Daily Management Review

Bond Market turns bearish thanks to Computer Driven Hedge Funds


The European Central Bank recently had announced their quantitative easing program in January following the quick sell of bond holdings around late April.

The European Bank having gobbled up Eurozone, there have been primary speculations of another group of investors having dumped the same and thus have increased the rate of selloff in the regions bond market.

A number of computer driven hedge funds had built up large bets according to which the bond prices would certainly rise after the ECB made the announcement regarding its quantitative easing program in January. Data from the Royal Bank of Scotland Group show up the quick sell of bond holding following the entire ordeal.

According to the verses of the RBS strategist Clement Mary-Dauphin, “CTA selling engulfed ECB buying by a factor of three, enough to be a strong spur for the bond selloff.”

The basic strategy of CTAs is investment in future contracts across stocks, bonds, currencies and commodities thus tending to follow the momentum of the market. One of the noticeable moves from them is setting up risk limits to guard against potential losses and then shedding their positions once these limits have been breached.

The above mentioned strategy was mentioned by Nikolaos Panigirtzoglou, who happens to be an analyst at J.P Morgan Chase & Co. This in turn created a self-reinforcing cycle comprised of rising volatility and position cutting as well.

As quoted by Mr. Mary-Dauphin, CTA funds are basically “a bit overlooked by other investors” despite of the fact that “they are major players and can move the market.”

According to latest and revised reports, between the period of March and mid-April, the ECB bond-buying program pushed the yield on German government bonds to a record low of 0.05%. Following the negative movement the bond yields began to rise and thus culminated into a volatile spike on the 7th of May. The German 10 year bond yields were recorded at 0.63% on Wednesday.

After detailed analysis of CTA fund returns comparison with bond market performance, RBS provided with an estimate according to which CTAs have sold €100 billion worth of 10-year futures since the second half of April. This flow seems to equate almost three times the €60 billion worth of bonds that the ECB buys every month under its quantitative easing program.

Aref Karim, the chief executive of QCM which happens to be a CTA fund with $63 million worth of assets under management, versed that his firm had aggressively cut positions towards the end of April “for all portfolio assets,” beginning with government bond-related investments near around mid-April.

Mr. Karim also had to say that his fund has lost money because of the sharp selloff in the prevalent markets. This scenario seems to have emerged despite of the fact that his returns for this year at the end of Aril were almost 8%.

Heiko Zuehlke, head of investor relations at the Amplitude Capital, an enterprise with $2 billion in assets, spoke that his funds avoided the worst of the potential losses owing to the fact that it basically holds positions for only a few days. This allows it to dump losing positions quickly.

The pressure seems to be also mounting on the CTAs to drop their bond bets. According to Lyxor Asset Management, CTA returns for the year on average have been down 0.5%. They also had been up almost 9% earlier this year prior to the bond selloff.

Analysts are still debating the trigger for the dramatic bond market reversal. Some point to growing optimism over economic growth in Europe and signs of a rebound in inflation–scenarios that would ordinarily lead to higher bond yields. Either way, RBS’s Mr. Mary-Dauphin notes heavy selling from CTAs undoubtedly “magnified the move.”

There has been an ongoing debate among analysts regarding the trigger for the bond market reversal. There has been growing optimism over economic growth in Europe with signs of a rebound in inflation. Either way Mr. Mary-Dauphin quotes that CTAs undoubtedly “magnified the move.”
He also added, “When everyone has the same trade at the same time, you can get this kind of wave of mass selling.”