February opened with a major jolt to what was heretofore a low volatility equity bull market. The CBOE Volatility Index (VIX) experienced one of the largest single-day increases in its history. The VIX chart below helps to provide perspective in that while the extent of the move was much greater during the 2008 financial crisis, this “gap move” was preceded by a period of unusually low volatility.
The program, which had registered strong performance to start the year, carried over positioning that was long equities, long energies, short US dollar and short interest rates. The first week of February saw a sell-off in stocks, which was accompanied by a concomitant fall in energy prices as the two have moved in tandem in recent years. One of the primary performance driving indicators we monitor is the TNR of markets. The TNR incurred significant drops that first week in the majority of the Energy subsector markets, with the Equity and Currency markets reinforcing what we already knew would be a challenging environment for Polaris models. The macroeconomic factors weighing heavily on the markets included lower unemployment, wage increases leading to higher inflation expectations, and fears of faster and larger increases in US Fed rates.
A majority of the medium to long-term CTA space has been impacted by this sudden infusion of downside volatility in the equity markets. The Polaris program, unfortunately, was no exception to the sudden change in trend across equities, commodities and currencies. However, our performance in the interest rates sector was positive. This performance is a promising indication and may ease reasonable concerns expressed by investors as to whether CTAs would be able to profit in a rising rate environment. If this trend develops into a full-fledged bear market in equities over the medium horizon, the models ideally should be in position to catch the changes in trend. Medium to long-term CTA strategies with long track records in general, and Polaris in particular, have seen and navigated similar “sudden trend changing environments,” but typically a drawdown preceded the recovery. For example, the program experienced a significant drawdown in 2008, but eventually was able to capitalize on the change in trends across the four major sectors and recorded a positive overall result that year. We are continuing to closely track our benchmark to the SG CTA index. On a positive note, our research team is in final beta testing for models which we hope may better navigate a potentially higher volatility environment going forward.
The commodity sector was down -1.58% (gross) this month with the Energy sub-sector contributing to the majority of the losses in this sector. If you overlay the NYMEX Light Crude Oil price chart with the FTSE 100 Index price chart shown in the Equity section, you will see how the move mirrored the sudden change in the trend of the equity markets.
The currency sector was down -2.35% (gross) this month. The ICE Dollar Index chart shows the timing of the VIX leap coinciding with the break in the bearish US dollar trend in the first week of February.
The equity sector was down -5.99% (gross) this month. The FTSE chart below details the sudden spike in downside volatility, which was reflective of all global equity markets. The European equity subsector was the worst performer within the portfolio. The equity markets continued to remain uneasy throughout the month and closed the month with a further sell-off in response to the introduction and testimony before Congress of the new Fed chair.
The lone bright spot in trading was the Interest Rate sector which was up +0.85% (gross). The performance this month is a promising indication and may ease reasonable concerns expressed by investors as to whether CTAs would be able to profit in a rising rate environment. Polaris’ models did very well to identify and capture the developing bear market in this sector. The CBOT 10-Year Note chart highlights January’s trendy move which was followed by some understandable choppiness in February. Irrespective of all the volatility elsewhere, the trajectory continued downward. Moreover, the new Fed chairman reinforced his commitment to raising interest rates. The TNR continued to remain high in this sector, which reinforces the positive results and may portend further opportunities as we look ahead.