Will commodity trading advisers continue to underperform in 2023?

The rise (and fall) of the machines?

Advances in artificial intelligence (AI) have reached the stage where, according to at least one researcher, the concept of ‘artificial general intelligence’, or AGI, may now be possible. ¹ That may not sound like much of a breakthrough, but it would mean that computer systems are now capable of generating new scientific knowledge and performing any task that humans can.

The Financial Times (FT) recently summarised the arrival of AGI as ‘a historical and technological turning point, akin to the splitting of the atom or the invention of the printing press’. It also raises Terminatoresque fears of a future that belongs to robots rather than humans. Fortunately, the FT adds that other estimates on the arrival of AGI range from a decade to half a century or more.

On a more mundane level, the rise of CTAs is just one way in which AI is increasingly influencing financial markets. In 2022, for example, CTAs – which manage about $200 billion in assets, according to eVestment² – enjoyed a record year, delivering returns of around 20%. ³

That’s according to Société Générale, whose SG CTA index covers the 20 largest such managers, including AQR Capital Management, Winton Capital Management and Graham Capital Management. CTA strategies thrived last year as US interest rates advanced steadily higher, sending the dollar on a long rally, while equities fell significantly.

Also known as quant funds, managed futures and even trend followers, CTAs use computer algorithms and other quantitative techniques to surf price trends by trading futures. They trade on the theory that assets that are going up are more likely than not to continue going up, and that assets that are falling are more likely than not to continue their decline. The funds buy or sell massive amounts of stocks – tens of billions of dollars’ worth in a session.

There are concerns, however, that CTAs could exacerbate upward and downward moves in markets and ignore technical fundamentals. In March, for example, Bloomberg reported that CTAs kept buying stocks early in 2023 on momentum and volatility signals despite falling earnings – and ignoring fears that they were pushing investors into a classic bear-market trap.⁴

Banking crisis exposes pitfalls

The banking crisis that erupted in March 2023 certainly revealed the dangers of relying too heavily on CTAs. Having chased equities up early in the month, CTAs experienced their worst month since the dotcom crisis of the early 2000s.

They were forced to rapidly deleverage legacy positions on short-term interest rates and eurodollar futures that covered around $127.7 billion in shorts, amid expectations that Silicon Valley Bank’s collapse would force the Federal Reserve to capitulate on tightening, according to the FT. ⁵

The newspaper added that ‘the sudden shift in hedge fund positioning helped fuel some of the biggest moves in the Treasury market since the 1980s, and drove volatility to its highest level since 2008’.

There are also wider doubts about AI’s ability to beat the markets. As a recent article in the Wall Street Journal stated, and despite all the hype, "the investing results using AI haven’t been especially impressive". ⁶ Indeed, predictions about AI taking over investing could prove just as wrong as all those forecasts of driverless cars: Ford pulled out of self-driving vehicles last year because of the server technological challenges it faced. ⁷

Figure 1: CTAs suffer extreme decline in March as bets on US interest rates reverse