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Trend-driven Funds Profit on Oil's Slippery Path

News Items

Trend-driven Funds Profit on Oil's Slippery Path

Craig Gilbert

Reuters Article, Published August 28, 2015
Article republished with permission of Reuters
By Barani Krishnan and Luc Cohen

Aug 28 (Reuters) - The oil market's 10 percent surge on Thursday offered a visceral reminder that many of its most active participants could not care less about global oil inventories, Saudi Arabia's stressed finances or the American shale revolution.

For dozens of commodity trading advisors (CTAs) from Rotterdam to Chicago, so-called "systematic" funds that typically use price charts or computer models to plot their trades, all that matters is finding a trend and sticking with it.

That formula paid dividends for many this summer, as oil entered a nearly ruler-straight two-month decline. U.S. crude fell below $40 a barrel from $100 in June of last year.

But with short positions at a near-record high as big hedge funds and speculators expected the supply glut to persist, it also made for an unruly exodus on Thursday.

While it is too early to say how many of those funds got out before the bounce, interviews with five of the largest or best-performing CTAs involved in the oil market this week show that the persistent downtrend has been friendly to most.

Some say their ignorance has, in this case, been bliss. Many of the oil market's most sage analysts and investors have been shocked by the depth of the latest decline, having bet earlier that falling U.S. production and racing Chinese demand would support the market throughout the summer.

"We don't claim to be experts in the sense that a discretionary trader might," Grant Smith, head of research in Greenwich, Connecticut, for the Millburn Commodity Program¹, said earlier this week. His $80 million CTA [strategy] is up nearly 20 percent this year, helped by a bearish bet on oil. [Millburn note: As of August 31, 2015, the Millburn Commodity Program had approximately USD 75 million AuM and Millburn's total AuM was USD 1.5 billion. As of the same date, Millburn's Commodity Program was up 9.1% for 2015.]

"If you think of yourself as an expert, you can sometimes cling to your preconceived ideas of what's going to happen in the market. We are data-driven, and our models have no problem changing their view if the market says they are wrong."

Unlike CTAs, which tabulate daily returns based on marked-to-market positions, most commodity fund managers will not report their August performance until the end of this month or the first week of September, making comparisons difficult.

At least through July, things have not been great for the biggest hedge fund managers in oil. Andy Hall, the sector's most prominent member and an avowed oil bull, lost 17 percent last month at his $3 billion hedge fund Astenbeck, the largest monthly drop in almost four years at the Connecticut-based firm.

Pierre Andurand, another well-known oil trader, eked out a modest 3.4 percent gain last month at his London firm for a 5 percent yearly gain through July.

Chicago-based Hedge Fund Research, a closely followed industry database that does not include Hall and some other big names, has an average 6 percent gain through July for funds on its energy-focused commodities index.

"The last three weeks have been very difficult for people in the energy/oil space," said HFR President Ken Heinz. "I expect performance for August to be difficult."


The presence of CTAs in the oil market is all but impossible to quantify, though they do account for a portion of the relatively small speculators and funds that have amassed a 163 million barrel short position on the U.S. oil markets.

That speculator group's short holdings hit a record 179 million barrels in March, when U.S. crude fell to six-year lows of around $42 a barrel. The price trough deepened this month to a 6-1/2 year low under $38.

"The trend-following models we've built don't know or care what's driving the prices," said Chris Reeve, director of product management at Aspect Capital in London, which allocates up to 40 percent of its $4.8 billion capital to commodities.

"Often the best profits come when people think the fundamentals don't justify a trend but actually that trend continues," said Reeve, who has seen Aspect's main fund rise 8 percent on the month as of Aug. 24, helped largely by a bearish bet on oil.

CTAs also represent a growing, if underappreciated, risk for the oil sector. While each CTA's model differs - and some were far from perfect in recent months - a change in oil's long slide could send a signal that it is time to quit the short-oil trade, triggering a rash of buying that may cause oil to rebound just as fiercely as it has fallen - regardless of the glut.

Red Rock Capital, a Chicago-based CTA, saw its short position in U.S. crude, which opened at $58.77 a barrel in early July, stopped out on Thursday when the market rebounded more than $2 intraday.

"It's all very similar to blackjack," said Thomas Rollinger, Red Rock's chief investment officer. "Basically you're not going to win at every hand."

U.S. crude eventually settled the day at $42.56, up almost $4. But Red Rock's exit at $40.99 still netted Rollinger almost $18 a barrel. On the broader side, the $42 million fund is up 21 percent on the year, almost 15 percent of that gained since the start of July when oil began tumbling.

"Typically when you have these big trends, the systematic people do a better job capturing them," said Sol Waksman, president of BarclayHedge, an Iowa-based firm that tracks CTA performances. "The problem is, once that trend ends, that's when the systematic trader is more likely to give back a bigger piece than a discretionary manager." (Additional reporting by Eric Onstad in London and Lawrence Delevingne in New York; Editing by Lisa Shumaker)

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RISKS OF AN INVESTMENT IN MILLBURN COMMODITY PROGRAM (the “Strategy”) include but are not limited to the following: (i)  The Strategy is speculative.  Investors may lose all or a substantial portion of their investment in the Strategy; (ii) The Strategy is leveraged.  The Strategy will acquire positions with a face amount of as much as six to eight times or more of its total equity.  Leverage magnifies the impact of both profit and loss; (iii)  The performance of the Strategy is expected to be volatile. Since inception, monthly returns in the Strategy ranged from up 16.65% to down 7.09%; (iv) Investors will sustain losses if the Strategy is unable to generate sufficient trading profits and interest income to offset its fees and expenses; (v) A lack of liquidity in the markets in which the Strategy trades could make it impossible for the Strategy to realize profits or limit losses; (vi)  A substantial portion of the trades executed for the Strategy take place on foreign exchanges.  No U.S. regulatory authority or exchange has the power to compel the enforcement of the rules of a foreign board of trade or any applicable foreign laws.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Millburn Ridgefield Corporation, its affiliates or its employees.The information above is based on performance and other data available as of the date of this article or as otherwise noted. Any markets, models, leverage, portfolio weights and other data described herein change over time, but are accurate as of the date indicated herein.

The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Diversification does not eliminate the risk of experiencing investment losses. The information contained herein is intended for use by sophisticated investors who may be interested in opening a separately managed account. Prospective managed account clients must be "qualified eligible persons" within the meaning of CFTC Rule 4.7. Futures accounts are speculative, employ significant leverage, involve a high degree of risk, are not suitable for all investors, and may involve high fees. There can be no assurance that an investment strategy will achieve its objectives. This information is not a solicitation for investment. Such an investment may only be made on the basis of information and representations made in the appropriate written disclosure document.

¹Returns described herein are net of all fees, expenses and transaction costs typically incurred in a separately managed account trading the Strategy (2% per annum management fee; actual transaction costs incurred; 0.25% per annum ordinary operating and administrative expenses; 20% annual profit share, subject to a high water mark), and reflect the reinvestment of profits.