Author: Eric Uhlfelder

1 February 2005, Investment Advisor

In Pudd’nhead Wilson’s Calendar, Mark Twain observed that October is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.

For some advisors, the market’s two-year winning streak has revived confidence in equities. But any such complacency may be misplaced. Last year’s gains were only on the back of a last minute rally that now appears to have run out of steam with the turn of the calendar. And while bonds have held up remarkably well as the Fed started pushing up interest rates, government statistics are finally recognizing that inflation has returned which never bodes well for bonds.

What then to do?

Managers who have ventured into the world of alternative investments have long since discovered that commodity trading advisors [CTAs], also known as managed futures, are an effective means to diversify beyond traditional securities and to profit whatever the market is up or down to.

There’s been an explosion in assets flowing into CTAs, according to the industry-tracking firm Barclay Trading Group, driven of late by formidable movement in commodity prices and increasing awareness by institutions and retail investors that managed futures are an effective means by which to profit from this movement. Total global assets in CTAs were $51 billion as of the end of 2002. By the end of 2004, 400 CTAs were reporting $131.9 billion in assets.

Among the largest pure players are Campbell and Company [$9.4 billion under management], Graham Capital Management [$5.8 billion], FX Concepts [$4.7 billion], John W. Henry [$3.6 billion], and Sunrise Capital Partners [$2.6 billion]. [See table below for examples of specific programs these firms manage.] However, the bulk of CTAs are mom-and-pop firms who manage as little as several million dollars. Performance of most are regularly reported to various industry groups such as International Traders Research and Barclay Trading Group who subsequently provide in depth performance analysis.

By their very nature, managed futures excel during bouts of uncertainty that challenge traditional investments. Using futures contracts to make leveraged bets on various pieces of the global economy—currencies, energy, bonds and interest rates, stock indices and agricultural and consumer goods—CTAs are able to profit from price swings no matter in which direction they are heading.

Sound like hedge funds?

In some ways they are. CTA managers can invest in a far greater variety of financial instruments than mutual funds, capable of going short as well as long everything from corn to Mexican pesos. They can invest in domestic or foreign instruments. Like many hedge funds, their management costs typically average 2 percent and with incentive fees running around 20 percent, paid when a fund’s price exceeds its previous high. Some of the top hedge funds, such as Paul Tudor Jones and Renaissance Technologies, in fact started as commodity trading advisors.

CTAs, however, differ from hedge funds in two basic ways which goes to the heart of their appeal. One, they are far more transparent than hedge funds, enabling advisors to discern performance, strategy, exposure and liability. And two, many offer significantly lower minimum investments, making them available to a far greater number of investors.

To Brian Kline, an Indiana-based CPA/financial advisor and principal of Kline’s CPA group, commodity funds are an effective way of enhancing portfolio returns. “But,” he notes, “the potential for greater performance often comes with greater risk, and investors must not only be able to tolerate this, they also must do their homework in selecting and maintaining a position in a fund.” Some programs, Kline has observed, are less than scrupulous, claiming to have earned returns that just weren’t so.

To help thwart off frauds, Kline recommends advisors contact two oversight agencies, the Commodity Futures Trading Commission [] and the National Futures Association [], to vet the integrity of individual programs and to learn the ins and outs of investing in managed futures.

Risk/Return Advantage

Richard Pfister, vice president of institutional research and partner at Altegris Investments in La Jolla, California, an alternative asset manager, observes that “most money managers don’t realize that commodity trading advisors offer an effective means to diversify a portfolio with virtually no correlation with stocks and bonds while sustaining a proven record of long-term profitability.”

While the average CTA program underperformed stocks last year, they have significantly outperformed major US market indices over the longer term. Through the end of 2004, three-year annualized price returns of the S&P 500, the Dow, and Nasdaq were 1.82, 2.50, and 3.71 percent, respectively. Average annualized returns of Altegris’ benchmark ITR Premier 40 CTA index was 11.08 percent. [This dollar-weighted index is comprised of the 40 largest CTAs by assets, representing approximately half the managed futures’ assets]

Differential for five-year annualized returns since the beginning of 2000 is even greater. The S&P 500, Dow, and Nasdaq indices returned -3.71, -1.30, and -11.77 percent, respectively, while the ITR 40 was up an annualized rate of 9.83 percent.

Moreover, CTAs have been able to consistently outperform the market with substantially less risk. The historical standard deviation of the ITR 40 [the amount returns fluctuate above and below its monthly average] is lower than that of stock indices: 12.87 versus 14.81 for the S&P 500, 18.78 for the Dow, and 22.29 for the Nasdaq.

Another measurement of risk is known as the maximum drawdown–the largest price descent from a peak to the bottom of a trough. Since 1990, when ITR 40 index was created, its worst drawdown was 15 percent during an 8-month period, bottoming in April 1992. While varying in duration, all three equity indices experienced their worst drawdown [excluding the Great Depression] during the last bear market, all bottoming in September 2002. The S&P 500 fell 46.28 percent over a 35-month period, the Dow lost 33.97 percent over 33 months, and the Nasdaq collapsed by 75.04 percent over 31 months.

Perry Jonkheer, president of the Institutional Advisory Services Group, a CTA industry clearinghouse and brokerage, also echoes the benefits of CTA exposure. “Over the long term,” he observes, “managed futures can enhance portfolio returns while decreasing risk.”

A plain vanilla portfolio comprised of 60 percent stocks and 40 percent bonds can generate annualized returns of 13 percent with an average standard deviation of 12 percent. According to Jonkheer, replacing 10 percent of both stock and bond exposure with 20 percent managed futures reduces standard deviation to less than 11 percent while pumping up potential returns above 14 percent. “Even a 10 percent exposure to managed futures improves risk by 1 percent while boosting returns by 50 basis points,” Jonkheer observes.

While the efficient frontier theory on which these findings were based carries weight in the portfolio management world, advisors must be mindful that actual performance will likely vary significantly depending on the precise investments made. This point emphasizes the need for continuous due diligence to prevent significant underperformance.

Drilling Down

Where many of the largest CTAs, including most making up the ITR Premier 40 index, are diversified programs, a significant number focus on specific sectors. These programs are especially useful to ensure investment diversity. Putting money in several diversified programs may actually be redundant, where allocating assets into specific sectors ensures weighted exposure to distinct markets.

Carmel Capital, a small southern California-based private investment vehicle, with a third of it’s $9 million assets invested in managed futures, thinks investors should be exposed to 3 to 5 different CTAs, combining diversified with specific sector programs.

Concurring with this strategy, Perry Jonkheer explains that “overlaying programs that have little to no correlation with one another is among the simplest ways to reduce volatility and create a consistent rate of return.”

Since 1987, Barclay Trading Group has been extensively tracking performance of managed futures’ three largest sectors: financials and metals, currencies, and agriculture. Its findings help advisors discern average performance and risk by sector, revealing virtually no correlation with US stocks and bonds.

Financials and metals CTAs [those that invest currencies, interest rates, stocks indices, and precious metals] have been among the best performing specialized sector. Barclay found that while the 77 programs reporting suffered an average loss of 0.14 percent in 2004, they realized annualized returns of 7.20 percent over the last three years and 6.41 percent over the last 5 years. [Returns are simple averages, not asset-weighted.] Since the index’s inception in 1987, financial and metal traders had two down years in addition to 2004, off 4.70 percent in 1994 and 4.52 percent in 1999. Its worst drawdown was limited to 11.14 percent.

CTAs that invest exclusively in the foreign exchange market turned only modest gains in 2004 despite significant moves in the currency market. Of the 72 programs reporting, Barclay found that the group was up 1.44 percent. However, over the past three years, annualized returns averaged 6.20 percent and 5.14 percent over the last 5 years, significantly outpacing the broad market. Barclay’s currency index registered only two down years since its inception, off 3.33 percent in 1993 and 5.96 percent in 1994, with its worst drawdown having been 15.26 percent.

While agricultural traders had a very good 2004, with 17 programs averaging gains over 15 percent, longer term, Barclay found the sector to be among the weakest performers. Between 2002 and 2004, the sector’s annualized returns was 2.06 percent and a paltry 0.97 percent since the beginning of 2000. Historically, this sector appears to be the riskiest, having experienced four down years in the late 1990s and early 2000s, the worst occurring in 2001 when the index was off 11.75 percent. The index’s worst drawdown reached close to 20 percent.

In contrast with these sectors, Barclay’s survey of 217 diversified programs reveals that multi-sector approach, on average, has generated superior returns since 2000. While like most CTAs, they turned in only modest gains of 1.21 percent in 2004, diversified programs achieved 3 and 5-year annualized returns of 8.79 and 7.88 percent, respectively, outpacing the three sectors along with the S&P 500. Since the index’s inception in 1987, only the financial and metals sector has outperformed the diversified group on an annualized basis: 13.40 versus 11.97 percent.

While Barclay’s averages suggest that CTAs in general are not the high stakes plays many outsiders perceive them to be, advisors looking for a little more octane can certainly find plenty of programs, diversified or specialized, with higher risk/reward characteristics.

One such sector, still too small to generate meaningful averages, is option writing. But this relatively new niche is rapidly expanding, according to Barclay’s CEO Sol Waksman. “Interested primarily in selling short-term options,” explains Waksman, “these advisors short overpriced options, collecting premiums on contracts they expect will not be exercised.”

Most options programs focus on stock indices, such as the S&P 500, but they may also involve currencies, interest rates, and commodities. Key variables are current/strike price spreads, implied volatility, and length of contract.

While this category may be too specialized for many investors, it is noteworthy because of the performance of the Zenith Resources Index Options Program. Commencing operations in December 1999, the program has achieved an annualized rate of return of 30.76 percent through the end of 2004 with an annual standard deviation of just 8.01. Its worst drawdown was a mere 3.12 percent.

Just as startling is how the program, with a minimum investment of $50,000, has managed to stay off most managers’ radar screens. Its assets are a modest $18.25 million. But keeping small may be part of the program’s success, reflected in the fact that it is now closed to new investors.

President of Zenith, Ed Padon, ascribes the rare combination of consistent profitability and minimal risk to his particular options writing strategy. “Our focus is on risk, not premiums,” he explains. “We make sure that we sell S&P 500 contracts at least 100 points out of the money. This reduces the premium we can collect but helps ensure we are more often than not on the right side of the bet.”

When writing contracts, Padon tries to ensure there’s adequate liquidity in the market to establish defensive hedges if the spread closes and the likelihood of the options going into the money increases. He closed his program because he feels there currently isn’t adequate liquidity to manage additional risk.

How CTAs Work

Because futures are leveraged plays, an advisor need be right only once out of every two to three bets to make money. And downside is managed through two basic techniques: systematic trading programs [used by 70 percent of advisors] to automatically limit losses and maintenance of approximately two thirds of assets in Treasury bills as margin protection on futures position.

Systematic trading is based on a wide series of metrics including price movements and trading volumes to trigger non-discretionary decision-making. “This approach removes the emotional factor from trading,” explains Jeremy O’Friel, principal of Appleton Capital Management which also relies on systematic trading, “enabling programs to quickly cut losses while permitting profitable positions to run.”

Mark Rzepczynski, president and chief investment office at John W. Henry & Company, relies extensively on systematic trading to help sidestep many of the problems of when markets disconnect from underlying fundamentals. “We’ve achieved more consistent and less volatile results,” Rzepczynski explains, “by developing programs based on trading patterns generated by how the market responds to various stimuli.”

Therefore with momentum shifts triggering investment decisions, CTAs are largely known as trend followers. They don’t care which way the price of a currency or a commodity is heading, just so long as it keeps on heading in a particular direction. No surprise then that the least profitable times for CTAs are when price movements are trendless. “With fairly conservative stop-losses in place,” O’Friel explains, ‘it’s very easy to be stopped out of a position when prices are in flux.”

This is precisely why FX traders did not fare well in 2004. “The strong late-year rally against the dollar is what saved many currency funds from having a very poor year,” explains Michael Clarke, principle of Clarke Capital Management, who’s new FX Fund soared by more 25 percent in November to end the year up 4.75 percent.

However, Clarke’s Millennium Program, with $200 million of assets and among the best performing programs around, reveals the many advantages of diversified systematic trading. Between 1999 through the end of 2004, it has achieved annualized returns of 25 percent where the S&P 500 has lost 2.3 percent a year.

Program trades has recently enabled Clarke to profit from long positions in various oil, foreign currency, and metal contracts, which have all risen sharply. However, as of January 2005, his programs have pared back investments as trends have broken down. Only 10 percent of his assets are currently invested [his maximum exposure is normally no greater than 35 percent], sprinkled across a variety of positions. With short-term rates expected to continue to rise and long-term rates to fall, Millennium is short 2-year US Treasuries and long 10-year euro and UK bonds and 30-year US Treasuries. The program’s agriculture bets are mixed, expecting cotton and sugar prices to rally, and soybeans and wheat prices to falter.

Advisors need be mindful, however, that Clarke’s consistent performance does come with substantial risk. ITR calculates that that the program’s annualized standard deviation is 27.67, nearly twice that of the S&P 500’s, which is 14.34.

Integrating systematic approach with some discretionary authority may seem like the best way to optimize results. However, Quadriga Fund Management found that not to be the case. When the CTA started its diversified AG Fund in March 1996, it lost 10.3 percent for the year. “We had a program trading system in place, but with the ability to override the computer when our gut told us so” explains company CEO Christian Baha, “but we learned that was a mistake, like the pilot who ignores his instruments when flying into a cloud bank, only to find that relying on his senses has turned him upside down.” Since the beginning of 1997, the fund has always been profitable, enjoying annualized returns of 27.3 percent.

But like Clarke’s Millennium Program, such profitability has followed a rough ride with annual standard deviation averaging 24.17. [AG fund is not available to US investors. However, Quadriga has recently established its Series A fund that tracks a comparable investing strategy.]

All of this is not to dismiss outright the merits of discretionary trading. While diminishing as a proportion of all traders, nearly one third of all CTAs still rely on this approach. Several of the largest CTAs run successful discretionary programs with more than $1 billion in assets. Beach Capital Management has racked up 5-year annualized returns in excess of 15 percent with standard deviation under 15 percent. Over the same time, Graham Capital Management’s has generated annualized growth of more than 10 percent with a standard deviation of 4.24 percent.

Carmel Capital believes that CTA exposure should be split between systematic and specialized discretionary programs. And last year’s performance validated that strategy. According to Barclay, 85 programs that rely on at least 65 percent discretionary judgment significantly outperformed 333 systematic programs 8.70 versus 0.51 percent.

Altegris’ Pfister believes that discretionary traders can excel during specific market conditions in which they’ve developed an expertise. However, when trends change is when they are most vulnerable to underperformance. And this might explain why over four of the last five years, when markets have seen substantial volatility, systematic programs have outpaced discretionary traders by an annualized rate of 144 basis points, 6.75 percent versus 5.31 percent.

Some Fine Points About Investing

Unlike mutual funds, CTAs have a higher rate of closure. Altegris’ Pfister has found that this is most likely to occur between the third and fifth year of a CTA’s life. “This is proving to be an inflection point,” Pfister explains, “where a CTA has likely proven the ability to invest effectively but is now confronted with the tricky chore of balancing asset expansion with increasing operational costs.” Where a drawdown will not likely hurt the asset base of a large established firm, it could send new investors fleeing a younger trader, threatening investment positions and leaving it with excessive costs.

Helping investors to identify CTAs prone to failure, Greg Gregoriou, assistant professor of finance at the State University of New York, college at Plattsburgh, and an editor of Commodity Trading Advisors: Risk, Performance Analysis, and Selection [John Wiley & Sons, 2004], has found several key traits of the most sustainable programs. Tracking performance between 1990 and 2003, Gregoriou and his colleagues found that half of all CTAs do not last beyond 4.42 years. The main reasons: an asset base that was too small, excessive volatility, and management fees that were either too high to compete or too low to sustain itself.

The group identified four key metrics essential for selecting CTAs that are most likely to endure: assets of at least $2.9 million; mean monthly average returns above 0.98 percent, minimum investments of at least $250,000, and annual management fees no greater than two percent.

As with stocks, the market is starting to offer indices as a means of mitigating risk and achieving balanced returns. Plus Funds Group offers access to the S&P Managed Futures Index. The purpose of the index is to provide an accurate cross-section of the CTA world by investing in 14 diversified programs that have at least a three-year track record and a minimum of $100 million under management.

On the smaller end of the scale, RSI/Access Asset Management has created an emerging CTA Index fund that invests in 40 to 60 CTAs with each less than $20 million under management. Most CTAs are removed when AUM exceed $50 million.

And on the larger side, Barlcay, along with Asset Alliance, is currently seeking approval to market the former’s BTOP 50 index that represents 50 percent of CTA assets. Barclay’s has maintained this index since 1987, from which time it has never experienced a loss during a full calendar year. Inclusion in the index requirements including two years of trading activity and advisor experience of at least 3 years. Dating back to 1987, the index is currently comprised of 23 CTAs that are equally weighted and rebalanced at the beginning of each calendar year. Historic annualized returns exceed 11 percent.


While many CTAs’ long-term performance numbers may suggest that this asset class is a sensible alternative to traditional investments, Michael Clarke warns both money managers and investors that they should not be deluded into establishing heavy positions. “All markets can be quite mercurial,” warns Clarke, “and short-term volatility is inherent when investing in futures contracts.”

Advisors and investors must realize this in advance. Otherwise, they could suffer losses they could not afford or they may panic and sell out of their positions at the worst possible time. Accordingly, Clarke recommends that the decision to invest in CTAs should be predicated on a long-term investment horizon and significant risk tolerance, with allocation best limited to five to ten percent of an investor’s portfolio.


  • Traditional CTAs have large minimum investments that can start at $50,000 and range up to $5 million; a few are being repackaged into retail fund versions being brought to market by major brokerages—Salomon Smith Barney, Morgan Stanley, Merrill Lynch, and A. G. Edwards–offer access for as low as $5,000 for personal accounts and $2,000 for retirement accounts.
  • Annual expenses of managed accounts run between 2 and 4 percent. They currently may be in the high single digits for retail versions, but percent will likely fall as more firms start offering access to more programs. Until then, be careful to distinguish performance between the proprietary programs [the high minimum versions] and the retail version due to the latter’s high annual fees. Pro Forma restatement of performance is essential for determining past performance.
  • CTAs typically earn bonuses of 20 percent of the profit, but this is only paid when a fund’s NAV exceeds its previous “highwater mark” and is based on the difference between past and current highs. Reported returns are always net of this payment.
  • CTAs may have an early redemption fee during the first year to discourage hot money flowing in and out. While appearing restrictive, such control on the flow of cash helps advisors sustain a stable asset base and their investment positions. While some managed accounts may offer immediate liquidity, withdrawals are frequently limited to the end of the month with ten days notice.
  • Profits are not distributed to investors like in mutual stock funds, but investors do accrue tax liabilities, most of which are short-term in nature, consistent with the term of most futures contracts.
  • Programs that trade significantly below their highwater mark for a protracted period are more at risk of closure as advisors are unlikely to earn their incentive fees. When programs are closed, assets are returned to investors.
  • There are plenty of free clearinghouses that track data, including Altegris/International Traders Research [], Barclay Trading Group [], Lind-Waldock [], and Institutional Advisory Services Group [].
  • Two oversight agencies, the Commodity Futures Trading Commission [] and the National Futures Association [], promote industry integrity and provide investors with extensive information about the ins and outs of investing in managed futures.

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