CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

31.6 PERFORMANCE OF CTAS DURING PERIODS OF FINANCIAL STRESS

Numerous studies have examined the benefits of CTAs in terms of providing downside protection during periods of financial stress.8 Since CTAs have access to multiple markets and can easily take long or short positions in these markets, they are able to take positions that will benefit from increased uncertainty and financial distress in markets. For example, a decline in equity prices could benefit CTAs who are (1) short equity indices, (2) long short-term Treasuries which benefit from a flight to safety, (3) long USD which typically benefits from turbulence in financial markets; and (4) long implied or realized volatility derivatives.

31.6.1 Are Trend-Following CTAs Long Volatility?

Some argue that CTAs are long volatility, and since equity volatility appears to be the most dominant factor affecting volatility in other markets, CTAs are expected to benefit whenever equity market volatility spikes.9 As will be discussed further, CTAs are not long volatility in the same way that a holder of a volatility swap or a straddle would benefit from an increase in volatility. CTAs, in general, do not directly invest in derivatives that are closely linked to volatility. Therefore, if CTAs are able to produce positive returns when there is a spike in equity market volatility, it has to be the result of their trading strategies in financial and commodity futures.

It is a well-known empirical observation that sharp declines in equity ...