Submitted by Peter Tchir of Academy Securities
In our family, it was Baba Yaga who was going to “get you” if you weren’t well behaved. Whether it was the boogeyman, or some other fear that kept you awake at nights, it is time to consider what the next ‘pain trade’ might be. While the focus has been on Risk Parity or Risk Parity Lite (my personal favorite), what is the next big strategy at risk? Could it be Commodity Trading Advisors (or CTAs)?
These two asset classes were moving somewhat in lock-step for much of the second half of 2017. They started to separate a little bit in December and accelerated at the start of this year.
Simplest Explanation of the Chart?
The simplest explanation is that both were long stocks but one was long bonds and the other was short bonds (if you are looking for who holds all those short future future position shorts in bonds – probably think CTA).
Commodity positioning probably had something to do with the performance as well, but I would argue that CTAs are very long equities and very short bonds – and have benefitted from that.
Simplest Explanation CTAs
At the risk of annoying the CTAs on my distribution list, I don’t think we lose too much by simplifying CTAs to
- Largely systemic, or model driven
- Largely trend following, or momentum
Which Strategy Is More at Risk of Position Changing?
I think CTAs might be more at risk of having to stop out. On the Risk Parity side, I am not seeing evidence of outflows, if anything I am hearing some anecdotal evidence that the strategy is more interesting here – instead of your ‘hedge’ paying 2.4% it is paying 2.85% (depending where on the treasury curve you put on the hedges).
CTAs are always at risk of changing position – they are systematic, and momentum driven and by their nature constantly ‘looking’ for reasons to change position or direction (they tend to be remorseless when they do – though remorseless confers human emotions to what would be an algo driven policy).
CTAs are exposed to bonds doing ok and stocks doing poorly (which is my current view of the world).
With 10-year yields breaking my 2.8% initial target (I still think 3% could be in play) much of the move to higher yields may be over, which would not be good for CTA positioning.
Any classic ‘risk-off’ move would be problematic, and while we haven’t seen a true ‘risk-off’ move, we did see the flight to safety trade directed to the 2-year treasury on Friday.
I for one am leaning towards the real boogeyman being CTAs.
* * *
Where Have All the Vol Sellers Gone?
If anything, while seeing which strategy might be most at risk, I am waiting to see sustained selling pressure on VIX. Vix has sold off this morning from overnight highs, but I think is far from signaling the all-clear sign, especially after the recent surge in buying.
The real clue to exposing the boogeyman might be seeing what triggers real fear in the volatility markets. On Friday we saw some signs, but it seems like today, retail is coming back to sell VIX (I will admit that I too am hoping to time a nice short volatility trade in my personal account) although that has since reversed sharply with the VIX surging above 24...