Commodity Trading Advisors and Capturing Alpha

I wanted to comment on the CTA performance paper I mentioned the other day. From the paper:

We focus on commodity trading advisors, a subset of hedge funds, and show that during the period 1994-2007 CTA excess returns to investors (i.e., net of fees) averaged 85 basis points per annum over US T-bills, which is insignificantly different from zero. We estimate that CTAs on average earned gross excess returns (i.e., before fees) of 5.4%, which implies that funds captured most of their performance through charging fees. Yet, even before fees we find that CTAs display no alpha relative to simple futures strategies that are in the public domain.

So, these funds do a good job of capturing alpha (or at least the beta of the strategy) but charge way too much. I am a huge fan of managed futures, but it is nothing more than a long/short approach to commodities (though some trade financials and interest rates) very similar to my paper. The marketers for these funds always compare graphs that show the benefit of adding them to a standard 60/40 stocks bonds allocation, but never to a balanced allocation including commodities (where the benefits are much more muted).

I also think this is an area that was formerly alpha that has now been commoditized to alternative beta. Most (the paper estimates 75%) of CTAs are just simple trend-followers that can be captured with some standard strategies. As an example, RYMFX was the first public mutual fund to come out trading managed futures, and cost a more expensive fee of around 1.7%. Competition will bring those fees down, and the LSC ETN charges around 75 bps.

One could substitute LSC for some of all of the commodities portion of the allocation I mentioned.

Comments

[Bob Mayo:]

I wonder how correlated the strategy is to the DJ-AIG commodity index.

By eyeballing the graphs for RYMFX and LSC it looks like negative correlation to both the DJ-AIG and the S&P 500, but there isn't enough data. Is there a longer-term data series available for the strategy?

2008 Oct 30 03:05 PM

[Roger Oveur:]

Bob Mayo,

RYMFX is designed to mimic the S&P DTI and LSC is designed to mimic the S&P CTI. Go to www2.standardandpoors.... click United States, then Indices, then Alternative Indices for lots more info including pro-forma performance on each.

2008 Oct 30 06:13 PM

[Bob Mayo:]

Thanks Roger, that is indeed good information.

Looks like the correlation of the CTI (long/short commodities) index is roughly around 0.5 and less than 0.5 for the DTI (long/short currencies and commodities) index. I'm going to read the report more extensively; perhaps they will indeed provide a little diversification.

Any reason not to include them in my portfolio?

--Bob

Pages 16-17 of www2.standardandpoors....

Page 18 of www2.standardandpoors....

2008 Oct 30 11:21 PM

[Bob Mayo:]

From reading the October 2008 report, the S&P CTI is short on all commodities except energy, where it is neutral (it will not short energy because of the risk). So it is no wonder that lately LSC has been almost the mirror image of things like DJP, which are long commodities.

The S&P DTI holds the same positions in commodities, but is also currently short on all currencies except the Yen and the Dollar. This explains the great recent performance of RYMFX.

I could not help but notice there are ETFs or ETNs for all the currencies in the index, as well as for most of the commodities. Some exceptions are hogs and cattle; ETFs for these can be traded in London or you could lump them together and trade the US livestock ETN. A similar problem might crop up for corn, wheat, and soybeans. Since the index is just an exponential moving average, it would be possible to compute it yourself and trade the ETFs/ETNs without dealing directly in futures.

2008 Oct 31 02:31 AM