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FRM Part II · FRM Exam Part II · Hedge Fund Investment Strategies

A risk manager at a fund of hedge funds is reviewing a managed futures CTA that follows a trend-following system across commodities, currencies and bond futures. In which market environment is this strategy most likely to perform poorly?

Trend-following CTAs perform worst in choppy, range-bound markets with frequent reversals, because signals trigger entries that are quickly reversed, producing repeated whipsaw losses. Sustained moves in commodities, bonds or currencies generally benefit the strategy because the positions can ride the trend.

  1. AA prolonged, sustained move in oil prices in one direction
  2. BA choppy, range-bound market with frequent reversals after each signalCorrect
  3. CA financial crisis with persistent flight to quality and falling yields
  4. DA period of sustained currency depreciation driven by central bank policy

Explanation

Trend followers profit when price moves persist, as in sustained commodity, bond or currency trends. In range-bound, whipsaw markets they repeatedly enter after a move begins and exit at a loss when prices reverse. The other options describe trending conditions that usually favor the strategy.

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