By Barani Krishnan
NEW YORK (Reuters) - Long-term trend-following hedge funds are heading for a third straight year of losses unless the commodity and financial markets they trade in settle into a more predictable pattern, which does not seem likely given the Federal Reserve's mixed signals on the U.S. economic stimulus.
Known generically as "managed futures", or Commodity Trading Advisors (CTAs), many trend followers were whipsawed in the first half by market gyrations over whether the Fed would cut its bond buying this year. More volatility seems likely; last week, the Fed said it needed more time to decide.
Commodities often saw sporadic price moves this year that eluded the computer-piloted trading models of managed futures funds seeking to build out positions from trends that typically last over months.
Speculation over when the Fed will curtail its monthly bond-buying of $85 billion has been central to this year's market volatility. Since the Fed resumed its quantitative easing programs in 2010 after a brief lull, markets have bet on how long each program would last. Fed easings, which boost asset prices, caused sharp commodity gains in 2009 and 2010.
This year, some CTAs trading on shorter time horizons and focused on gold made money as bullion prices swung on speculation over the Fed. Other funds gained in the past two months by following a relatively steady rally in oil caused by Middle East tensions, and a run-up in cattle prices.
By and large, trend followers were hamstrung by commodity markets that were either flat or fickle.
"The essence of succeeding as a CTA is having the opportunity to enter and stay in a market," said Juan Carlos Herrera, managing director at Quantum Leap Capital, a trend follower in Sugar Land, Texas.
"You really need continuous movements and in one direction. If only three or four of the markets you're in are doing that, then it's going to downsize your returns," said Herrera, whose fund is down double digits as one of the bigger casualties of this year's volatility.
Although commodity traders by name, most CTAs keep half their assets or more on financial instruments such as stocks, bonds, currencies and interest rates.
Another peculiarity is many strive for balanced exposure across the markets they're invested in. For instance, they would not take more risk on oil and gold at the expense of other assets just because those two markets may be seeing outsized moves.
The biggest managed futures firms trade dozens of markets at a time using algorithmic models that aim to detect the start and end of long-term patterns. As a whole, they manage about $400 billion, and are part of the $2 trillion hedge fund universe.
The last time most made money was three years ago, when asset prices climbed broadly in the second half of 2010 as investors welcomed resumption of the Fed stimulus after a lull.
Things got rough for these funds when markets diverged on uncertainty over when the program would end.
"The last couple of years, there have only been two trades: risk on and risk off," said Sol Waksman, founder and president of BarclayHedge, a database in Iowa that tracks trend followers. "Often, they were triggered by what the Fed said or didn't."
BarclayHedge data suggests that trend following has suffered more than other investment strategies as the Fed has tried to stimulate the U.S. economy with hundreds of billions of dollars.
Since a 7 percent gain in 2010, the average trend-following fund on the BarclayHedge CTA Index has slid, losing 3 percent in 2011 and nearly 2 percent last year. This year through August, the index is down 2.6 percent.
In comparison, the average hedge fund is up more than 3 percent for a second year in a row after a 9 percent drop in 2011, according to the Global Hedge Fund Index published by Chicago's Hedge Fund Research.
Herrera's Quantum Leap, which has about $450 million under management and trades 15 markets, including commodities, is down 14 percent through August, data from funds-tracking portal Altegris showed.
Herrera declined to confirm the losses, which Altegris said would be the fund's first since 2009. But he said it had been a difficult year for Quantum Leap, which relies on automated trades to enter and exit markets.
"We kept getting stopped out of our trades by mixed signals in July," Herrera said. "We have very tight stops, tighter than most CTAs. We got chopped up on gold, soybeans and copper."
Gold is down 20 percent for the year, but up 7 percent for the third quarter as one the most volatile commodities of 2013.
Oil's benchmark Brent crude is off 2 percent on the year but is 6 percent higher for the quarter. Copper is down 9 percent and up 7 percent respectively. Soybeans had a clearer trend, sliding 7 percent on the year and 15 percent for the quarter.
"In the years CTAs really made money, markets moved 30 to 50 percent over 6 to 12 months. This year's moves are much smaller and too short," said Salem Abraham, founder of Abraham Trading. The Texas-based trend-following firm's $234 million fund was down half a percent through August after four straight months of losses, Altegris said.
While there is no evidence of disappointed investors pulling money from poor performing CTAs lately, big trend followers like the $52 billion Man Group
The portfolio manager at a New Jersey-based investment firm that allocates money from pension funds and other institutional investors to CTAs said trend followers could come under pressure if they finished another year down.
"If you're a commodities-focused CTA with at least half of your combined assets in metals, oil and ags, and you haven't made money for 3 years, it isn't unreasonable for your investors to question your performance or strategy," the manager said.
(Editing by Josephine Mason and David Gregorio)