Proving their noncorrelation — revenge of the CTAs

Mon Dec 15, 2008

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By Neil Wilson

Amid all the recent gloom about hedge funds, one important subset of the industry has stood out as a major exception - withhighly positive returns, noncorrelated with the plunging equity markets. The major exception: those that ply strategies in the futures markets - collectively known as commodity trading advisers (CTAs).

The HedgeFund Intelligence Global Composite index was battered as never before in September (down 3.71%) and October (down another 2.35%), taking its year-to-date loss for 2008 to nearly 7.3%. But at the same time, the HFI Global Managed Futures index posted gains for both September and October (when it was up around 3.75%), taking its year-to-date gain up to a highly impressive 12.3%.

The managed futures community represents a not-insignificant portion of industry assets - in Europe, it accounted for about 13% of total assets in mid-2008, according to the latest EuroHedge survey. So it is probably fair to say that without the contribution of the futures players, the industry's overall performance would look considerably sicker this year than it does already.

There are various ironies in this. Futures trading, for instance, is hardly new. Many of today's biggest macro managers, such as Louis Bacon and Paul Tudor Jones, began as futures traders in the 1980s. By the early 1990s, CTAs and macro funds accounted for the biggest chunk of industry assets.

But then came a prolonged period during which CTAs gradually fell out of favor. This was not necessarily because CTA performance was poor. It was simply put in the shade by the apparently easier returns in other areas, such as equity long/short, arbitrage, event driven and fixed-income-based strategies. Moreover, returns from those areas generally came in a smoother pattern - and hence at much higher Sharpe ratios than CTAs.

CTAs, by contrast, are rightly famed for their higher volatility. They are typically directional players, often using significant leverage. Most are described as "trend-followers" - using computer-aided technical indicators and trading systems, often derived from charts.

Maybe it shouldn't be surprising that CTAs came to be derided by other sections of the alternative investment world. First, for their high volatility. Second, for the "black box" nature of the systems. And third, for the fact they were so different. Many investors were understandably reluctant to back strategies they couldn't comprehend. And it was only a short step further to the widespread caricature that portrayed CTAs as some sort of cult mixed up in the "dirty" world of commodities.

While the history of commodities no doubt includes some fraud, this sort of caricature has been off base and out of date for many years. First, because at least two-thirds of volume in futures markets has for a long time been in financial futures - on interest rates and bonds, equity indices and currencies - and only a minority in oil and gas, coffee, sugar and cocoa, or base and precious metals. Most CTAs operate diversified strategies, so their portfolios typically reflect this.

Secondly, CTAs have for many years been much more tightly regulated than hedge funds in general. Many hedge funds trading securities in the United States have avoided direct regulation by adhering to the terms for exemption from registering with the Securities and Exchange Commission. But to manage money in U.S. futures markets, even if you are based outside the United States, you need to be registered with the futures market regulator - the Commodity Futures Trading Commission.

So the recent performance patterns will be seen by many in the managed futures community as vindication - particularly of their noncorrelation and their ability to perform in the worst of market conditions.

Also important to remember is that many leading CTA players are neither new nor small. Indeed, the three biggest CTAs in Europe - Man Group's AHL unit, David Harding's Winton Capital and BlueCrest's BlueTrend team - are among Europe's six biggest alternative strategies overall by assets. After strong gains again in October, all of them were up again by well more than 15% this year.

At some point, it seems likely that investors still sceptical of CTAs will wake up to the facts of the matter and ask themselves the question: How's that for noncorrelation? And what was at midyear only 13% of industry assets in Europe will quickly become 25% or more.

ISSN: 2151-1845 / CDC10004H

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