Institutional investors are beginning to view Commodity Trading Advisors as a core hedge fund allocation, according to Don Steinbrugge of Agecroft Partners.
The hedge fund consultant and third-party marketing firm recently published an article on the subject, suggesting that institutions are increasingly attracted to CTAs as they “scramble to enhance their returns and reduce the volatility of their portfolios after the market correction of 2008.”
CTAs, according to Agecroft, typically use a quantitative trading program to generate momentum or trend-based returns by going long or short futures contracts in areas like commodities, foreign currencies, equity indexes, fixed income and interest rates. Few pension funds allocated to CTAs before 2009 even though the strategy represents about 15% of the hedge fund industry.
But during the crisis of 2008, institutions were unpleasantly surprised to discover their portfolios were not as diversified as they’d thought they were. Many, according to Agecroft Partners, saw “their emerging market equity managers down over 50%, their U.S. equity managers down over 40%, high-yield mangers down close to 30%, the DJ-UBS Commodity Index down 35% and the average hedge fund manager down in the high teens. While all this carnage was going on in their portfolios, the Barclays CTA index was up over 14%, which began to get institutional investors attention.”
Institutional investors who took a closer look at CTAs discovered they not only did well in 2008, but they also, on average, did well in 2000, 2001 and 2002—all years, like 2008 in which the S&P posted negative returns.
Bernie Madoff also, inadvertently, did his bit to increase the popularity of CTAs. In the wake of the Madoff scandal, while many hedge fund managers were gating withdrawals or suspending redemptions, CTAs were able to offer full liquidity. Post-2008, with investors placing a higher premium on liquidity, transparency and risk management, CTAs began to look increasingly appealing. According to Agecroft Partners:
“CTAs in general trade only in highly liquid, price-transparent futures and currency contracts and typically allow their investors monthly liquidity. Some CTAs have even begun to offer weekly or daily liquidity. While many hedge funds are reluctant to take on separate accounts, CTAs typically welcome separate accounts and offer full transparency of the underlying securities. Many of the leading CTAs are mature and well-developed business, and so are able to offer an institutional infrastructure with large teams in research, technology, operations and legal/compliance.”
Institutions that have jumped on the CTA bandwagon to date include Texas Teachers Retirement System, New Jersey Public Employees’ Retirement System and Eastman Kodak Co.
Of course, CTAs have their drawbacks - some money managers suggest that, as trend followers, they don’t perform as well in trendless markets and tend to suffer as markets turn. But Steinbrugge says this is not a serious flaw:
“No investment strategy does well in all markets,`he told FINalternatives. ``The key to building a portfolio of hedge fund strategies is to make sure the portfolio is diversified across various market risk scenarios such as rising interest rates, rising credit spreads, falling equity markets or a depreciating currency. It is true that CTAs in general do not do well when you have sharp reversals in markets or during periods of trendless markets.That is actually a benefit of the strategy in a diversified portfolio, because other hedge fund strategies could potentially do well in those markets.”