Commodity hedge funds down shutters as computers dominate
“Chocfinger” made his name and his money by taking bold bets on cocoa markets. But after nearly four decades of trading, sometimes winning, sometimes losing, Anthony Ward threw in the towel.
Ward blames the rise of computerdriven funds and high-frequency trading for forcing him and some other wellknown commodities investors to close their hedge funds and look for opportunities where machines can’t make a difference. While computerised trading is not new, Ward and others argue its steady rise has reached a tipping point that is distorting prices and creating uncertainty not only for investors, but for chocolate firms, carmakers and others who rely on commodities.
It was in January 2016, after a slide in cocoa prices, that Ward decided the days of traditional commodity investors doing well from taking positions based on fundamentals such as supply and demand may be numbered. “It was just too big, too quick, too dramatic. And completely against the fundamentals,” Ward told Reuters. Commodity markets fell across the board that month after weak factory data in China raised fears of lower demand from the world’s top consumer of raw materials.
Ward blamed the slide in cocoa on what he regarded as misplaced selling by computer-driven funds reacting to the Chinese data, given China has scant impact on the cocoa market.
“The actual fundamentals in cocoa were extraordinarily bullish in January 2016. We were forecasting the largest harmattan in history, which is exactly what happened,” he said.
His prediction that a hot, harmattan wind from the Sahara desert would hit harvests in Ivory Coast and Ghana and drive cocoa prices higher did come to pass — but not before the fund had been forced to cut its losses when the market slumped. At the end of 2017, Ward closed the CC+ hedge fund that had invested in cocoa and coffee markets for years. And at the end of January, commodity hedge fund Jamison Capital Partners run by Stephen Jamison closed. He told investors that machine learning and artificial intelligence had eliminated short-term trading opportunities, while commodities did not offer obvious benefits in the long term.
Also in 2017, renowned oil trader Andrew Hall, who earned $100 million in 2008, called time on his main Astenbeck Commodities Fund II. He had said in an earlier letter to investors that extreme volatility caused by “non-traditional investors and algorithmic trading” made it difficult to hold onto long-term positions when the market moved against them.
In 2016, Michael Farmer, founding partner of the Red Kite fund that specialises in copper, also accused high-frequency traders using super-fast computers of distorting the market and getting an unfair advantage.
Other investors have taken refuge in related sectors or left commodities altogether, exasperated by the automated trading that drives about half of U.S. commodity futures trading.
A study by the US Commodity Futures Trading Commission last year showed computerised trading on the world’s largest futures exchange, CME Group, accounted for 49 per cent of the volume in agriculture contracts and 58 per cent for some energy contracts. At the same time, data from industry tracker Hedge Fund Research shows the average hedge fund returned 8.64 per cent in 2017 but commodity hedge funds eked out returns of just 0.43 per cent.
Ward estimates that while in the past automated trading would distort the market by 10 per cent to 15 per cent from prices justified by fundamentals — which he said was irritating but often manageable — it can now reach 25 per cent to 30 per cent. Algorithmic, or systematic, funds use computers to make decisions after processing vast amounts of data, or trade on signals such as market momentum or when prices hit key levels.
Those who run automated funds argue that they inject much-needed liquidity while capturing the dynamics of the market more efficiently than traditional trading strategies. Farmer and others say, however, that it is unfair for exchanges to allow high-frequency trading groups to have co-location platforms, allowing them to put super-computers in the same data centre as the exchange servers. They say that gives HFTs the tiny advantage they need to jump ahead of incoming orders, effectively piggybacking. Traditional investors say this exacerbates market moves and in turn makes it more costly for them to take out hedges when price moves go against them.
Systematic fund managers see the rise of their sector as a part of a trend that is transforming not only financial markets but wider society with the advent of artificial intelligence, robots and machine learning. “I don’t feel too sorry (for traditional fund managers),” said Anthony Lawler, co-head of GAM Systematic, the quantitative part of Swiss money manager GAM Holding, which had assets under management of 148.4 billion Swiss francs (114.12 billion pounds) at the end of September.