Was The Catalyst Fund Really The Catalyst?

Submitted by Brean Capital's Peter Tchir via Forbes.com,

There was a lot of discussion last week about how the $ 3.5 billion Catalyst Hedged Futures Strategy Fund (ticker: HFXAX) was running the entire stock market.

To be frank it is disturbing to me that a fund of this size could be viewed as the key market driver for even a few days, but the chatter was so prevalent that I felt the need to explore it a bit further.

Since it is a mutual fund, as opposed to an ETF, the latest positioning data is not helpful in dissecting what is possible but it does verify that the fund's policy: buy at the money options and funding those purchases by selling even more out of the money options (this is a simplified view of the fund strategy but close enough for examining whether it could have impacted markets).

Inverse HFXAX versus S & P 500 Since December 1 (source Bloomberg)

This chart maps the inverse of HFXAX versus the S & P 500 (the blue line ups drawing price declines in HFXAX).

Since every of the other has been to overshoot the move in the S & P 500, the S & P 500 - the pink line - moved the first. That move in the S & P present to lead a move

While this is too small of a sample size to determine causation as opposed to correlation it is compelling enough that you can not simply dismiss the possibility that the Catalyst fund was in fact the catalyst.

Inverse HFXAX versus S & P 500 for 12 months ending Dec 2016 (source Bloomberg)

Prior to these recent moves, the fund had behaved quite differently relative to the S&P 500.  There was no obvious pattern between the S&P 500 and this fund, at least not to the extent seen recently.

In attempting to explain the fund's recent performance versus the S&P 500

  • It is possible that the correlations of assets shifted in such a way that the portfolio of trades wasn't offsetting each other as well as in the past

  • That the overall levels of volatility and relative flatness of some curves had forced them to write increasing amounts of options to cover the premium on those bought

  • That shifts in volatility and curves and correlations all combined to hit this previously steady fund hard

So it is possible to understand why the fund may suddenly have done so poorly, but could it really have driven the market?

$3.5 billion seems too small at first to drive the entire market (and the manager has been quoted to saying it wasn't responsible for market moves), but it did act leveraged - with returns of more than 5 times that of the S&P 500 - so it may have acted more like a $20 billion fund - large, but still hopefully too small to drive the market.

In all likelihood this particular fund is just a relatively public example of a more widespread strategy - a strategy that was getting hit across the board.  I am more willing to believe the argument that this fund was just one of many funds trading this strategy and that everyone employing this strategy was hit by the same combination of factors and that this widespread unwind was driving the market.

I want to believe that view, because the alternative, that liquidity has devolved to the point that a relatively small and formerly obscure fund can drive the entire market for days on end is quite scary as both a trader and investor.