Managed futures funds suffered their third down year in four in 2012 as black box strategies struggled to cope with the choppy macro conditions.
BarclayHedge’s CTA Index was down -1.65% last year, but a number of the best known funds fell even further. The $10 billion Winton Futures fund lost 3.5%, while Man group’s $17 billion AHL Diversified fell by 2.1% with BlueCrest’s $14 billion BlueTrend fund flat on the year.
After delivering stellar returns in 2008, managed futures and CTA strategies have attracted over $100 billion in assets as growing numbers of investors have been drawn to their diversification benefits. But following another year of negative returns for the sector, should investors continue to back them or are many of the existing quants models unable to cope with the zero interest rate, post-financial crisis world?
Ewan Kirk, founding partner of Cantab Capital Partners, stresses that the broader index contains a wide variety of underlying strategies and viewing it as a whole is a misnomer. Cantab’s flagship $4.5 billion fund was up around 15% last year according to brokers and Kirk insists the underlying benefits for investors in holding managed futures still hold firm.
‘The reason sophisticated investors and institutions buy CTA funds is because they are uncorrelated to equities and risk and provide diversification for their portfolios,’ he says.
‘On average, CTAs seem to have one down year every six years. It was a very difficult year, particularly for purely trend-following funds, but you cannot have everything. The only investment style that makes money all of the time is fraud.’
In fairness, quants-based funds have had to navigate a risk on/risk off environment punctuated by announcements from the likes of the US Federal Reserve and the European Central Bank sending asset classes whipsawing up and down. Coupled with the near zero interest rate backdrop, clear trends have proven more difficult to identify.
‘We believe that a major portion of the CTA returns prior to 2009 came from the interest income, says Peter Kambolin, chief executive of Systematic Alpha Management. ‘If on average, CTAs use 15% or less of equity for margin-to-equity purposes, that means that at least 85% of assets under management in the past generated 3%-4% per year in interest income from investments into Treasuries and short-term commercial paper.
‘That accounts in some cases to over 50% of CTA net returns on the year. Clearly, since interest rates have dropped to nearly 0% level, CTAs have not been able to produce any returns.’
Indeed, Pacome Breton, chief risk officer at fund of hedge funds firm FQS Capital, stresses the importance of examining the performance and track records of individual funds judged against the moves in interest rates.
‘Investors should always review and model performance by discounting the risk-free rate to the monthly or yearly returns to get a comparable understanding of the different periods,’ he says. ‘This is especially true with CTAs due to very high levels of cash. This is something we systematically carry out in all of our modelling of hedge fund performance and allows us to compare one period to another more accurately.’
But Kirk insists that despite the loss of interest rates as a source of return and the low volatility in short-term interest rate futures, for example, one of the benefits of investing across a very broad spectrum of asset classes means there will always be opportunities for managed futures fund managers.
He highlights commodities as a case in point. Several high profile funds suffered heavy losses in their commodity trading last year, but there were still attractive returns to be made from shorting natural gas prices.
However, the failure of many managers to capture these gains is indicative of the fact that many firms’ models need updating, Kambolin believes.
‘Models have to be periodically tweaked and those managers that are successful in doing so will emerge as the next best performing CTAs,’ he says.
Kirk prefers to avoid tweaking as much as possible, he says, ‘because the danger is that you are effectively taking an implicit view that the current environment is looking like last year’.
Indeed, the amount of money that CTA firms invest in their systems and data infrastructure is one of the many significant attractions of the sector, insulating it from the ‘key man’ risk that overhangs fund groups with star managers.
‘Consequently CTA funds are among the oldest strategies in hedge funds and the average duration of CTAs tends to be longer than most other strategies,’ Breton says. ‘A lot of them experienced periods of underperformance and significant outflows in the past and managed to keep their business model and funds alive. This is often less the case with other strategies.’
Mike Azlen, executive chairman of fund of hedge funds group Frontier Investment Management, expects the sector to continue to thrive with the likes of Winton continuing to see major inflows from institutional investors seeking to diversify away from bond and equity risk.
‘Even with the lacklustre performance of the past two years, the long-term track record, daily liquidity, high regulation and unique correlation profile all make managed futures a very attractive investment,’ he says.