For the first time in the 33-year history of the Barclay CTA Index, the index produced back-to-back negative years. In fact the –1.65% return for 2012 is its second worst performance following its worst, –3.09%, in 2011. What made 2012 so difficult? There was the usual lack of trends and choppy markets, plus fear that a news event or government announcement could change the course of markets at any time.
Making 2012 more difficult is that it came on the heels of the worst year ever for managed futures. However, some niche managers did well. The Barclays Agricultural Traders Index returned 5.29% thanks in large part to this past summer’s drought, and the Currency Traders Index returned 1.71%. These sectors skewed the numbers upward while the core Diversified Traders Index was down 4%.
Sol Waksman, president of CTA database BarclayHedge, cites several factors for recent poor performance, but the biggest is pretty obvious. “When you look at various sectors — ags, energies, currencies, stock indexes — there have not been large trends the last two years,” he says.
In addition to that, markets have been whipsawed by greater government and central bank interventions and a tendency toward risk-on/risk-off trading that has caused many sectors to correlate more than normal.
“Now the dollar goes down and commodities go up, interest rates go up, stock indexes go up. When it switches to risk-off, it is the opposite. The four major sectors all are correlated,” Waksman says.
Greater correlation adds risk and the drivers of risk-on/risk-off often have been political announcements that were uncertain and frequent. “[An] announcement can switch us from risk-on to risk-off in an instant, which makes for a very choppy market with few sustained trends. These types of fundamental moves cannot be modeled,” Waksman says. “How do you trade that? With difficulty.”
Despite all that, some managers did well in 2012, which could be attributed to a greater variety of strategies.
Managed futures, like other asset classes, have better and worse environments, and 2012 was not a great climate for them, especially for the most common strategy: Medium- to long-term trend-following. But at their core, managed futures represent a group of absolute return strategies and attempt to earn profits in all market environments; many managers do, regardless of strategy.
There is a tendency in investment circles to try to benchmark every conceivable strategy, define it and place a value on it. But trend-following is not nearly as homogenous as, say, the average long-biased hedge fund or the numerous convergent arbitrage strategies.
Long equity funds are expected to match the S&P 500 returns and are considered successful in years they lose less than their benchmark index. Various convergent arbitrage strategies adhere to a belief in normal distributions and can see ugly drawdowns when markets prove to be inefficient.
However, trend-following strategies vary in length and methods, and those involved often use the term as a catchall for a variety of diversified approaches to finding value in futures markets. These mad quantitative scientists create a multiple of approaches that often are unique.
Clarke Capital Management has been trading numerous trend-following type strategies since 1996, and performed extremely well in 2012. Its Global Magnum Program returned 53.32% in 2012 and five of Clarke’s seven programs earned double-digit returns (see profile above).
Clarke President Chad Butler says the strong returns show the robustness of their models. Butler says the performance is proof that managed futures are a good non-correlated asset class. It earned strong returns in currencies and interest rates in the first quarter, particularly March.
Butler attributes much of Clarke’s success to filters that pull out potentially unprofitable trades. That selectivity is a theme for the few trend-following managers that performed well in 2012. (see “Briarwood: Nothing odd about success,” page 46).
RAM Management Group is another CTA that loosely falls into the trend-following space that not only survived 2012, but thrived. Its Aggressive Program earned 28.25% for the year.
RAM Principal Jeff Earle says they performed well in 2012 “by being very selective in our trades. We found that there were several short- to medium-term trends.”
When the dollar rallied sharply in the spring, RAM pinpointed the yen in March and the Aussie dollar in May to post double-digit profits each month. “We allocated units to the weakest currencies,” Earle says. They also caught the early move in soybeans. “What makes us different is our selectivity; we are often flat and our time frame is shorter,” he adds.
RAM’s performance is a testament to their skill in model building and execution — RAM Chairman Bob Moss executed trades for Richard Dennis in the 1980s — but also illustrates the variety across the managed futures world even for those who fall under the broad definition of trend-following.
Both RAM and Clarke employ some countertrend elements in their approaches as well as robust risk management, but having unique qualitative elements is shared across the managed futures space.
New and improved options
As noted in our October 2012 emerging manager feature, there has been a growth in the number and sophistication of options strategies. Most options players are taking a more holistic approach to volatility — buying and selling options as opposed to simply collecting premium.
While this year’s mild environment for volatility — the CBOE Volatility Index peaked in June at 27.73 and spent most of the year in the teens (see “Markets,” page 14) — was an ideal environment for pure premium collectors, option traders have taken more of a value approach to volatility following the 2008 carnage and the August 2011 spike that caused large drawdowns in the space. This change not only has provided protection from the huge sigma events that happen much more often than quantitative risk models would indicate, but also has opened up doors from allocators who dismiss pure premium collection strategies on principle.
LJM Partners (see profile, page 42) transitioned in recent years from a pure premium collection manager to a volatility trading program. Like several other options traders featured recently, LJM has added long options positions to provide some safety to their mainly options writing strategy, and found that long options could be a driver of returns as well as a risk management tool.
“Positions we put on to manage risk ended up adding to our returns,” says Lauren Caine, LJM business development manager and daughter of founder Anthony Caine. “We are managing a portfolio of long and short puts and calls instead of a straight premium gathering program.”
She says volatility as an asset class is on the rise. “It has been a huge difference in being able to sit across the table from a pension fund,” Caine says. “I have heard all the clichés, ‘picking up nickels in front of a steamroller,’ [but] it makes [asset raising] way easier. A lot more people are willing to listen and volatility strategies are doing well this year.”
ITB Capital Management Principal Jeff Dean agrees (see “Black & Dean’s options evolution,” February 2013). “People are starting to look at options a little differently,” he says.
Ziqiang (Chon) Tang, principal of Junzi Capital Engineering, employs a volatility arbitrage strategy that produced a 43.24% return in 2012. Tang says that the more holistic approach to options trading, in addition to bringing more allocators to the table, gives him more confidence in writing options. By mixing long options with premium collection, “we felt confident to be in the market, comfortable being engaged,” Tang says.
While Tang’s strategy always is short gamma, by buying options on the wings through his “black box,” the strategy gains protection and sometimes profits.
“Our black box [long option overlay] gives us the confidence to engage in the market despite uncertainty,” Tang says.
He is just one of a growing group of options traders who view volatility as an asset class instead of just looking to collect premium, a trend also highlighted by Waksman. For example, of the 102 option managers in the Barclay database, only 66 have at least three years of experience.
Despite the last two years, it is an exciting time to be involved in managed futures. Regulatory changes are opening up the space to retail investors and many programs are being recalibrated to fit into a mutual fund structure. Also, more allocators are seeing the need to gain exposure to this space.
“We have seen a sea change and you can see it in [assets under management (AUM)] figures,” Waksman says. “We have had two down years in managed futures and throughout that period AUM has grown. Having 40 Act [managed futures funds] is allowing for the retailization of managed futures.”
Continue to the next page for our profile on Clarke Capital Management...
Clarke: Maintaining excellence
We try not to repeat our Top Trader choices as there are a multitude of talented managers in the CTA world. However, given the dreary overall performance in 2012, it is hard to ignore Clarke Capital Management, despite them having been highlighted multiple times over the years, for consistency in producing solid non-correlated returns.
Clarke’s Global Magnum program earned 53.32% in 2012 and five of Clarke’s seven primarily trend-following programs earned double digits in the second worst year for the Barclay CTA Index. Also five of the programs, some of which go back 17 years, have produced compound annual returns in the teens or better. Global Magnum has a concentration in interest rates and currencies and earned double digits in February, March and May 2012.
The performance is timely as the firm is going through a transition with founder Michael J. Clarke stepping back from day-to-day operations and letting others manage the strategies he carefully designed over the years.
It is no accident that Clarke’s models have held up. In addition to creating robust systematic diversified strategies, Clarke built into to his models ways to continually optimize the strategies by weighting them based on more recent data, yet still incorporating 50 years of testing. This is not done in an ad hoc fashion but in a systematic way that gives the firm confidence to stay the course even amid the inevitable drawdowns.
The CTA was purchased by the John O’Brien family three years ago. Chad Butler became president of Clarke and is in charge of operations. In May 2012 John O’Brien Jr. took the role of CEO and Michael Clarke transitioned to chairman.
Butler says the 2012 performance is proof that the robustness of the strategies can be carried forward.
He says the task of moving over all the model code to the new entity is complete and now it is more about, “downloading all the data from Michael’s brain.”
A large task in its own right as Clarke built the models on his own and has always worked relatively independent of the larger CTA space, ensuring the uniqueness of his models.
Clarke created hundreds of models and built his seven trading strategies by bundling many of them together and applying them to a diversified group of markets. He built risk management overlays for each system and applies his “fuzzy logic trend filter” that eliminates many of the signals for each strategy.
In that regard, Clarke is similar to the small group of trend-followers able to find profitable trades in 2012 by using risk management filters to find only the best signals.
“We spent a significant amount of time with Michael going through the genesis of his models — his biggest concern is managing those models,” Butler says. “He doesn’t want to have style drift. Michael’s philosophy was not to go in there and make any material changes. We are managing the models the same way.”
Butler says they are working on creating an institutional program based on existing models with the same robustness of the current strategies but with less volatility. He says having the O’Brien brand and John Jr. heading up the firm will be an asset in creating and marketing institutional products. “We have strong relationships in place that will [minimize] the counterparty risk from the standpoint of the investor,” Butler says.
Continue to the next page for our profile on LJM Partners...
LJM: Opening up world of options
The biggest change Anthony Caine has seen since he first launched LJM Partners in 1998 is that volatility is being recognized as an asset class.
Like several traders recently profiled, LJM has evolved from a pure premium collecting CTA writing options on the S&P 500 to robust volatility traders capable of earning returns in rising volatility markets as well as from premium collection.
“I did some things extremely well, I also had some weaknesses,” Caine says of his original approach to option trading. Today Caine no longer pulls the trigger on his stable of options strategies. “I somewhat backed off from trading,” Caine says. “My role is in [directing] our macro discretionary overlay — the strategy is systematic and I am addressing how much risk to take.”
He says that LJM is much more disciplined in its approach to risk. “We have done a lot of research on selecting strikes; we track volatility and spend on hedging.”
Currently they target spending 12 to 14 basis points of risk in premium and four to six basis points in hedging.
LJM already had added long option positions to its conservative program and funds, but its original Aggressive Premium Collection program, which earned 46.47% in 2012, had a loss of 34% in August 2011 when volatility spiked.
“We made a lot of changes in our portfolio management,” says Caine, who is confident they would handle a similar spike much better now. “August 2011 was actually a much more extreme event than what occurred in 2008,” he adds, noting that volatility spiked at a faster rate.
A good example of the positive changes is that LJM’s Aggressive program earned 6% in May 2012 when the S&P 500 tanked and volatility rose rapidly. “Gamma wasn’t as high but the general movement of the S&P was similar [to 2011],” Caine explains. “Our longs were able to absorb the loss and cash in on our hedge.”
Caine says the programs have a bias against the upside. His daughter Lauren, who helps market the program, points out that this is the way they were positioned at the end of 2012. “During the fiscal cliff [debate] we shifted risk to the upside,” she says. “We were more prepared [for a rapid down move] than at any other time. We would rather take our risk on the upside.”
Caine says they remain that way in 2013. “Starting out 2013 is similar; if the market reverses we will do extremely well.”
Caine acknowledges that there is a maturation process for premium writers. “Ten years ago I might have gotten closer to the fire,” he says, adding, “[for premium collectors] without hedging the probability of a blow-up is 100%.”
He is no longer a pure premium collector, instead defining his approach as spreading between implied and realized volatility.
You don’t see too many longtime option traders, yet LJM has been around for 15 years and has produced a compound annual return of more than 20% despite experiencing and surviving some extreme volatility. Each painful drawdown has produced refinements and LJM is now at the forefront of a new, more robust volatility asset class.
Continue to the next page for our profile on White Indian Trading Company...
White Indian: Surviving turmoil
Good thing Robb Ross has a sense of humor because if he couldn’t laugh, he surely would have been crying for much of the last 14 months. Not that his unique trading strategies struggled; in fact, they thrived despite a challenging environment that had nothing to do with market activity.
Ross, who is a part-time stand-up comedian, lost half of his customer base in the twin debacles of MF Global and Peregrine Financial Group. It also meant taking a hit to the proprietary capital, including money of family members, he places in all his programs.
“Anything that I put out to the public, I have prop money in. I don’t just have skin in the game, I have blood in the game,” Ross says.
Despite these problems, Ross’s Stairs program thrived. He also rolled out his Scantily Clad Straddle (SCS) program in 2011, which he introduced in 2010 (see “Options naked straddles: A more modest approach,” Jan. 2011). That program earned 17.94% in 2012 with White Indian’s Stairs program earning 28.72%. He also introduced a strangle version of the SCS and offers numerous versions in the various sectors he applies it to.
The Stairs program (see “White Indian and rubber chickens,” Aug. 2010) is a countertrend program that trades exclusively S&P 500 futures and options.
“Basically my system is unique in that it looks for trend decay, period,” Ross says. “Once it spots trend decay, say I take a short position in futures or buy a put; win, lose or draw my next position will be long, buying futures or buying a call.”
The program earned double-digits in June, July and October 2012 when the S&P 500 experienced extremely choppy markets, allowing customers to earn strong returns when other investments were most likely under stress.
“Choppy markets are my friend; very strong trending markets are not my friend,” Ross says. “You look back at 2008-09, I hit four out of five winning trades and I had several trades that were 60-point winners in the S&Ps. Those choppy markets that seem to be taking a trend for a couple of days and then reverse, those are usually the times that I make money. “
The SCS program sells straddles and then will buy or sell the underlying futures depending on where the market moves. It collects premium similar to a naked option writer but protects itself with futures when one end of the straddles gets close, hence the scantily clad moniker.
Both strategies are unique and offer non-correlation to not only traditional asset classes but also to the CTA universe. “I want to offer products that you are not going to find at other CTAs or CPOs,” Ross says. “In the trend-following space there are a lot of very successful traders. Why would I go into that space?
Ross now has $3.4 million under management but he has faced some big headwinds not related to performance and has proven that he is a survivor.
“I feel like I am in a space with a great potential for growth because I am filling a need,” he adds. And that is no joke.
Continue to our Trader Profile on Briarwood Capital Management...