This is the 18th year Futures has profiled emerging commodity trading advisors (CTA) and perhaps one of the more difficult years to make selections.
Equity index programs that seemed on the wane in recent years made a comeback as the long bull moves helped earn profits and the short-term nature of most of these programs prevented large give-backs in the reversals of February and July.
For the first time in seven years we are not profiling an option writing program as recent volatility spikes and sharp upward moves created a more difficult environment for option writers than in recent years.
When reviewing candidates, we look at not only recent performance but also overall performance and the manager’s general approach to trading.
This year we once again looked at where a manager’s allocations came from and their fee structure. While acknowledging that raising money with short track records is extremely difficult, we favor managers who refrain from taking allocations from futures commission merchants (FCMs) or introducing brokers who charge added management fees or exorbitant execution fees.
It was disturbing to see numerous relatively new managers with above-market fee structures. The normal fee structure is a 1% to 2% management fee and a 20% incentive fee; we see a 25% incentive fee as reasonable if no management fee is charged. Anything above that is unreasonable for an emerging manager. Futures eliminated several program from consideration based on fee structure.
Previous “Hot new CTA” profiles have gone on to great success and some have slipped into obscurity. This is not an endorsement but a review of new talent. We would like to thank all the managers who sent us their documentation. We will do this again next year, so look for our announcements.
For contact info on these CTA’s, go to our Web site at www.FuturesMag.com.
Scaling-in profits
Robert Weinreb, principal of Ace Capital Management, successfully traded futures for his own account for more than 20 years while running his accounting practice in Lawrence, N.Y. He even registered as a CTA in the mid-1980s when he was publishing a market letter, but he never attempted to manage money other than his own until recently.
His personal trading was more long-term. “When I traded several years ago I was holding contracts for two months or longer. Even though I made money doing that, it was not something I would be able to trade other people’s money with because positions would move against me for a period and I could run up a large drawdown. Something like that is difficult to do when you trade for other people,” Weinreb says.
As his trading evolved, Weinreb traded a short-tern time frame and in 2005 he developed a short-term technical system based on simple indicators to trade stock indexes.
He describes the system generally as trend following but he will enter positions on short-term contra trend moves. “It is an intermediate-term trend- following system but I may enter a trade as the market is moving against me, Weinreb says.
“I determine where the intermediate-term trend is, that is the most important part of the system. Once I know where the trend is, then I place my trades accordingly.”
He can be in and out of positions in a day but generally holds positions up to a week. “I am not a day-trader. I don’t enter trades the same day and close them out. I have a profit target and sometimes I will close out of a position the same day but more often than not I will keep it for a couple of days or a week.”
The program is not entirely systematic as Weinreb allows himself discretion. For example, in August as volatility in the E-mini S&P 500 escalated, Weinreb chose not to take every signal. The decision helped to hold down the program’s first losing month to 7.48%.
Once a trend is identified, Weinreb looks for small pullback to enter a position. He scales into the position, entering a one lot and then adding to the position, as his initial position proves correct. He can hold up to six contracts per account and each position has a profit target, so he scales out as his profit targets get hit.
After returning 52% in a year of proprietary trading Weinreb decided to offer the program to customers. “After doing this for about a year, I felt confident that this would work as a managed program. That is when I decided to pursue this as a managed account and went back and became a CTA and started managing other accounts.”
The August drawdown reduced the program’s return in its first year managing customer funds to 22.2% and taught Weinreb a lesson. “I have been waiting for volatility to come down and I was a little more cautious [at the end of August] and will probably wait for the volatility to come down before I commit to six contracts.”
Note: Ace Capital Management has no affiliation with CTA ACE Investment Strategists.
Uniquely diversified
Dario Michalek, president and CEO of Springville, Utah-based CTA Vision Capital Management, spent years studying market behavior in the hope of developing a truly unique strategy, and based on his portfolio of markets and on the first 19 months of performance, he appears to have accomplished that goal.
“The foundation of the strategy has to deal with our strong conviction that trend following is a valid strategy. Markets have a tendency to trend at least some of the time as part of its behavior,” Michalek says.
While trend following may not be unique, a trend following system with a compound annual return of 33.75% over the past 19 months is, and a program with a portfolio that includes 70% foreign markets, including sunflower seed futures traded at the South African Futures Exchange, certainly is.
“We want to be original, we want to be different and we just like those markets,” Michalek says. “There is slightly less correlation to the U.S. markets. We are trying to provide less correlation to a portfolio. Many CTAs are trading the same markets with very similar strategies and so the returns are very similar so they add no value to a portfolio.”
Michalek organizes the portfolio based on correlation and trades a very long-term time frame, holding certain positions for more than a year.
“Non-correlation is the key,” Michalek says. “The financial markets are the most correlated markets so we have less exposure there. We feel there are more opportunities and less risk in commodities because there is less correlation in those markets.”
Vision’s commodity exposure is approximately 62%, which makes them uncorrelated to most of the larger long-term trend followers. Non correlation within the overall portfolio is vital for a program that trades long-term because trends reverse. “We only need a handful of markets out of the portfolio to perform well in a year for us to generate our objectives, Michalek says. “We trade eight interest rate contracts — four short-term and four long-term. In the U.S. we trade [10-year notes] and Eurodollars. We trade the long gilt, the Japanese bond and the 10-year Australian bond.”
Michalek says the way Vision identifies trends also is unique. “Basically I narrow it down to two patterns. The market is either expanding or contracting. There is a relationship between price and time. If the market moves 20% in one direction in one month, we look at that very differently than if the markets moves 20% in a year.”
Michalek is a practitioner of the Elliott wave principal but even with that he has a different approach. “Our signals are unique, we are getting in and out of the markets when nobody else is, our portfolio is different and how we manager risk is unique so every aspect of developing a trading program is different and that is why the results are different.”
The program trades 55 markets in 13 sectors and Michalek is constantly looking for more markets to add. “There are 85 futures exchanges in the world; there are about 20 to 50 new markets being created every single year. Many of these markets are not going to be liquid enough for years but there is tremendous opportunity out there and we want to capitalize on that,” Michalek says.
While just getting started, Michalek says his approach allows room for growth despite the obscure nature of some of the markets he trades. “When we back tested the program we took into account a lot of slippage. We are outperforming the backtest because we overcompensated for those things. He says the program has more than $1 billion worth of capacity despite such obscure things as sunflower [seeds].”
And Michalek points out the large long-term CTA Transtrend, has $5 billion under management and also trades sunflower seed futures, which is Vision’s smallest market.
“When I first made that trade the broker laughed at me, he said ‘I am going to have to ask my manager on this one.’ But it is a great market, we made good money on that market,” he says.
With returns of 42.98% over the last 12 months (through July), no one is laughing at Michalek now.
Note: The CTA Vision Capital Management is not affiliated with FCM Vision Financial Markets.
Exploiting volatility
While many CTAs have struggled with the spike in equity volatility this August, it played right into the strength of DeSoto Capital Management’s E-mini program. The program uses short-term trend and countertrend signals to day trade the E-Mini equity index complex, primarily trading the S&P 500 and Russell 2000 indexes. The program returned 15.81% in August, the strongest monthly return in the four-year history of the program, pushing its 2007 year-to-date performance to 46.1%.
Stewart DeSoto, CEO of DeSoto Capital Management, says “[The strategy] is trying to figure out where the market will go in the next two hours. We don’t like to hold positions overnight. Typically we are in and out of the trade after only one hour.”
DeSoto, who holds a PHD in physics from the University of Illinois, began trading the strategy in the late 1990s when he worked in Dallas for Texas Instruments as an integrated circuit system designer specializing in the application of digital signal processing techniques.
He found his electronic engineering work to be extremely helpful in designing his day-trading strategies. He says digital signal processing uses high level mathematics to filter out noise to enhance the signal properties of a telecommunications channel. DeSoto applied this discipline to filter out market noise.
Most of his trades are placed at the beginning and end of the day. “In the middle of the day there is a lot of noise — I try and get in, in the mornings and then late in the day.”
All of the program’s signals target quick short-term moves. He uses wide stops, 4% of a customer’s equity, and will get out of the trade in two hours if profit targets or stops are not hit.
DeSoto averaged more than 100% per year in his proprietary trading account from 1999 to 2004 as he perfected his program. By that time friends and family took notice. “After several years of trading with my own money, I had requests from family members and friends to manage their money and went through the process of becoming a CTA,” DeSoto says.
In 2003 he moved back to Chicago’s western suburbs, where he earlier received a degree in mathematics from Wheaton College, and worked on enhancing his program as well as
serving as an associate professor of physics at Wheaton College.
DeSoto is a firm believer in systematic trading. He trades every signal and rarely uses discretion. “I find that systematic trading is the way to go. It is better if you can automatically trade your system so you can’t override it.” He has automated his proprietary trading but still enters his customer’s orders based on his systems signals.
“Right now I take the signal and enter the trade myself but eventually it will be automated. I want to be sure that I can take care of the customer. My personal goal is to try and lower drawdowns,” DeSoto says. Because of this he suspended trading from October 2006 through February 2007. DeSoto explains that the program had three consecutive down months and there was very little volatility in the market to exploit at the time.
“It turned out to be a good thing that I held the system in check during those months,” DeSoto says.
The layoff was part of his strategy to limit drawdowns and maximize gains. “I would rather stay out of the market and save my powder for another day.”
The program performed respectably from 2003 through the first part of 2007 despite that equity volatility was shrinking to historic lows. The program dropped 2.1% in 2006. It showed small losses each month that year except for May and June when the VIX spiked higher.
DeSoto say his systems are robust and have proven themselves through 10-years of trading. The strategy clearly enjoys high volatility and has performed respectably in historically low volatility periods that don’t look to repeat themselves soon.
