In the dark days of late 2008, when stockmarkets were in a downward spiral and liquidity in the world economy had all but dried up, managed futures firms were experiencing a ‘told you so’ moment.
For years, these firms’ sales pitch had been that they were uncorrelated with mainstream markets, especially when markets were falling. Now they had a chance to prove it.
Millions of people watched as the value of their stock portfolios disappeared before their eyes. Yet many commodity trading advisors (CTAs), the entities that trade managed futures, produced positive returns.
In October, November and December 2008, as the rest of the investment universe reeled, the Barclay CTA Index scored returns of 3.45%, 1.87% and 1.28%. For 2008 overall, the index returned 14.09%.
CTAs grabbed the attention of institutions and individual investors who had previously dismissed the asset class. Many decided to investigate and perform due diligence for the first time. 
However, in early 2009, as governments around the globe stepped in to rescue financial institutions and pumped stimulus money into ailing economies, many of the most significant global macro trends that had been like a lead foot on the accelerator of the stockmarket, pushing it lower at breakneck pace, suddenly came to a screeching halt. Good for the equity markets, but not for CTAs, for whom global macro trends, good or bad, are the bread and butter of their returns.
As a result, 2009 turned out to be a year in which the asset class underperformed the stockmarket, finishing the year down -0.10% according to the Barclay CTA Index. For the first quarter of 2010, the index read -0.42%.
So the question now is: as the global economy digs itself out of recession, will investors who have incorporated managed futures as part of their portfolio because of their proven ability to produce returns in otherwise falling markets, remain in the asset class? Or will they be tempted to chase returns elsewhere?
Dedicated followers of fashion
Managed futures traders, also known as commodity trading advisors, make money by investing in futures, forwards or options in a variety of asset categories, from agricultural commodities and metals to stock indices and currencies. Many CTAs trade one or more of these assets across dedicated or diversified portfolios.
CTAs, however, are not only characterised by what they trade, but also by how they trade. The most common strategy is that of systematic trend-followers, which use technical data to anticipate future price movements.
These players, which account for about 80% of all CTAs, employ complicated computer algorithms to work out when to enter and exit a trade, as well as how big it should be, relative to a portfolio or to the market. Trades can last less than a day, with medium to longer term trades likely to be held for months.
Using little or no discretion at the moment of trading, systematic CTAs generally spend a great deal of time devising how their systems will interpret market data, such as price changes, inflation or employment figures. Once the secret formula is set in motion, they can sit back and watch it run, making tweaks, or occasionally significant adjustments, along the way.
It is important to emphasise, however, that managed futures traders are not seeking to identify the source of price changes, nor to increase momentum in a particular direction, but simply to take advantage of the change in price itself, for its own sake.
“Managed futures are not playing on the direct sentiment, they are playing off the prices which are reflective of the sentiment which is a function of volatility,” says Stephen Klawitter at California-based Altegris Investments, a broker-dealer that helps customers invest in hedge funds and managed futures.
Standing out from the crowd
Living off trends in the market, rather than the health or robustness of the assets they trade in, is what enables CTAs to fulfil their central value proposition: being uncorrelated with other markets.
“The lack of correlation is something that has always been the hallmark of managed futures, which have always been zero or negatively correlated with most traditional asset classes and markets,” says Klawitter. “There have been major equity pullbacks over the last 10 years that have led people to look for non-correlation and managed futures has been a major beneficiary of that movement.” 
CTAs emerged winners in 1998 after the Russian government bond default, in 2002 in the aftermath of the technology stocks boom and the terrorist attacks of September 11, 2001, and in 2008 as a result of the credit crisis.
But if splendid isolation is good when other markets are falling, what does it mean when other assets are rising?
Counter-cyclical
During normal or bull markets such as the period between 2003 and 2005, CTAs generally lag in producing returns.
In late 2008, when the world was being buffetted by larger-than-life macro trends, CTAs had the wind at their backs. Systematic trend-followers were blessed as full blown trends played out in just about every market they traded.
Before the crisis took hold, CTAs had been benefiting from trends since the end of 2007, helped by the decision of the US Federal Reserve to start cutting interest rates.
“The cut in rates provided a big boon for commodities and also led to a big sell-off for the US dollar. So even before the crisis, CTAs were taking full advantage of those trends,” says Klawitter.
Then as the subprime mortgage debacle morphed into a global crisis, commodities started to sell off and the dollar started to rally, giving CTAs a whole new set of trends to take advantage of.
But many of these trends petered out in 2009 as governments applied the stabilisers. What followed was a period too unpredictable even for the CTAs.
The first part of 2009 was marked by the violent fall and rise of many markets. The US equity market, for example, tumbled nearly 27% from January to early March. However, by early May, it had recovered the entire year-to-date loss.
Unfortunately for CTAs, markets characterised by abrupt and violent reversals pose difficult challenges for trend followers.
Just as bad was the second half of 2009, when markets – with the notable exception of gold – had neither volatility nor direction.
“Front month crude oil was trading at $73 per barrel on the last day of the second quarter of 2009 and traded at the same price in late December as the markets began to close for the holidays,” says Kenneth Webster, president and chief operating officer of Florida-based John W Henry & Co, which manages some $189m of managed futures assets.
The Chicago Board Options Exchange’s Volatility Index, which tracks expectations of near term volatility in the S&P 500 index, fell throughout 2009 and finished the year more than 60% lower than at the beginning of the year.
Fairweather friends?
So as 2010 gets into gear, will investors be willing to stay in managed futures? The answer, it seems, is that while some will temporarily chase returns to greener pastures, others now believe that a return profile that lags during the good times is a small price to pay for asset protection in down times.
For many, the liquidity of these investments was another big attraction. “Managed futures did exactly what they were supposed to do. They were up in down markets, but almost as importantly, they provided liquidity to investors when there was no liquidity to be had anywhere else,” says Mike Swift, director of Dublin-based Abbey Capital, which invests $2.5bn of client money through a fund-of-CTAs and a fund-of-global macro managers.
Each of Abbey’s products allocates money to about 20 managers.
With managed futures, unlike other alternative investment strategies such as hedge funds, investors do not pool their capital into a fund – rather, each has its own personalised managed account. The investor can usually get its money back at any time, rather than having to wait until a defined monthly or quarterly redemption window, as with a hedge fund.
Unfortunately, in 2008, the combination of positive returns and liquidity was rare. This meant that when many investors were faced with liquidity problems, they had to draw funds from what was often at the time the only well-performing asset class in their portfolios.
Set for growth
Nevertheless, now, nearly 18 months down the track, as assets have steadily crept back on to balance sheets, CTAs claim that investors are looking to the asset class more than ever before.
“As people place more emphasis on the liquidity of an investment, they are remembering that CTAs have proven themselves to be reliable in this way. You know what you own, you know what it is worth, and you know you can get at it if you want to,” says Brian Walls, who is based in the Chicago office of Newedge, the futures broker which has had a team performing CTA research and due diligence since 2001. 
Christopher Stuart at London-based Aspect Capital, which invests some $3.6bn for clients, mainly in managed futures, says the asset class did not capitalise on 2008’s strong results in 2009, as short term investors sought to take advantage of the sharp recovery in equity markets. However, Aspect continues to see interest from a different set of investors.
“It is clear that long term investors are aware that the underperformance by CTAs in 2009 was mainly due to a lack of trend-capturing opportunities, and that the robust liquidity they valued in 2008 still remains,” says Stuart.
As a result, Aspect is fielding new client interest, particularly from pension funds, not only in the US and Europe, but also from Asia.
At the end of the day, says Stuart, when you take 2008 and 2009 as a whole, CTAs were net positive. “Most other investment strategies were not net positive over the same period,” he says. “So it has been a matter of people seeing the long term investment value of the strategy rather than the short term, year to year performance.”
Overall, industry assets under management are expected to grow. They are now measured at $213.6bn by the Barclay CTA Index, up from only $41.3bn in 2001, and from $206.4bn at the end of 2008.
The money is invested in the 1,057 CTA programmes that report to the database. Over 60% of those are domiciled in the US, 20% in Europe and nearly 10% in the Caribbean.
Waiting for a fair wind
While liquidity has come to the fore of the argument for managed futures, returns, of course, are what it’s all about.
With global growth gathering strength, will trends emerge that CTAs can ride?
So far in 2010, while the Barclay CTA Index was down 0.42% for the first quarter, it was up 1.28% in March. Year to date, agricultural traders have been most successful, up 3.01%; currency traders have made 1.24%, and discretionary traders 0.28%. However, Barclay’s diversified traders index was 1.02% in the red, systematic traders were down 0.8% and financials/metals traders had lost 0.6%.
While the Barclay Group has yet to rank CTA performance for March, the top performing programmes in February with assets of over $10m were Revolution Capital Group (Mosaic programme), up 22.48% for the month, Dacharan Capital (High Exposure programme), up 17.86%, and Heyden & Steindl (Tomac2 programme), up 10.73%.
Looking ahead, Swift at Abbey Capital believes there will be market movements for CTAs to exploit. “We expect to see trends on the back of the inflation created due to the monetary stimulus that has been pumped into economies around the world in the recent past,” he says. “Inflation is very much the trend of trends so it will be a good time to have exposure to managed futures.”
Webster at John W Henry believes the erratic shifts in sentiment between default and recovery in countries like Greece and Portugal have created a difficult trading environment for trend followers.
However, he notes that March was a positive month for CTAs. Webster attributes this to markets recovering their individuality, and moving in a volatile way based on their own fundamentals, rather than differences being stifled by outside forces such as government policy.
Pick your horses
The best way to invest in the market, according to Walls at Newedge, is to gather a portfolio of two or three large CTA managers and combine them with four or five smaller, niche players. While much of the serious money has typically allocated capital among the biggest managers, such as London-based Aspect Capital, Winton Capital and Man Financial, and Connecticut’s Graham Capital Management, in recent years the correlations between these firms have diverged, making a super-portfolio of all major CTA players less effective.
“Because of this divergence, the niche strategies such as short term traders, commodity-only traders – whether they be technical or discretionary traders – and sector-specific traders have been getting more attention from investors,” says Walls.
Over the years, the managed futures market has been divided into two camps: large CTAs with more than $1bn of assets and small home-based traders managing the money of family and friends.
While mid-sized managers with a few hundred million dollars did, and still do, exist, the industry has been largely characterised as one of haves and have-nots. CTA specialists say the top handful of managers control a large share of the assets.
However, specialised managed futures platforms are set for expansion over the next year, which may help to expand the ranks of CTAs that can claim credibility at an institutional level.
In April 2010, Deutsche Bank announced that it intended an “aggressive” expansion of its FX and CTA specialist platform known as DB Select, which allocates some $3.5bn across 91 funds.
This number is set to swell by some 20 CTAs before the end of the year. In addition, CTA specialist AlphaMetrix, which allocates to some 60 CTAs, expects to add a further 30-60 funds by the end of 2010.
Trying to be the smart money
However, it is not only the practice of gathering assets that tells a story of haves and have-nots, according to Michael Frankfurter, co-founder and managing director of Cervino Capital Management, and chief investment strategist of Managed Account Research.
“Futures is a zero sum game, so for every winner there is a loser, and for every loser there is a winner,” says Frankfurter.
As a result, he says, when considering the performers in the asset class, it is important to look at the entire sphere of commodity pools, including commodity exchange-traded funds.
“Commodity ETFs are not considered to be part of the managed futures universe, but technically they are,” Frankfurter says. “Although they are securitised, if you take apart any commodity ETF structure and take a look at what is underneath it, generally speaking it is a commodity pool.”
However, the zero sum nature of futures returns and the advent of commodity ETFs bode well for CTAs, Frankfurter believes. “Sophisticated investors realise that to get exposure to the commodity space, you need to have active management, and CTAs offer active management, whereas commodity ETFs do not. As a result, I believe that commodity ETFs will come to represent the dumb money in commodities whereas CTAs will represent smart money,” says Frankfurter.
Walls at Newedge also believes commodity ETFs will be an interesting comparator for CTAs in the years ahead. “If by taking a position in a commodity futures trading strategy you are simply trying to capture the general data of the commodity market, perhaps expressing the idea that there is a lot of dislocation in a particular commodity, then there is certainly an argument to be had that an ETF is the way to go,” says Walls.
Love your regulator
Other areas of evolution include regulatory issues. Like other futures traders, CTAs that trade energy futures are waiting to see whether and what kind of position limits will come to pass. “There are many CTAs that weight the positions they would usually have in the market based on the volatility and liquidity of the market. So a false constraint that forces people to lower their positions in a market to a level below that which they would optimally want could produce problems for CTA models,” says Walls.
Also in the area of regulation, as the US Senate begins to debate significant financial reform and over-the-counter derivatives start moving towards clearing houses and exchange trading models, will any of these new markets be included in CTA strategies? Nothing is guaranteed. As Walls puts it: “Changes could mean that the portfolio of tradable markets for CTAs will change over the next few years.”
For the managers, and for investors, that is likely to be a good thing. The more opportunities CTAs have to spot trends and correlations, the better.
In the mean time, managers are hoping 2010’s markets will enable them to capitalise on the new wave of investor interest, by delivering outperformance. Lots of people are hoping for volatility – of the right sort.