The BarclayHedge CTA Index ended July up 7.08% year to date, outperforming the aggregate hedge fund index by more than 10%. The Barclay hedge fund index, however, returned –4.45% up to the end of July. Returns such as these are encouraging investors to allocate to CTAs away from other strategies, say managers.
“These are the perfect conditions for CTAs and that is likely to continue for some time. A CTA makes money from price movements, be they within asset classes or from price movements of assets relative to each other. In this evolving global credit crisis, there has been a tremendous shift in relative valuations between currencies, equities, interest rates and derivatives, and those are the ideal conditions for CTA performance,” says Patrick Welton, co-founder of Welton Investment Corp, which runs a diversified CTA and global macro portfolio.
Scott Sykora is president of LJM Partners, a CTA that sells options on S&P 500 futures. He says recent market conditions have been perfect for his fund’s strategy. “We are in the best stretch of our existence relative to the performance of the stock market. Despite the steep decline in the stock market, the move downward has been fairly controlled. There is volatility but there have been no major sells off or gap moves down.”
Difficult for some
Not every CTA will do well in this environment, however. Sol Waksman, founder and president of BarclayHedge, says currency traders and financials and metals traders have had a difficult year. At the end of July, the Barclay currency CTA index was up just 1.05% and the financials/metals index was up 3.09%. The agricultural index, however, was up 10.67%. With varied returns in subsectors of CTAs, Welton says it is a good idea to have a diversified portfolio to help smooth performance and volatility. Indeed the Barclay diversified CTA index was up 12.12% at the end of July.
Assets under management in CTAs have increased but not as much as expected says Barclay’s Waksman. “We were at $206.6 billion at the end of 2007 and we are now at $234.1 billion. Some of that increase would be from returns rather than inflows. We would have expected more inflows.”
 |
“These are the perfect conditions for CTAs and that is likely to continue for some time” |
Volatility of CTAs deters some investors, says Sykora. “Investors have to accept that there can be swings but we find that once they have experienced the swings and come out the other side they understand the idea of taking a long-term view of performance and feel more comfortable.” LJM Partners has produced positive monthly returns in 80% of the months over its 10-year existence, which Sykora says is attracting investors. The fund has $400 million in assets, up from $200 million in early 2007. Performance has been the key driver, but Sykora says the transparency and risk management also attracts investors. “It’s not a black box model and we have a lot of rules that discipline our thinking. That can mean taking a loss. In January we decided to take some risk off the table and suffered an 8% loss as a result, but we thought it was important to close out near-term put contracts and wait till the market stabilized. That can be scary for investors but we’ve made it up since and avoided a scenario where we could have lost a lot more by taking on extra risk if the markets had moved differently.” In addition to outperforming other hedge fund strategies, CTAs benefit from their lack of correlation to other markets, and it is a positive attribute that managers say investors will increasingly appreciate.
Persistent stress
“CTAs offer truly diversifying investment returns, and do well in times of persistent stress on the financial system like this year, so investors are being drawn to the asset class. The larger and institutional investors tend to appreciate the diversifying benefits of the style class due to its tendency to generate returns during good times and bad, however, and they are careful about looking around and putting together a CTA portfolio,” says Welton.
Sykora says that investors have also begun to reassess how they look at risk and reward. “The fixed-income strategies that have blown up were taken on by investors as they looked like only a bit more risk for incremental returns. Now they better understand that if they are going to take risk, it should be transparent and to balance out the rest of their portfolio.” Sykora says the fund “fits nicely as 10 to 15% of a portfolio because the returns are uncorrelated with the stock market and so can smooth out overall returns”.
