Are CTAs broken?

This analysis suggests that the performance issue for CTAs may be systemic. Despite this, CTA assets under management has increased five-fold over the past ten years.[2]

The question is: why? The most compelling explanation is that investors place a premium on assets with a low correlation to equity markets. What’s often overlooked is that a key assumption underlying modern portfolio theory is that each asset has the same expected risk-adjusted return. From the above, it is difficult to conclude that the expected returns for CTAs should be comparable to those of assets with clearly defined risk premia – like equities or credit.

A secondary explanation is that CTAs are often sold as a “hedge” with the expectation that they will perform well in a material drawdown in the equity markets, as they did during 2008. The return standard for insurance-like investments may be somewhat lower than that for others: it may be given a “pass” when it loses money as long as other assets are rising. A third possible explanation is that CTAs generally have lenient liquidity terms, a valuable feature post-crisis.

The primary beneficiary of the increase in assets under management appears to be the managers themselves. Using an assumed fee structure of 2/20, slightly less than half of gross returns were paid away to managers over the past 10 years. Adjusted for Libor, the numbers are more pronounced: fees were roughly double what the managers made above collateral interest. Over the past five years, virtually all of gross performance was paid away.

The figures raise a fundamental issue of fairness in the managed futures space and argue for a material change in the industry fee structure.  Simply put, investors should question whether managers should be rewarded for warehousing cash in interest bearing accounts.  At a minimum, a LIBOR based hurdle is warranted.

The analysis raises a serious question about whether the pre-crisis returns of managed futures funds were an anomaly or are likely to recur. Given performance over the past 10 years, it appears that investors should expect CTAs to earn 1% to 3% over time in a low interest rate environment. Moreover, the performance of systematic strategies is dependent on the ability to capitalize on market anomalies – such as evidence of excess returns from momentum or mean reversion. Recent poor performance implies that many anomalies are subject to being arbitraged away over time and that the recent underperformance of the industry is likely to persist.



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About the Author
Andrew Beer

Andrew Beer, CEO:  At Beachhead, Mr. Beer oversees all marketing and research efforts and is influential in portfolio construction. Mr. Beer began his career in mergers & acquisitions at the James D. Wolfensohn Company, a boutique firm founded by the forthcoming President of the World Bank. Mr. Beer worked in leveraged buyouts at the Thomas H. Lee Company in Boston during his tenure at Harvard Business School. Upon graduating, he joined the Baupost Group, a leading hedge fund firm, as one of six investment professionals. Additionally, Mr. Beer co-founded Pinnacle Asset Management (leading commodity fund) and Apex Capital Management (Greater China hedge fund). Mr. Beer is an active member of the Board of Directors of the US Fund for UNICEF, where he serves as Chairman of the Bridge Fund, an innovative financing vehicle designed to accelerate the worldwide delivery of life-saving goods to children in need. With his wife, Mr. Beer is a co-founder of the Pierrepont School, a co-educational K-12 independent school located in Westport, CT. Mr. Beer received his Master in Business Administration degree as a Baker Scholar from Harvard Business School, and his Bachelor of Arts degree, magna cum laude, from Harvard College. Mr. Beer lives with his wife and two daughters in Fairfield, CT.

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