It's not just that 2013 was a bad year for commodity trading advisers and managed futures strategies: It's that it was the latest in a string of bad years—and people in the space are the first to admit it.
“Overall I would say the environment's been tricky in that, with the quantitative easing and some of the central bank actions globally, it's really kept markets range-bound,” Maxwell Eagye, director of CTA and futures broker Altegris Clearing Solutions, told FINalternatives. “And being range-bound, it's short bandwidths of volatility which have not created any real trends in the marketplace or allowed trend-followers in general to capture very much. Even the short-term guys have not been excluded from being whip-sawed around.”
Eagye has an interesting vantage point on CTA/managed futures performance in 2013: his La Jolla, Calif.-based firm launched the first annual Altegris CTA Challenge this year, ranking participating professional managed futures managers.
“Using technology, our proprietary system and Investor Analytics software systems, we created a series of seven metrics, three position-based and three risk-based, for our CTA Challenge,” said Eagye. “It's not perfect but it allows us to filter guys who are doing well on their daily risk-adjusted basis and highlights them in the past, and then we take a deeper look at that top five or 10.”
Number 10 (as of the end of November) was Switzerland's Quantis Asset Management, which manages the ULYSSES Futures program. Quantis co-founder Bertrand Savatier agrees with Eagye that managed futures strategies have hit a rough patch.
“After the outstanding returns of 2008, and a mixed 2009, for the last three years CTAs have produced rather poor results, illustrated by a small gain of 0.63% for the Newedge CTA index since mid-2009,” he said.
Even ULYSSES, which has generated “good and regular returns” (13.67% in 2012, 12.09% in 2011, a total return of 44.19% since 2009), was up only 0.3% as of early December. Savatier said the fund actually started out well this year (up 9.57% in the first half) but fell victim to “summer 2013 decay,” which he attributed to unusually low stock market volatility.
Secret To Success?
Of course, not all CTAs struggled this year. Altegris CTA Challenge leader Mehnert Capital Management, led by Robert Jay Mehnert, was up 24.91% at the end of November.
Eagye believes the most successful CTAs this year have “focused on money management or risk management as far as dealing with the volatility in the marketplace and how they size their trades and their entry and exit points. There's a lot of ways you can capture and find trends in the marketplace, depending on what kind of trader you are, but often they'll find a trend and get in, it will reverse, stop them out and then a run. So, guys th who've been successful have been able to manage that entry with a little bit of volatility and those exit points without getting stopped out.. I've got to say, it's more of an art than a science because you could have guys in very similar things, but one guy can catch that trend while another guy may get stopped out because of volatility triggers and other things.”
Mehnert, whose firm is a startup, “does trend and counter-trend trading,” said Eagye, “but one of his little secrets is he's created the money management algorithm that looks at volatility in the marketplace and how he manages his entry and his exit points and his sizing based on volatility. I believe that that's given him an edge.”
Lee Partridge, chief investment officer of Texas-based Salient Partners, whose Trend Index managed-futures strategy rose an impressive 39.96% last year, agrees that “volatility matters a lot.”
“To the extent that managed futures are constructed to be lowly correlated with equities or core portfolio exposures, it is imperative to size allocations properly to achieve measurable advances in the return/risk ratio of the entire portfolio,” he told FINalternatives. “We believe higher volatility funds are better suited to compete with the volatility of equities. Allocating to higher volatility funds during protracted bear markets may provide better portfolio protection than what is offered through lower volatility alternatives.”
Eagye's Altegris colleague Michael Lock added that the ability to adapt was another key to CTA success in 2013.
“The marketplace has changed with all the central bank sub-trends and we've seen now for years that some of the old styles of trading just haven't been working. Some CTAs have made small adaptations that seem to be working for them. They're not necessarily fundamentally different from what the trader was doing prior, but these guys have got their ears open and they're keeping an eye on everything. They're really trying hard to capture profits and they're not just sticking to what used to work that is not working anymore."
Quantis' Savatier said there were several factors behind his firm's success, one being “the time horizon on which ULYSSES Futures is building its trades. Average trading duration is 24 hours, which means that many opportunities may exist for this approach which might appear as noise for other CTAs.”
“The second factor is the general principles of ULYSSES, which tries to identify excess in the markets which tend to be corrected within the next period. As a result, this approach can produce positive results on short trades in an uptrend, long trades in a down trend or both sides trade in a trading range. This process is well adapted to the trading of stock indices futures, which are generally underweighted in more classical trend-following approaches.”
Discretionary vs. Systematic
“From what we’ve seen this year, in general,” said Eagye, “discretionary traders have done slightly better than the systematic traders in that, they're able to see movements that are more fundamental, like a central bank or government making a policy change that they can see coming as a human rather than a system. The system looking at tick data is probably not going to pick that up initially.”
But some systematic strategies have also succeeded this year—the aforementioned Salient Trend Index being a case in point.
Salient's Partridge defines systematic strategies as those “based upon a predefined set of rules that determine the positioning of a portfolio and may include concepts such as trend following, mean reversion, statistical arbitrage, pattern recognition, carry or value.” And as a general rule, he said, “trend-following strategies offer the lowest correlations with equities and become more pronouncedly negatively correlated during extended bear markets.”
Partridge believes the contrast between his strategy's strong performance and the “flat to negative” performance of managed futures generally comes down to more than just volatility, and systematic design—there are also fee structures and he is especially critical of those that direct a disproportionate amount of the profits from a managed-futures strategy into managers' pockets:
“We believe this is largely a function of inefficient fee structures derived from an inappropriate focus on diversification within the managed futures allocation, high incentive fees and layering of fees by commodity pool operators and fund-of-funds providers,” he said. “Over-diversifying a managed futures portfolio can backfire if the resulting portfolio becomes more correlated with the core portfolio or if incentive fee structures reward winners but fail to penalize losing managers.”
It's customary to end year-end pieces by looking ahead to the year to come, but that's not so easy in the managed-futures space.
Partridge said Salient expects to see a reduction in accommodative monetary policy in 2014 (and, indeed, shortly after he made this comment the Federal Reserve began to taper its economic stimulus program) which “may remove a significant economic tailwind that investors have enjoyed over the past four-and-a-half years.” Accordingly, he said, Salient is “favorably disposed toward modest reductions in long-oriented equity exposure in favor of trend-based, managed futures strategies that maintain equity-like volatility and fair fee structures.”
Savatier said that given the uncertainty surrounding the global economic recovery, “2014 will certainly see the comeback of volatility to either standard or high levels, which has proven to be good for ULYSSES Futures whatever the direction of the market is.”
But Altegris' Lock just laughed: “We can't even predict December,” he said.
Eagye agreed. “You could have a geopolitical event somewhere in the world that causes market pressure. You could have a natural occurrence, whether it be a drought or a flood or a tsunami, earthquake or tornado. These are all factors and there's many, many, many more, so as the world continues to get smaller and these things persist, they can create opportunities for success, but at the same time, they can create opportunities where markets gyrate in a fashion that doesn't do well for most traders."
“It is absolutely impossible to know what is going to happen in the future," Eagye continued. "I think the best thing we can say is, if you're going to participate in the market with CTAs, have a few CTAs in a diversified portfolio that once again will allow you to take advantage of certain market conditions, and find CTAs that can handle their risk so when the market conditions are not there for them, they can preserve capital to the best of their ability.”