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In association with Hedge Fund Intelligence |
Amid all the gloom in recent weeks about the apparent inability of hedge funds to cope with a collapsing world economy, there has been one subset of the industry that has stood out as a beacon – an exception, where returns have continued to be very positive, and of course non-correlated with plunging equity markets. The exception has been those that ply strategies trading in futures markets – collectively known as managed futures traders or 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%) to take its year-to-date loss for 2008 to more than 7%. But, at the same time, the HFI Global Managed Futures index posted gains for both September and October (up about 5%), taking its year-to-date total gain up to an impressive 12.3%. Indeed, it is probably fair to say that without the contribution of these futures players – which made up about 13% of total European hedge fund assets at the mid-year point of 2008 – the overall performance of the industry would look much sicker this year than it does already.
There are ironies in all of this. Futures trading, for instance, is nothing new in the world of alternative investments. Many of the biggest macro managers of today, such as Louis Bacon and Paul Tudor Jones, began as futures traders in the 1980s. By the early 1990s, CTAs and macro funds, which also tend to do a lot of their trading through futures markets, accounted for the biggest chunk of industry assets.
But then there came a long period, during which the equity markets went through various booms, when CTAs gradually fell out of favour. This was not necessarily because CTA performance was poor during the 1990s. It was simply that the strategy was put in the shade by the easy returns from other areas, including from equity long/short as well as from arbitrage, event-driven and fixed-income and credit-based strategies for prolonged periods. The returns from all of those areas were not only generally strong, they were also coming in a smoother pattern – with much less volatility, and hence at much higher Sharpe ratios than you could get from CTAs.
CTAs, by contrast, are rightly famed for their higher volatility. They are typically directional players, often (though not always) using a degree of leverage, that operate in fast-moving markets where prices can change rapidly. Most of them are described as “trend-followers” – which trade using computer-aided technical indicators and trading systems, often derived from charts – aimed at identifying whenever a trend is emerging in a particular market, and then getting the right way around (long or short) to take advantage of it.
Religious cult
Maybe it shouldn’t be surprising, therefore, that CTAs came to be derided by other sections of the alternative investment world as second-class citizens – compared with so-called genuine hedge funds. First, for their high volatility. Second, for the black-box nature of their trading systems. And third, for the fact they were just so different. It was understandable that many investors were reluctant to give money to strategies they couldn’t comprehend, and only a short step further to a widespread caricature that portrayed CTAs as some sort of religious cult caught up in the “dirty” world of commodities.
Although there has been some history of fraud in commodities, this sort of caricature has been off-base and out of date for many years. First, because at least two-thirds of the volume in futures markets has for many years been in financial futures – on instruments such as interest rates and bonds, equity indices and currencies – and only a minority in energy commodities such as oil and gas, soft commodities such as coffee, sugar and cocoa, or base and precious metals. Most CTAs operate diversified strategies – so their portfolio exposures typically reflect this.
And secondly, because CTAs have for many years in practice been much more tightly regulated than ordinary hedge funds. Most hedge funds trading securities in the US have tried to operate by adhering to the terms required for exemption from registering with the SEC – so as to avoid direct regulation. But to manage money in the US futures markets, even if you are based outside the US, you need to be registered with the US futures market regulator, the Commodity Futures Trading Commission, as either a CTA and/or as a commodity pool operator (CPO).
So recent performance patterns will be seen by many in the managed futures community as a vindication – particularly of their non-correlation and ability to perform in the worst conditions.
It is also important to remember that many of the leading CTAs are neither new nor small players. Indeed, the three biggest CTAs in Europe – Man Group’s AHL unit, David Harding’s Winton Capital and BlueCrest’s BlueTrend team – are among the six biggest alternative strategies overall by assets in Europe. After October, all of them were up again by well over 10% this year.
And most of the other big CTAs in Europe – such as Aspect Diversified, the Transtrend team in the Netherlands and the Lynx team, which is part of Brummer & Partners in Stockholm, are also well up for the year to date. The same is true of Lawrence Staden’s GLC, Karsten Schroeder’s Amplitude, Aref Karim’s Quality Capital, Tulip Trend and Altis. The list goes on and on.
At some point, it seems likely to me that investors who are still sceptical about CTAs will wake up to the facts and ask themselves: How’s that for non-correlation? And what was only 13% of industry assets at mid-year will quickly become 25% or more.
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In association with Hedge Fund Intelligence |
