The question going into 2010 was, could managed futures match their strong performance of 2008 following a subpar 2009? The answer, in terms of performance, was unclear as most managers experienced a choppy first half of 2010 with the BarclayHedge CTA Index in negative territory.
There may have been a sense of lost opportunity as the sector performed poorly in 2009 and equity markets roared back from their March 2009 low. But it appears that investors’ memories are not as short as some believe, because the sectors saw a nearly 25% growth in assets in 2010.
Sol Waksman, president of BarclayHedge, says, "It was a good year and we saw a robust increase in assets under management."
The Barclay database showed assets under management grew from $213.6 billion at the end of 2009 to $266.8 billion by the end of 2010.
While 2010 ended up being a good year for CTAs — the Barclay CTA Index rose by 7.03% — it did not have the same benefit as in 2008 when equities and nearly all other alternative investment styles had horrendous returns.
"In spite of that, money was flowing in 2010. Why are they putting money into managed futures?" Waksman asks. "That is a trend we haven’t seen often. It is reflective of the growing realization that managed futures do make sense within the context of a diversified portfolio."
Word is growing beyond the typical institutional and high net-worth investors as innovative fund companies and managers are beginning to utilize the mutual fund structure to offer managed futures to a wider array of retail investors. While there may be regulatory hurdles to overcome, once retail investors get a taste of the diversification offered, it would be hard for it to be taken away and for this trend not to lead to greater allocations to the sector.
In terms of the year, a variety of managers did well. "We made money in most sectors. The biggest ones were metals, grains, interest rates and the currencies. All sectors were firing on all cylinders," says Jeff Earle, principal with Ram Management Group. "There were a lot of opportunities [whatever you traded]. The interest rate complex, the foreign currency complex, the grain complex and softs were very good."
Managers were able to take advantage of dislocations in interest rates and currencies because of the European debt crisis.
Hawksbill Capital Management Principal Tom Shanks (see Trader Profile) says their strong year was powered by moves in the interest rate complex. "In the early part of the year, we were able to take advantage of falling rates," Shanks says.
Strong moves in currencies and interest rates enabled larger managers, most of whom have greater allocations to the more liquid financial sectors, to perform well. The Barclay BTOP 50 Index returned 6.55%.
While strong moves in currencies and interest rates benefited the larger managers, big moves in smaller markets, like the grains and the softs in particular, provided opportunities for managers small enough to allocate significant capital to those markets. Cotton, sugar and cocoa had big moves and the grain complex had a major upswing in the second half of the year.
While the Federal Reserve still is claiming inflation is not a problem, don’t tell trend followers that. They don’t look at it from a macro economic view, they just spot a trend, jump on and ride it to profits. When and if the current bull move reverses, trend followers will ride that. Di Tomasso says there likely will be opportunities to short in 2011, pointing out that the CCI index (formerly CRB) has risen above where it was in mid-2008.
It was also a good year for options writers, whose ranks were thinned during the highly volatile equity crash in 2008.
"These are perfect market conditions for us," says Scott Sykora of LJM Partners. "A lot of the systematic risk has been reduced. Corporations are sitting on boatloads of cash, they have lots of liquidity, their balance sheets are robust; lets see if the banks stay stable," Sykora says. "Outside of geopolitical events, we are going to continue to do pretty well."
The interesting thing about 2010 is that it was hard to know who did well and why, just looking at the market activity. While there were opportunities for trend-followers, there were also some choppy markets. What we have learned in recent years is that there is perhaps more diversity in the space than most people acknowledge. Trading legend Bill Eckhardt said as much in our interview (see "William Eckhardt"). "People look too much at the correlation between traders. The correlations tend to overstate the relationship. …there is more diversification among trend followers than one would expect. There really are different variance of trend-following and they have different properties," Eckhardt says.
That is good news for managers and investors because if allocation growth continues at last year’s pace, investors will need to find new managers as the largest ones will have capacity issues.
Waksman says the increase will force people to look at the full plate of managers. "You have to diversify your holdings. Do you want to have all your investment in managed futures with one manager, regardless of how good they are? The additional money will have to go to other managers," Waksman says.
Typically, new money has gone to short-term traders. Waksman points out that many short-term traders saw a large increase in assets, despite unspectacular returns. But the vast array of traders offer plenty of opportunity.
"This is one of the best investment areas that exists because of transparency, the facility with which traders can go long or short and because there are so many areas, in terms of geopolitics, economics and even weather, where things can change significantly enough to give rise to price dislocations," Shanks says. "Opportunities are going to persist for a long time and this is a great vehicle to take advantage of them."
Shanks is not looking to offer a retail product, but sees no problem with managed futures being offered to retail. "There are an awful lot of good traders out here that the retail side is not getting enough exposure to."
Continue to the next page for our profile on RAM Management Group...
Ram Management Group at first blush looks like a typical long-term trend-following commodity trading advisor. Its aggressive program earned 38.36% in 2010 and returned 71.96% in 2008, a layup year for most trend followers. After all, Ram’s chairman and president, Robert Moss, learned at the foot of legendary trend follower Rich Dennis and was a floor broker for C&D Commodities, executing the firm’s orders on various New York commodity exchanges.
But while there are many similarities, Ram Principal Jeff Earle says, "We are different from most trend followers." Some differences are obvious based on countertrend elements in its core pattern recognition methodology and some more subtle, like how Ram focuses in on the best market to exploit a move.
"We are not in 60 markets simultaneously; we are much more selective. We are looking for the driving market," Earle says. "We are looking to be short the euro during the European debt crisis, not be short all the currencies and wasting units in the yen when the [weakest] market is the euro."
The sharper focus was created by improvements implemented by Ram in late 2006. "We were finding that there were too many correlations in the positions that we had," Moss says. He adds that their adjustments run contrary to the prevailing wisdom in the industry that being in more markets creates diversification and is better for the overall portfolio. "Since we did that, we actually reduced our drawdown and have enhanced returns," Moss says. "We are trying to do it a little bit differently so that we can add some value to a portfolio and have something less correlating to some of these consistent programs that have been operating for some time."
Earle adds, "A lot of trend followers fire the shotgun and spray the bullets everywhere; we are a little more fine-tuned."
"If the markets are going to go through a jolt because of higher oil prices, you don’t want to be buying corn and wheat because crude has broken out, but your shotgun approach gets you long crude, corn, beans, wheat and sugar," he says. "When the market turns, the weakest of those is going to hurt you."
Ram’s non-correlation was obvious in May when it returned more than 20%, while the Barclay CTA Index dropped 1.16%.
Earle says that even though Ram was successful along with many trend followers, they accomplished it in a different way. "A lot of commodities were up 30%, but intra-year there were a lot of drops. We were able to capture some of those drops in the long-term trend."
One example is in sugar. "Sugar probably rallied 30% on the year, but we didn’t make our money being long sugar. We made our money being short sugar during its short, rapid drops during the rally," Earle says.
In developing his strategy, Moss took advantage of some of his observations from the floor. "Some markets move for reasons that are important, but aren’t revealed for a certain period of time. Price really does dictate what the true value of a commodity is at any give time."
This led to his pattern recognition style. "What we are looking at is pattern and we are also looking at price movement within a certain area of the pattern and that is what constitutes a signal for us," Moss says. "Patterns have a way of repeating themselves over and over again."
When Moss executed large positions for C&D Commodities, other traders watched what he was doing. "It would take a little finesse to get the positions on and it would take a lot of finesse to get the positions off, particularly if they knew what way we were set up. My job was to keep them guessing," Moss says. This led Moss to take some circuitous routes to filling an order, but also educated him as to how to spot patterns.
Ram’s systematic approach to trading is nothing like the way Moss executed orders in the pits, but that experience helped him to spot patterns and understand when traders were caught on one side of the market, knowledge he would use in creating his systematic approach. "Some of it came from those observations," Moss says.
Continue to the next page for our profile on VACA Capital Management...
Chicago-based Vaca Capital Management takes a scientific approach to the markets. Before becoming a trader, CEO and CIO Francisco Vaca worked on the Superconducting Super Collider particle accelerator for the University of Illinois at Chicago (UIC) while at Fermilab. When funding for the program waned in 1996, Vaca answered an ad for a research job at C&D Commodities, where he would work with legendary trader Richard Dennis and in 2000 launched his firm with current partner Paul Rabar.
However, Vaca’s approach is not similar to the turtle trading methodology. Vaca says, “What I learned from Rich Dennis is that you can beat the markets. I saw him do it. My approach to trading is statistically based; it has to be proven in a scientific way that what we are doing is correct.”
He has done that by building multiple levels of diversification and then applying rigorous scientific and statistical measures. He has 16 systems, four strategies and two timeframes to trade 70 markets. This has allowed him to produce solid returns — 27.81% in his global diversified program in 2010, a compound annual return of 19.28% since 2004 and 1.08 Sharpe ratio.
“Our first diversification is going to be the number of markets we trade. Then we want to trade as many different styles as possible because we know that nothing works all of the time. We also want to be diversified by timeframe,” Vaca says.
In building multiple styles, Vaca took the approach of an allocator. He allocates equally to his pattern recognition, momentum, trend-following and countertrend styles. Within each of those four styles, there is a short-term component and a medium-term component.
Vaca’s strategies are independent of each other. Many managers use momentum as part of their trend-following approach, but Vaca sees it as a distinct style that can be as much countertrend as trending. “Pretty much anybody can spot a trend, visually you can see it,” Vaca says. “Momentum on its own has value; you don’t need a trend to indicate a momentum trade. Sometimes the momentum is trend-following and sometimes the momentum is countertrend.”
All 16 systems are independent and equally weighted. “What the countertrend component is doing is looking at the long-term trend and waiting for a broad enough deviation from the trend, with a little bit of a reversal. Think about a trend with a hook hanging at the end,” Vaca says, “we are looking for that hook.”
His pattern recognition model is independent of trend, momentum and countertrend. “Pattern recognition is looking for a specific, quantified price pattern in the data. When that price pattern emerges, there is no additional requirement other than that this pattern [has] emerged,” he says.
“It is crucial to have different styles otherwise you are stuck with one. When that one is not working, then you are [out or in a losing trade].”
He takes every signal, even if they have opposing positions. Sometimes they all will be in one direction, even trend and countertrend. While Vaca always will have an absolute stop for every position, his risk management is more complex and, as with everything, scientific.
He has a probability overlay he applies to all his trades that is independent of the signals. “It is a pure quantitative, statistically-driven algorithm. Any given day it asks the question, ‘What is the probability the market, let’s say gold, will go up over the next X number of days?’ We profile [gold] for current volatility, momentum and price action,” Vaca says. They end up with a probability number for each market. From that, they determine whether they will lighten up a position or add to it. If it is a current signal, it sets the size of that position.
The filter improves the risk/reward of the program. Vaca acknowledges that at times the probability filter will keep him out of some successful trades, but says, “We are not trying to make a killing on any one trade in any one market on any given day. We know the probability filter will increase risk-adjusted returns over the long term.”
Vaca applies this scientific approach to everything he does. That approach has proven itself, particularly in 2010.
Continue to the next page for our profile on Fort LP...
When you offer two programs, one contrarian and one trend-following, and both programs earn double-digit returns, you are doing something right. Yves Balcer and Sanjiv Kumar have been doing things right for some time while operating commodity trading advisor Fort LP since 1993. The Chevy Chase, Md.-based CTA continues to produce strong non-correlated returns in all of its programs.
In 2010, Fort’s Global Diversified program returned 34.47% and its Global Contrarian program returned 27.85%.
They are not completely non-correlated, as the Global Diversified program is an equal mix of their trend-following and contrarian approaches. The contrarian program was launched in 2002 and has never had a negative year, even in the strong trending year of 2008. Once they launched the contrarian program, they offered it as a standalone and created Global Diversified.
“The contrarian program is trying to make money earlier in the trend,” Kumar says. “There is an overlap; it is contrarian in the short-term. The way it enters and exits is different; it is buying on weakness and selling on strength, looking for short–term reversals. It is still trying to make money in the trends.”
Kumar says that in the intermediate-term the contrarian approach could be in the same moves as their trend-following model, but gets in them earlier. Fort put the two together because it was difficult to compete with the established trend-following programs, despite success in their core trend-following approach. They needed to offer something different.
Both programs are intermediate-term and have a heavier weighting to financial instruments, mainly global interest rates. Putting them together allows Fort to take slightly larger positions in each.
It was the interest rate sector where they had their greatest success in 2010. “The curve is somewhat steep. You do benefit greatly from the steepness of the curve and riding the curve was part of the success last year,” Balcer says. “We made [about] 12% in short-term interest rates, 14% in bonds and 3.5% in FX. We made money everywhere we traded,” Balcer says. “Interest rates kept going down because governments kept printing money.”
They were long the yield curve for most of the year. “Everything has been moving up in the last couple of months, but at the same time the curve has remained very steep because the front-end hardly budged,” Balcer adds.
The two PhDs gained a lot of experience trading fixed income while at the World Bank. They were discretionary traders tinkering with a systematic approach and when they decided to launch their own programs in the early 1990s, they were ready to make the transition to systematic trading. Kumar and Balcer understood that their discretionary fundamental proprietary trading success was partly due to an informational advantage being at a large institution. That advantage would go away once they were on their own.
“It is a slightly different way of looking at the markets. You are not in the middle of that flow of information, so it becomes a lot harder,” Kumar says. “The other problem with discretionary trading is people tend to burn out. It was better for us to be systematic.”
Fort is constantly looking to improve and in 2010 they added a short-term mean reversion system to the Global Diversified program and gave it a weight of 10% with the remainder equally split between contrarian and trending.
The short-term mean reversion program positions average two to five days and only trades equity indexes. In 2010 it did not add to their overall returns, but did reduce the volatility of the program.
“In the long-term it lowers the standard deviation of the program, going forward you will see lower volatility,” Balcer says. Kumar adds, “The returns are non-correlated to both our trend-following and contrarian [models].”
Kumar and Balcer have been managing money on their own for nearly 20 years and they are still making improvements to their systematic models. No burnout in sight.
Continue to our Trader Profile on Hawksbill Capital Management...