You have to go back to 1990 when the Barclay CTA index had a higher return, 21.02%, than the 14.11% in 2008. The index produced several 20% plus years in the 1980s, but the entire industry was much smaller and the interest rate earned on capital was much higher.
Making the year more amazing is that it produced these returns in the midst of a financial meltdown of historic proportions. While managed futures pros know this is precisely the point — as Michael Clark, whose various programs returned between 45% and 95%, says, “Whenever the world looks like it is coming to an end, CTAs do well” — the contrast is still stark. If the world ever needed a non-correlated portfolio diversifier, it was in 2008 and managed futures delivered in spades for those wise enough to employ them.
Longtime commodity trading advisor Bill Dunn explained the outsized returns simply. “The bailout. There is so much going on and its blood in the street but we don’t mind being short. There were clear major trends generated by this.”
The Barclay CTA index actually returned more in the first quarter, 6.9%, than in the fourth quarter, 6.73%, but his point is valid as many markets collapsed at the end of the year and most CTAs were already short.
The year was split in two with long upward trends in place in many markets for the first half of the year and downward trends for the second half. While the obvious example is crude oil, many commodity markets followed a similar, if less spectacular, pattern.
Richard Scully, whose Poniente program earned 93.37% in 2008, says they caught the upside at the beginning of the year and then got short in August. “We spent March through July chopping around and then the big bear markets started in August. From then we were short commodities, long bonds, pretty much-short currencies [and] essentially everything from August to the end of the year,” Scully says.
Generally trend followers hope to catch big trends in a couple sectors and that is usually enough to generate solid returns. In 2008, there were huge trends in energy, grains, currencies, interest rates and stock indexes.
Richard Bornhoft, chairman and chief investment officer of the Bornhoft Group, says, “ If we have very good returns in two or three [sectors] it is a good year.” But in 2008, there were great trends across all six major sectors.
Scot Lowry, principal of Parizek Capital, which earned 120.73% in 2008, says, “Currencies were doing well, interest rates, metals, grains, stocks, energies; I made money across the board.”
Top trader Bob Pardo adds, “In all the years I have been involved in the markets, I have never seen this level of trendiness and volatility across all reaches of markets, ever.”
Dunn says they earned profits in,“anything that was trending,” adding, “in the last four or five months everything was trending, mostly down.”
But it wasn’t just long-term trend followers who did well in 2008. The average return of short-term CTAs in the Barclay database was 13.80%. Revolution Capital’s short-term Mosaic program returned 94.05%.
Elk River Trading, which is a non-directional forex options program, returned 75.67%. “We are not taking directional bets on the currencies but trading volatility,” says chief risk officer Eric Hoyle. “We have a bias to long volatility. It was a volatile year. Starting with January with the Soc Gen trader, then when Bear Stearns [went down] in March and September and October when everything was falling apart. It is spikes in volatility that allowed us to do well.”
Emil van Essen’s Spread Trading Program earned 86.55% by exploiting money flows in the commodity markets. The program bear spreads in front of traders attempting to exploit the effect of the commodity funds roll. The massive moves in commodities provided opportunities and the program’s returns where noncorrelated with long-term trend followers.
The volatility was so extreme in 2008, that despite some of the outright obscene returns posted, many managers say they were constantly reducing their exposure due to volatility and the correlation of many diverse sectors.
“We felt we needed to scale back our risk because of that correlation,” Scully says. “It was a challenge from the risk management perspective because whereas you usually expect softs to have no correlation to metals, in this case everything was moving together. When multiple markets are moving up and down together it really boosts your risk exposure. Managing risk in this game is everything.”
Clarke pared back his exposure as volatility increased during the year.
Pardo says, “All the physical commodities, as odd as this sounds, followed the stock market. The stock market was going up when they were going up and when it was going down they were going down. Everything was trading off of the stock market in the last quarter.”
The million dollar question is will 2008’s performance lead to greater allocations to managed futures? Most managers believe it will, but note that with all of the pain and losses in the wider investment community, it may take some time.
“When the dust settles and when people can reestablish some liquidity and they are finished licking their wounds, some will be knowledgeable enough to know that there is another asset class and it would have helped them a lot,” Dunn says. “There will be a rekindling of interest in managed futures.”
Jeff Earle, a principal at Ram Management Group (72.31% in 2008), expects more interest in managed futures, but probably not immediately. “People need to take money from their winners to cover their losers,” Earle says. But he thinks that money will eventually flow into managed futures because of the TLC factor. “Transparency, liquidity and centralized clearing — none of the other [alternative investments] have all of these characteristics.”
While no one expects a repeat performance, many managers believe that it is still a great environment for managed futures because many of the factors that produced strong returns are still in place. Scully disagrees. “The next year or so is going to be much more difficult. We certainly are warning our clients that we are not going to make anything near the returns that we made [recently],” he says.
Pegorsch: Always in
Roger Pegorsch has been trading his integrated price and time system (IPATS) program for 14 years and although he has had many good years—earning a spot on our back page in January 2003—he had his best year in 2008 with a return of 134.77%.
Pegorsch’s Hudson N.Y. based CTA, Commodity Futures Services, trades a long-term trend following reversal strategy that is always in every one of the 38 markets it trades.
While you may think that would make Pegorsch busy, in 2008 it meant he could relax and watch the profits roll in as many markets experienced two major trends with marginal corrections in between.
“There are a lot of commodities I only had two trades [in] all year,” Pegorsch says. “It was definitely an unusual year as I had more commissions on rollovers than I did on reversals.”
Crude oil, grains, stock indexes, metals and currencies all experienced major trends. “I reversed on crude at $120 [after it already started back down] so I missed the top by $25 but I was making money in the financials that offset any loss I had in the energies.”
“Here is the beauty of the system,” Pegorsch explains, “In June I was long with a pretty wide reversal stop — it might have been $50 because the market was going up at such a great rate — but then when it slowed down and pulled back in June and went back up in July and made a new high, then my stop starts to tighten up, $25 is not much considering I was long from $50 or $60.
Pegorsch says his reversal points were just wide enough in 2008 and adds that volatility plays an important role in selecting them. “When corn is trading at $2 a bushel, you may have a 15¢ reversal point, when it is trading at $4 a bushel you may have a 40¢ reversal point.”
While IPATS is a systematic program, it adjusts the criteria for each market. “It is the same system but in the Russell 2000 we may be analyzing a 20-day window, in OJ we may be analyzing an 80-day window,” Pegorsch says.
While any program capable of producing a 100% plus year is plenty risky, Pegorsch says adding markets has helped to lower the volatility of the program and his risk measures bear that out. “In 2003 when I had my worst year I was following 30 markets. I wasn’t following as many international markets. I found that has made a big difference. I’ve got some pretty good added diversification,” Pegorsch says.
By going from 30 to 38 markets and adding six additional international markets, Pegorsch had more opportunity to profit and to offset choppy underperforming markets.
In 1970 Pegorsch moved to Chicago from Toledo and began his career in futures trading. In 1979 he won a charting contest and was named the Commodity Perspective Charting Service Chartist of the Year. He used his study of cycles, which would become the basis for his IPATS system. After working as a broker for 25 years he moved to New York and began to work on his system.
Once his system was developed he realized that he had no skill for marketing, so in 1994 he entered into an agreement with managed futures legend Bill Dunn to market and execute his program. The agreement is still in place and IPATS is part of Dunn’s D’Best fund.
Pardo: Anticipating trends
A good trading system with sound risk management and markets that are active as hell.”
That is what Bob Pardo attributes his 142.02% returns in 2008 to. Pardo has operated his Kenilworth, Ill.-based CTA since 1999 and although it has featured some impressive years, including a return of 63.73% in 2007, 2008 was far and away his best.
“We are designed to take advantage of powerful trends and in all the years that we have [traded], this last year has been the largest collection of powerful trends in all markets that I have seen,” Pardo says. “We were able to get a hold of these trends early on and stay with them.”
But don’t call Pardo a trend follower. Though his program maintains a roughly 0.64 correlation to long-term trend followers, he says there are significant differences in his approach. “We are usually in before the long-term trend followers are in and we are usually out before the long-term trend followers get out,” Pardo says.
He prefers to refer to his methods as trend anticipatory, but he acknowledges that any manager who rides trends should have done well last year. “If we can’t make money when there are trends like these then we are not competent professionals.”
Pardo looks at 60 different markets but actively trades 45. The basic model is the same for each market but the parameters are adjusted to different trading paces and different levels of volatility. “There are different components to volatility and we are going to be less inclined to get involved in markets that are noisy,” Pardo says.
This was important this year as many markets that may not normally correlate began to correlate. “We size all of our entries based on new volatility levels. It is important to always be adjusting to current volatility levels and one of the ways we do this is when we roll,” Pardo says, adding, “Frequently it will have the effect of taking profits.”
Like many CTAs Pardo made money on both the rally in crude oil in the first part of the year and the plummet in the second half but had less exposure late in the year due to volatility. “We got long crude in January, we got short $10 or $15 off the high on the way down,” Pardo says, adding, “Energy got so volatile that it became less a part of our portfolio.”
Pardo was a pioneer in building trading system design and testing software. His “Chartist” program was one of the first commercially marketed computer charting programs and the precursor to his “Advanced Trader” program. Around the same time he also designed his “Walk Forward Analysis” software as a way to optimize trading systems without curve fitting.
By the mid 1990s Pardo decided to concentrate his energies on building his CTA business instead of simply designing software. His XT99 program, which is a component of the Dunn D’Best fund, has produced a compound annual return of 29.26%.
While it would be hard to duplicate 2008’s performance this year, Pardo says that many of the economic drivers that made 2008 such a good year are still in place. “This year stands to be an extremely good year for futures trading and for some years to come,” he says.
Blackwater: Participating in the best moves
Jeff Austin, principal of Blackwater Capital Management, started working on the floor of the Chicago Mercantile Exchange in 1994 handling CTA business for Dean Witter.
After a stop at Chicago-based Rotella Capital he went on to Eagle Trading Systems in Princeton N.J. where he was able to start working on system development. At Eagle he would meet future partner Andy Silwanowicz. Andy traded spot forex and forex options prior to going to Eagle.
The two developed a trading philosophy while at Eagle so when they left to go out on their own they were ready. “We knew exactly what we wanted to do so it wasn’t a long time between leaving Eagle and us cranking up the system,” Austin says.
The system is a medium to long-term pattern recognition program that trades 45 markets with strict profit targets. Its compound annual return is 21.30% since its July 2005 launch with a worst drawdown of 16.15%. Blackwater managed to hop on the numerous trends in 2008 to earn 56.07%.
Blackwater uses price and volatility patterns as well as some breakout elements. “It is the combination of these price and volatility patterns that gives us a gauge of how favorably we view the market,” Silwanowicz says. “Any one of the rules could potentially kick us out if they are not all lined up.”
After launching the program they added a second model that is longer term. “It is two models and two signals. The second model is based on the same structure; the patterns that we are looking for are a bit bigger,” Austin says.
“Once we hit these profit objectives we are switching to a proprietary momentum indicator that tells us when we view the markets as stalling. If the markets are screaming we will stay with the trade until we see any kind of weakness,” Austin says.
This risk overlay can pull the program out of a trade and lock in profits. “After we caught a good portion of the move, that is when the overlay is going to step in and take some money off of the table,” Austin says. “We also do that on the overall portfolio.”
This is important because Blackwater does not use trailing stops. “This gives us the ability to give markets the room they need. We don’t want to ratchet up our stops to be taken out by the market. What gives us the ability to leave our stops [wide] is the addition of the portfolio overlay, it helps us take money off of the table along the way and helps us control the volatility.”
Blackwater made money in 80% of the markets they traded in 2008 and traded a generally shorter time frame. “We had many winning trades that we were in and out in three weeks, [one] week at times due to our portfolio overlay,” Austin says. “We pride ourselves on making adaptive models. There are times when the markets are going in a slower pattern and we can stay in trades for nine, 10, 11 months.”
Silwanowicz says, “Throughout 2008, we were long the energy sector and at times would enter trades, reach our objectives, be out and then reenter. By the time [crude] hit $140 we had been out of everything.”
Austin adds, “We don’t gear our models to make 50% but if the opportunities are there, we will participate. If the models do not see very good opportunities, we are going to be much more quiet.”