Commodity Trading Advisor (CTA) returns have been lackluster in recent years, which has led some observers and investors to question the value of managed futures within a portfolio. The CTA Value Added Index (VAI™) was developed by Auspice Capital to demonstrate that managed futures consistently add value over the long term, not only in times of financial crisis. Additionally, the CTA VAI can be used to implement a simple market timing strategy that can further improve portfolio performance.
Some of the reasons for adding CTA exposure are well understood: The overall low correlation to equities and the historical negative correlation at times of equity market weakness. From 2004 through 2013, the correlation of the Barclay BTOP50 Index and the S&P 500 has been −0.01 and perhaps most importantly, during the crash of 2008, this correlation turned negative, moving to −0.65.
This is all good; however, investors often become frustrated when CTA strategies go through periods of relatively poor performance, often exiting these investments at exactly the wrong time because of behavioral biases. Too often investors sell at the bottom leaving them unprotected for the next market crash, or get in following sustained up moves.
However, managed futures in recent years has been accepted globally as an important portfolio diversifier by both institutional and retail investors. In Europe, more assets have gone into CTAs than any other hedge fund strategy since 2008. This makes it the most allocated to alternative strategy in Europe; almost 20% of the $382 billion European market.
The level of institutional investors in CTAs has tripled since 2008 (see “Moving toward growth,” right). This interest continues to grow even with the positive performance in equities since 2009. In North America, the focus primarily has been institutional participation.
However, in the last five years a rapidly gaining retail, Wealth Advisor and Registered Investment Advisor (RIA) channel is developing, accessed through 40 Act Mutual funds (US), ETFs and Indexes.
One of the characteristics of a traditional trend-following CTA strategy is that it goes through periods of extraordinary gain and then also extended periods of lackluster performance. Often these periods are modest pullbacks with many CTAs drawing down less than 25% from highs—less dramatic than the equity pull backs we have seen. The periods lacking performance often occur while the traditional equity markets are doing well (for example 2011 to 2013), which may be a perceived negative for many investors who are looking for constant gains.
While on an absolute basis, any investment that is performing below the average return level of the portfolio is a drag on returns, but on a risk-adjusted basis this may not be the case. A non-correlated asset, even with lower absolute returns, may reduce portfolio volatility and drawdowns, thereby improving the risk-adjusted performance of the portfolio over the long term.
That raises the question of whether CTA exposure should be held at all times or only added when a crisis is imminent, a difficult thing to try and quantify. We set out to determine whether managed futures adds value over time and if there is a timing aspect to consider that may add additional value.
The idea for the CTA VAI was conceived to address directly a common investor sentiment that CTA performance was a drag on their portfolio.