This is the 22nd year Futures has profiled emerging commodity trading advisors (CTAs). While every year is unique, we have seen a trend in recent years toward more short-term programs. That continued in 2011. Perhaps this is the result of a difficult environment for trend-followers, but it also may be a realization that for emerging managers to be recognized, they must separate themselves from the pack. Last year was a difficult one for CTAs up until the fourth quarter, and the BarclayHedge CTA Index is following a similar pattern in 2011 through the summer months.
When reviewing candidates, we look not only at recent performance, but the manager’s general approach to trading, risk management and consistency in style.
Previous "Hot New CTAs" 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.
Continue reading for more on each of our top three Hot New CTAs…
Bouchard: Adapting to success
Chris Freeman always was interested in computer programming and trading, but worked in accounting and corporate finance after graduating with a degree in economics from the University of California Santa Cruz.
"I was actually programming computers before the first version of Microsoft DOS came out (in the early 1980s). I was in the accounting field, but on the side I was programming and testing systems," says Freeman, principal and head trader at Bouchard Capital.
Freeman began trading equities in 1993 and futures in 1994. Back then, he always looked at technicals and price action, but never systematized his approach. "I didn’t hold myself to any parameters; there was no system generated trade. It was more from-the-gut, seat-of-the-pants trading. That wasn’t working for me. I only became a successful trader after making an art of system-based trading," Freeman says.
In the mid-2000s Freeman was working for a firm dependent on the housing market and anticipated the industry downturn. He quit his job and decided to build a trading business. By this time he understood that his trading needed more discipline and went about designing a short-term diversified program. He had 14 years of experience in the market trading from a technical perspective, so he wasn’t starting from scratch.
"It was pretty easy to put together the Bouchard system based on all my experience programming and looking at markets and price data for so many years. It all came together," he says.
It wasn’t called Bouchard at the time and he didn’t offer it as a CTA. He initially offered it in a newsletter format where investors subscribed to it to get the signals. The program thrived in the three years it traded through subscription, so Freeman looked to take it to the next level.
"It has been through all these situations — Bear Stearns, Lehman — and it held up. That is the three-year proving ground," Freeman says.
He started out with some basic breakout methods and then went about optimizing to improve performance and make the system more consistent.
"Markets are complex, adaptive systems and the only way to survive and thrive in those markets is to build a system that adapts to [them]," Freeman says. "We use the market data, we let the markets tell us where they are going to go. The system always is taking in new information from the markets and is using this new information to [signal] new trades."
Freeman has picked up lessons from the trading masters along the way and understands that finding low-risk opportunities is a key to stronger returns.
The breakout system selects an entry level and stop or fail level and risks 1% on every trade regardless of that level. If that stop is close, he will increase the position to risk 1%.
"There is an entry level, there is a fail level; sometimes they are far apart, sometimes they are narrow. When they are narrow, we can afford to put on more positions to stay at the 1% risk per trade," he says. "I envision that as turbo trades. It is kind of like stepping on the gas pedal and if you find out you are wrong, you quickly take your foot off of the gas pedal."
When Freeman decided to offer the program as a CTA, he cut the leverage in half and brought in partner Morgan Benson to help on the business side. Bouchard is Benson’s middle name, which sounded better than some combo contemplated such as Morgan Freeman.
"When we got started we didn’t know where we would fit into the market, and from a marketing standpoint you always want to figure out what makes you unique," Benson says. "What we are hearing from clients is that we are unique. Our returns this year, not only on a monthly basis, show that we are zigging when others are zagging. An example would be the grain correction in the first part of May. It was a very profitable period at a time when long-term trend-following got whacked pretty hard."
Benson provided the initial proprietary capital in February 2010 and earned 44.97% for his trouble. The program is up 19.14% after completing a full year of trading customer funds.
For more on Bouchard Capital including contact information, click here.
Continue to the next page for our next Hot New CTA…
Tanyard: Bringing home the bacon
Tanyard Creek Capital’s Randall Cleland got a job as a meat buyer for Sara Lee in 1996 after earning his master’s in agricultural applied economics from the University of Georgia.
Sara Lee was one of the largest meat producers with a meat procurement block of about $750 million. "My title was trading manager, but that is a fancy way of saying meat buyer. My job was to buy bellies," Cleland says. He estimates that he bought between 800,000 and
1 million pounds of bacon per week.
In addition to buying pork bellies, Cleland helped Sara Lee customers — large grocery market and restaurant chains — with forecasting and forward pricing.
While enjoying his work at Sara Lee, Cleland saw the huge opportunities in trading these markets and wanted to take advantage of his growing expertise. In late 2000, he moved from Georgia to Chicago and became a member of the Chicago Mercantile Exchange to trade bellies.
Cleland did not have immediate success, but his trading improved every year. By 2003 he was making good money, but an opportunity to return to Sara Lee and run their hedging business was too good to pass up.
"I went back to Sara Lee as the risk manager for meats, which was about a $750 million per year procurement block. My job was to lock in forward pricing against the entire meat risk," he says.
After three years, he returned to Chicago to start his own livestock-based discretionary CTA.
"I wanted to get away from the corporate mindset that commodities were only for a pure hedge," Cleland says. "There were always opportunities for us to take advantage of inefficiencies in the market. And because of our position, we had a lot of information that wasn’t widely disseminated. But we never were able to use that advantage to increase our profitability. We were given the directive to be a straightforward hedging operation."
Cleland felt constrained and wanted to test his trading chops. "I respect that they were true to their mission, which was to manage a pure hedge. I just saw a lot of opportunities [ and thought] that if they are not willing to take advantage of these, someone should, [so] why not me?"
Cleland began trading customer funds in his CTA, Tanyard Creek Capital, in June 2008 and had immediate success, earning 164% for the year in his discretionary fundamental program.
"There is no system, there [are] no technical signals. When you do something so specific, you get a feel for the market. More importantly, you develop relationships with people in the industry that you are able to feed off of. You pick up tidbits of information and formulate opinions [on] the direction of the market," he says.
Cleland says 80% of Tanyard’s trades are directional calendar spreads, with 10% being options and 10% being outrights.
Cleland trades spreads to hold down volatility in big moves. "The reason is not because the outrights don’t move, it’s because [we] are able to sit during markets that are directionally volatile where [we] wouldn’t be able to with an outright long/short position," he says. "You might be 100 lower in [December] hogs today and if you are long you would be stopped out, but if you are long [December short February], the Feb might be 120 lower. The spreads allow you to stay in a market that is volatile when you otherwise wouldn’t be able to. That is why they work so well over an extended period of time."
Cleland’s use of options also allows him to maintain opportunity while holding down risk. "It is a way to get long or short a market that you think is close to a reversal but hasn’t reversed yet," he says.
He attributes his outsized returns in 2008 to this. Cleland understood that lean hogs spiked in the summer because of huge demand from China during the 2008 Olympics and expected prices to eventually collapse. He was long the near month and short further outs and purchased out-of-the-money options.
"You probably wouldn’t be able to take advantage of the entire move being outright short, but I was backspread and in the first week of August I bought (out-of-the-money) December puts and sat on them."
His returns, while not keeping up that 2008 pace, have been solid: 22.47% in 2010 after dropping 1.61% in 2009 and 26.13% year-to-date through August with a Sharpe ratio of 1.42.
"I understand the fundamentals that drive the livestock market," Cleland says. He has the track record to prove it.
For more on Tanyard Creek Capital including contact information, click here.
Continue to the next page for our next Hot New CTA…
Adantia: Taking software to the next level
Brad Kuhlin and Bob Clancy are partners in software company Vertical Management Systems (VMS). VMS has been so successful that a few years ago Kuhlin and Clancy were looking for an avenue to invest their profits, hoping to earn an additional 20% per year.
"Because we are software guys and we are math guys, we figured let’s create software to build our capital when we are sleeping," says Kuhlin, an architect of the Adantia LLC Foreign Exchange Volatility Strategy along with partners Jagjit and Punardeep Sikka.
They took a systematic approach, looking at dozens of indicators, and built hundreds of systems based on various combinations of those indicators to trade commodities.
"We eventually moved away from commodities and into FX because of the leverage, liquidity and all the attractive features of FX," Kuhlin says. "By the time we got to FX, we realized that volatility was the biggest problem. We eventually said we have to go off the reservation and make volatility our friend instead of our enemy."
What they came up with was a technical-based reversion-to-the-mean system that exploits the volatility of volatility.
"Our number one design requirement is that no human being touches a trade. We want to eliminate any potential for emotions to interfere with the mechanics of the strategy," Kuhlin says. "We have developed our own mathematics for trading mean reversion in the FX markets."
The program, which is offered at four different risk levels, runs 24 hours a day and has 125 mathematical properties that influence the decision making of the models.
"Our goal was to seize on volatility, which is more or less a constant in the FX market. The question is the magnitude of that volatility and the stationarity of that volatility in the time series. So we decided that we would not use any technique anybody else uses," Kuhlin says.
They tested the strategy on 16 currency pairs and trade the four that it performed best with: The euro, Japanese yen, British pound and Canadian dollar.
Though it is short-term and technical, it exploits central bank interventions that can create volatile swings. "That is a good thing. Every time [an intervention] happens, we ring the register because we really don’t care what influences volatility. It could be macro long-term conditions, it could be interventions, it could be anything; all we care is that there is volatility," Kuhlin says.
While this is a short-term, high-frequency approach, they can hold some profitable trades longer. "I’d say 50% of our trades are less than a day old, but the other 50% are anywhere from two days to three months," Clancy says.
The program takes advantage of less liquid markets that tend to produce movement away from the mean. "Thin liquidity is one of the behaviors that drive magnitude into the volatility signature. The fact that nobody wants to make a market at a certain location in the market forces prices adjustments. It keeps adjusting and adjusting until it finds stability," Kuhlin says. "That is by definition volatility and that is what we seize on. Stable markets are less profitable for us; we make money in them, but hyper volatile markets are where we make the most money."
Operating a completely automated system involves risk and in the fall of 2010 a glitch in their software created a large drawdown in one of their four programs.
"When you want to automate something entirely so nobody ever touches it, the exposure to bugs goes up," says Clancy. "We thought we encountered every potential for bugs in [testing] the stop-loss mechanism, but unfortunately we hadn’t and got hit by it. [If] you build software, you are going to have bugs."
It left them with a 68% drawdown, ironically in their moderate program. It is still part of their track record and a vivid reminder of the need for due diligence in an automated system. "We repaired the defect and then we tested all around where that bug was. We tested every logic combination in that part of the code to make sure we didn’t miss another bug," Clancy says.
So far in 2011 their very aggressive program is up 48.64% through August, their aggressive program is up 20.74%, the moderate program is up 19.52% and the conservative program is up 7.68%. The returns are not as correlated as you might suspect because they begin calculating the models at different times, which creates entries at
Kuhlin says the mass of technical traders leave a footprint, which often leads to herd behavior that can be detected and exploited. "They all are using the same indicators and it produces a herd dynamic in the market; that is part of what drives volatility. It is seizing on the behavioral byproducts of herds," he says.
For more on Adantia LLC including contact information, click here.
Continue to the last page for an update on last year's Hot New CTAs…
HNC legacies perform well
Our 2010 Hot New CTAs, while not all hitting it out of the ballpark in 2011, are all positive in what has been a difficult environment, showing that they have staying power.
Stratford Capital Management
Stratford gave back some of its gains at the end of 2010 and first half of 2011, but has been on a roll of late. The fundamental program, which trades equity indexes off of the leading sectors, finished 2010 up 58.42%. The program had a nasty drawdown in March as volatility spiked mid-month and just as quickly receded, but a strong second quarter had moved it back into the black and a dynamite August, 59.30%, put it up 64.18% year-to-date.
Vergho Asset Management
Vergho Asset Management (VAM) continues to impress both on a total return and risk-adjusted return basis, if not in it ability to draw assets. The short-term discretionary program finished 2010 strong, adding to the totals we reported last October to end the year up 32.03%. In 2011, VAM is up 6.14% through August and continues in its disciplined approach with a worst drawdown of 3.07% and no back-to-back negative months.
Insignia Futures & Options
Insignia had a bad stretch of returns in September and October of 2010, most likely because of volatility spikes in currencies, but still produced an outstanding 18.99% return for the year. Its Medallion program is up 7.57% in 2011 through August. Oddly, its more conservative Epoch 3 program has done better in 2011, up 32.69% through August. The option program has done well in a difficult environment, particularly for option sellers.