investing long and short across equity, bond, currency, and commodity futures. Over the short-term, we expect current long energy exposure to drive gains, however, long equity and short U.S. dollar exposure are expected to weigh on returns. For managed futures to deliver as a source of crisis alpha, price trends need to persist, or many strategies and signals will be whipsawed and constantly reversing – one of the worst possible environments for the industry. Overall, within managed futures, we continue to favor holding a diversified mix of sub-strategies, including but not limited to, short-term momentum, volatility breakout, pattern recognition, and trend following. Diversification within trend following in terms of markets and time frame is encouraged as well.
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