The performance of the CTA sector has been less than stellar in recent years. Compared to equities it has been poor. Compared to the performance of 5 years ago it has been uninspiring. Why invest in CTA’s now? Tudor Investment Corp returned the investor money in their 120 mln USD managed futures fund in 2014 following 3 years of poor performance. Tudor started the Tensor fund in 2005 and it managed as much as $1.1 billion at its peak in 2009. Closing the doors at $120 mln is a failure of sorts. Clive Capital, a leading fund that had $5bn under management at its peak, returned $1bn to investors in 2013.Black River Asset Management closed its commodities fund in 2015, along with three other funds. Armajaro Asset Management said it would shut its $450m commodities hedge fund after losing 11 per cent in the first half of the year. Over the past 3 years the number of big-name CTA closures has vastly outnumbered the news of new entrants to the space. Notably, the commodities price rout starting in 2014 decimated a number of funds and the prevalence of QE across world equity markets has gravely disrupted the environment for trend-following strategies, creating a new environment where the trend is intermittent manipulation of capital markets by central banks.
This withstanding, the Barclay CTA Index is up +2.01% YTD and as of Q1 2016, total assets under management for the hedge fund industry was $2736.6 billion; the managed futures (CTA) industry was $333.9 billion. The same index finished the year of 2015 with a final return of -1.50%. Despite this, and the remaining bitter taste of recent years lacklustre performance, we still expect to see a lot of capital returning to managed futures strategies this year- and with good reason…
Barclay CTA Index Performance Since Jan 1980
|Compound Annual Return||9.83%|
|Correlation vs S&P 500||0.01|
|Correlation vs US Bonds||0.14|
|Correlation vs World Bonds||0.00|
Citing the Eurekahedge Hedge Fund Index, as of 2016 year-to-date, over half of managers tracked have posted positive year-to-date returns. Roughly 12% of hedge fund managers have posted year-to-date returns in excess of 10% over the past seven months, down from 16% of funds over the same period last year. One-third of these funds posting double digit gains are long/short equity mandated while another quarter of them are CTA/managed futures mandated hedge funds. The index has a YTD return of +2.55%. There continues to be a lot of uncertainty in the worlds capital markets at present; QE and central bank intervention, commodity price fluctuations and problematic inventory assessment, political and governmental reform, terrorism, low and negative rate environments. When fear manifests itself as negative market sentiment and assets sell off, poorly positioned investors will fall victim to the increasing correlation between traditional asset classes in a falling market. CTA’s have the capacity to restrict loss and increase profit in such environments.
What is hedging?
Most people will be familiar with the concept of “hedging your bets”. To hedge is to limit or quantify something. When talking about a proposition which contains an element of risk, then being able to limit and restrict that risk enables us to re-frame the proposition- often asymmetrically so, meaning that our pay-off is more than the potential loss. The concept originated in the agricultural industry long before it was appropriated by financial markets. Hedging enabled farmers to eliminate the risk of a poor harvest (due to factors outside of their control, e.g drought) negatively affecting their revenues by pre-agreeing a price for their products, irrespective of the affects of supply and demand pricing. You have the futures market to thank for price stability. Without it, imagine a dystopian universe where your Starbucks coffee costs $3 today, $3.25 tomorrow and $17.59 the week after.
There are doubtlessly thousands of strategies currently operating in the wheat futures space, but the takeaway point is that hedge funds are able to, using a variety of instruments and techniques, create asymmetrical profit scenarios by hedging; a technique that is in fact far from modern, and can in fact be traced back hundreds of years to the Dojima Rice Exchange in Osaka, 1710. Whereas mutual funds are traditionally limited to buying securities (being long) and profiting during price rises and losing money during price falls, hedge funds are able to sell short these same securities and profit when they decrease in price. This is an overly simplistic rendition of the difference between hedge funds and mutual funds and does not take into consideration other areas of note like leverage, asset class access, cash holding requirements, liquidity, lock-in periods, fee structures and tax. Unarguably, hedge funds are thematically better equipped than traditional long-only funds to produce positive returns in any and all market conditions- hence them being referred to as absolute return funds.
CTA’s and Equity Correlation
Sticking with our previous theme of old adages that everybody is familiar with, it is again canonical wisdom that you “should not put all of your eggs in one basket”. Traditionally in capital markets equities and bonds have been negatively correlated meaning that when one increases in value, the other decreases: they are mutually exclusive. If this were to be the case then an allocation to both asset classes (with an over-weighting or under-weighting to equities depending on the investment time horizon) would put an investor in good stead to endure any potential downturns in the market without having their portfolio decimated by a drawdown. Increasingly this previously sound premise has become unsound, as many asset classes can be seen to move to correlative parity; nowhere is this is as evident as in a bear market or market crash, where the majority of asset correlations shoot to 1 in a painful race downward. If we are to hypothesize that this is the new corellative status-quo, then it would be beneficial to look to other portfolio diversifiers which still maintain their correlative integrity, even in periods of market hysteria.
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Although some may debate that CTA’s are not an asset class in themselves, owing to the breadth of strategies encompassed in the category, we can faithfully infer that there are thousands of strategies within this grouping of funds that have marginal to zero correlation to equity, or any other specified asset class. So large in fact is this category, that it is possible to find the non-corellated CTA partner to any other instrument, irrespective of asset class or geographic focus. To this end investors will benefit from the inclusion of consistently un-corellated assets in their portfolio to offset the increasing correlation witnessed in traditional asset classes. Big or small, CTA’s have a place in every portfolio.
CTA’s and Liquidity
The futures market is one of the deepest most liquid markets in the world. Although there is no guarantee that a counterparty to a futures transaction will exist at all times, historically Futures trading venues have proved to have sufficient liquidity to accommodate satisfactorily efficient trading; be it for financials or commodity merchants. Furthermore, owing to the increasing prevalence of dark pools (non-public liquidity) the depth of the market (volume & open interest), across all trading venues is unquantifiable but definitely more substantial than we can reliably estimate. Futures contracts can be unwound immediately and are settled on the same day. Because of this many CTA’s have a very quick turnaround time for returning investor capital when the customer makes a redemption from the fund; unlike other funds which may trade in more illiquid asset classes like real estate or private equity.
Why invest in CTA’s?
It is important to remember than Commodities Trading Adviser is increasingly becoming a misnomer title as a large number of strategies may not even necessarily trade commodities. The same could be said for the categorization of a number of strategies as hedge funds; haphazardly categorized regardless of to what degree, if at all, they actively hedge their positions. The CTA universe continues to be a relevant and useful market for capital. Their popularity will continue to ebb and flow, likely in tandem with downturns in equity markets, as people search for returns outside of traditional asset classes. The number of different iterations or types of strategy within the category will likely continue to expand, until any one particular sub-section of the CTA universe becomes so big as to warrant a new name and new category altogether. Until that time investors will do well to spend some time familiarising themselves with the current successes of the space, and working out which strategy best compliments their portfolio.
– The Role of Liquidity in Futures Market Innovations Charles J. Cuny University of California, Irvine
– Perceptions of Futures Market Liquidity: An Empirical Study of CBOT & CME Traders by Julia W. Marsh, Joost M.E. Pennings, and Philip Garcia
– Facts and Fantasies about Commodity Futures Ten Years Later, Geetesh Bhardwaj, Summer H aven Investment Management Gary Gorton, Yale and NBER Geert Rouwenhorst , Yale University