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Analysis-Cocoa rally and market tumult hoist systematic hedge funds ahead of their peers

Published 2024/03/25, 08:05
Updated 2024/03/25, 08:15
© Reuters. Traders work on the floor at the New York Stock Exchange (NYSE) in New York City, U.S., March 7, 2024.  REUTERS/Brendan McDermid/File Photo

By Nell Mackenzie

LONDON (Reuters) - Record cocoa prices and markets whipped around by inflation and geopolitics helped hedge funds using systematic strategies outperform their peers in the first quarter, according to industry players and investors.

A systematic hedge fund manager uses coding and algorithms to determine whether to find trades strong enough to become market trends, unlike traditional managers who decide the trade themselves.

These trend funds made an average gain of almost 9% in the first two months of 2024, versus the wider hedge fund industry's 2.6% gain, according to Barclays (LON:BARC)' prime brokerage, which tracked the performances of 40 "classic trend" hedge funds.

Their success reflected how volatile markets had become and how market fortunes are differing globally, the sources said.

The U.S. S&P 500 has risen over 11% so far this year, but Hong Kong's Hang Seng is down about 2%. Japan's Nikkei has rallied over 20% and European stocks lagged with 6% gains, with China up around 3%.

Commodity markets have also been mixed, but the consistency of cocoa's sustained rally to record highs has been a bonus for systematic hedge funds.

Diverse performances across regions and assets are good for these funds which benefit from disparate markets, said Michael Oliver Weinberg, a professor at Columbia Business School and a hedge fund investor.

"Great market for systematic managers, as they are typically equally long and short," said Weinberg. A short position bets an asset's value will fall; a long position bets on prices rising.

In 2023, crowded positions in the "Magnificent Seven" U.S. tech stocks made most of the money for the wider hedge fund industry, whereas the sharp divergence this year within stocks, bonds and commodities has created the perfect environment for these specific kinds of strategies, said Weinberg.

In Europe, for example, aerospace and defence stocks have rallied almost 28% so far this year, while utilities stocks have fallen about 7%.


The highest-performing systematic strategies or trend funds took the most risk.

These use different volatility thresholds to decide when trades become so risky they should be ditched.

The top 10 performing trend funds, allowing almost two thirds more volatility than their peers, averaged about a 20% return for the first two months of this year, said Barclays prime brokerage data tracking hedge funds that was shared with Reuters.

Remaining funds with lower risk thresholds posted an average 5% return.

But even those with lower volatility allowances benefited from strong moves in agricultural commodities, currencies and energy, said several sources.

Long cocoa trades held since the first half of 2023 bolstered returns, said two investment sources.

Cocoa prices have more than doubled in the past year, propelled by poor crops in top producers Ivory Coast and Ghana and processors scrambling to get cocoa beans.

British hedge fund firm Winton Capital allows a volatility of about a 9% on its systematic $2.8 billion CTA (commodity trading advisor) strategy. It posted a positive 9.1% for the year to March 20, with profits from cocoa, stock indices, natural gas and the yen, said a source close to the firm.

Long cocoa bets and short positions on grains helped boost $5.4 billion Rotterdam-based investment manager Transtrend to about an 18% return to for the year to March 21.

It also benefited from short bets against carbon emission permits, actively traded by companies needing to pay for carbon dioxide they emit, alongside speculators betting on their value.

"A strong month like February, with close to a double-digit return, is typically triggered by a major event such as a war or other crisis that impacts markets across asset classes," Marc van Loo, part of Transtrend's investor relations team.

But this February differed as returns were simply driven by how strong the trends have been this first quarter, he said.

The $8.6 billion Aspect Capital, which returned 12% for the year to March 19, benefited from trends in cocoa, Chile's peso, the yen, stock markets and European emissions, a source close to the fund said.

"What makes this macro environment so constructive is that there are multiple sources of instability driving trend formation - be it the effects of El Niño or the normalisation of interest rates, or the heightened geopolitical risks," said Razvan Remsing, director of investment solutions at Aspect Capital. He declined to comment on the returns numbers.

One sticking point for these funds has been fixed income, as the timing of interest rate cuts remains elusive.

"Fixed income has been trickier in 2024; there have been trends but the frequency and timing may cause some dispersion in performance and the markets got ahead of the Fed with rates falling then rising again," said Boston-based AlphaSimplex's chief research strategist Kathryn Kaminski.

© Reuters. FILE PHOTO: A farmers holds cocoa beans while he is drying them at a village in Sinfra, Ivory Coast April 29, 2023. REUTERS/Luc Gnago/File Photo

At the end of February, the $8 billion firm had managed about a 5% return, helped by stock positions, energies and agricultural commodities, bank research showed.

The firm did not comment on the number.



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