(Bloomberg) -- Selling bonds short — a trade that hadn’t worked consistently for decades — has helped fuel a 38% gain so far this year for the AlphaSimplex Managed Futures Strategy Fund.
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And the trade looks like it has further to go, according to Kathryn Kaminski, chief research strategist at AlphaSimplex Group and co-manager of the managed-futures fund. She joined the “What Goes Up” podcast to discuss this and other trades that have made trend following in futures markets such a lucrative strategy this year. Below are condensed and lightly edited highlights of the conversation. Click here to listen to the entire episode, and subscribe on Apple Podcasts or wherever you listen.
Q. For those who aren’t very familiar with AlphaSimplex, why don’t you talk a little bit about the firm, what its strategies are, and how the notion of the adaptive-markets hypothesis is very important.
A. Yes, AlphaSimplex is a quantitative investment manager who focuses on systematic trading strategies. In particular, we apply rules-based and quantitative-based approaches to trading the markets. So in particular, we follow the futures markets and one of our largest strategies is managed futures, which is a trend-following strategy using a purely systematic process. So, of course, trend following is an exciting strategy because it’s easy to explain, but is a little complex to implement. So we buy things when they’re going up and we sell things when they’re going down. And we do it in a way that’s very systematic.
And so when it comes to thinking about the adaptive market hypothesis, the idea is that you want to build systems and processes that adapt with markets as they change to find opportunities. And so what that means is that our models are looking at what’s working now, not sort of sticking to theory or what makes sense because of some narrative. And that’s particularly important now. If you look at a year like this year, I mean, really a lot of things that have worked in the past aren’t working. And so being able to adapt to that is really important.
Q. And I know the managed-futures fund is having a tremendous year, it’s up like 38% or something like that. Is that mainly due to having the right call on bonds or are there other explanations behind it too? What was the secret secret sauce for having such a good year?
A. So I wish I could say it was one thing. It’s been multiple. One of the best trades this year has been shorting bonds. Another great trade has been being long energies, especially in the first part of the year. And more recently, we’ve also seen tremendous opportunities in currency markets, as you’ve seen the US dollar really sort of skyrocket in its strength relative to other currencies. So what that kind of shows you, it’s not really sort of a one-trick pony. It’s not one asset class. It’s really about adjusting to this current macro environment and using the information that we’re seeing in market moves to adjust positioning, which in many historical contexts seems complicated, but actually in this environment makes a lot of sense, especially from a macro view.
Q. I feel like if you are a discretionary macro fund manager, in what world would you be long both the dollar and oil? I think their head would’ve exploded. But I guess that kind of gets to the whole notion of adapting with the markets.
A. Yeah, exactly. And I think you brought up the bonds and let’s talk about that, ‘cause that’s fun. And we actually wrote a paper on shorting bonds recently because it is so sort of out of the scope of most investors that I talk to. If I ask a group of people, how many of you think that rates are gonna go up? They’ll all raise their hands. But if you ask them how many of you’re willing to short bonds or have shorted bonds? Nobody does. And that kind of highlights the fact that most of us are used to this idea that we only go long bonds, that bonds always help us. They’re sort of like our tried and true safety trade.
And so for 60/40 and the typical investor, this year has sort of left them standing there going, “I don’t want to do that.” Where someone like us, who’s really looking at what are the strategic tactical opportunities in the short run, that’s a fantastic trade, even if it’s uncomfortable from sort of a historical perspective. It’s a strategy that hasn’t worked since 1994. So, you know, think about that. That’s a long time.
Q. I’m curious how sort of fast-reacting trend following can be, because obviously we started the year with bonds doing terribly, yields going up. Then there was an interruption in that, yields came back down over the summer quite a bit. Are you able to sort of ride both ends of that trend or is it more important what the long term trend is?
A. So trend is a pretty adaptive strategy and it’s relatively quick in terms of relative positioning compared to long-term investors. But what we saw this year is exactly what you’re saying, that there were different macro themes that were evolving over the course of the year. So in the first quarter we saw inflation, rising rates as a theme that manifests itself across the long commodities and short fixed income. This particular trade sort of shifted to a short-bonds and also long-dollar trade later in the year as commodities started to dissipate.
So you saw that sort of positioning and views on commodities moved much more to that recession versus non-recession environment. And then in June we saw sort of the markets made a pivot, as you suggested, where volatility increased, cross-asset correlations increased and sort of a general sentiment that these themes were, in some sense, consolidating, came into the market and you started to see sort of a tremendous degrossing of some of that positioning that you saw earlier this year.
And then we started to see a pivot this month and last month back to what we saw earlier this year. And I think some of that comes with the fact that the central bankers have remained steady. Which has basically said, you know, this pivot toward “I think this is over” is a little preemptive. I think it’s time to wait a little bit to see how we really do deal with this inflation problem and how we handle things going forward.
Q. So what do you think, has the short-bonds trade sort of run its course for the year? Is there more to be had from it in your opinion?
A. Yes, I do. I think the short-bond trade has more legs to run, particularly with the commentary that we saw recently with the Fed in the recent period where they’ve really kind of held steady. The reason is a lot of the core problems that have driven to the point where we are now have yet to be completely solved. And I think we’re going to have to see inflation actually dissipate, and we’re going to have to see that we’re in a situation where things are much more stable before we can actually call this over.
And so in that sense, I think we could be in a rising rate environment for some period of time. And what we’ll see, what we’ve seen using more longer-term studies, is that we’re going to be a lot more short in fixed income if we are in a truly secular rising rate environment than we’ve been in the last 40 years. And that’s something to kind of think about from a investor’s perspective in that, you know, how do you think about your bond exposure if we have a prolonged, rising-rate market for bonds?
(This was just the highlights of the conversation. Click here to listen to the entire podcast.)
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