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A Look At CTA/Managed Futures

By: Danielle Silva

In 2011, analysts at BHA collected 691 mandates for CTA/managed futures funds, which represented 32% of all mandates received. CTA was the third most popular hedge fund strategy, preceded only by long/short equity (65%) and global macro (42%). Although the typical CTA fund in 2011 was down, these funds seem poised to see substantial inflows, particularly from pension fund consultants and UCITS investors.

CTA funds invest in exchange-traded futures contracts and over-the-counter (OTC) forward contracts using a discretionary or systematic approach. Managers who take a discretionary approach generally rely on their research, judgment, and experience to make investment decisions. By contrast, systematic managers rely on one or more computer-trading models. Each model is built with different algorithms, and managers run the models individually or in various combinations depending on market conditions.

CTA managers also typically take a trend-following or non-trend-following approach. Discretionary trend-following CTAs focus on long-term market movements. When a trend appears, traders will monitor it, increasing or decreasing their position only after determining whether the trend is stable. The main underlying assumption driving this approach is that trends will persist for a long period of time. Thus, these traders are not quick to take a position. When they do, however, they hold it for a period that typically exceeds one month.

Systematic trend-following managers also focus on long-term market moves but track trends using more sophisticated mathematical modeling, such as non-linear regression modeling. CTAs that employ such advanced statistical approaches generally rely on a few patterns that they have uncovered during their quantitative research process.

Compared with trend-following managers, non-trend-following managers generally hold commodities for shorter periods. These holding periods can be as short as several hours or as long as five days. Generally, most non-trend-following CTAs take a discretionary approach. Although these managers build positions more quickly than trend-following managers, the trades are relatively small, so there is little risk per trade.

Some non-trend-following CTAs are known as short-term systematic traders (Pending:STST). They profit from short-term market movements. Only a small percentage of CTA funds employ this approach because it is hard to develop a system that produces consistently positive returns.

It is worth noting a couple of other differences between trend-following and non-trend-following CTAs. Trend-following funds tend to invest in a large number of markets, whereas non-trend-following CTAs tend to focus on fewer sectors. Trend-following CTAs have higher volatility and lower returns than non-trend-following CTAs; however, the latter frequently have a higher correlation to the equity market and, thus, may not provide as much downside risk protection in a traditional investment portfolio. In the past, the returns of trend-following and non-trend-following CTAs have been uncorrelated.

Some investors have been less comfortable with CTA funds compared with other hedge funds employing fundamental strategies, such as long/short equity or global macro, which use more transparent trading models. Some larger consultants, however, have noted that CTA funds are becoming increasingly transparent. Thus, many pension fund consultants are looking to put money to work with CTA fund managers in 2012. Managers running UCITS-compliant CTA funds may also experience positive inflows throughout 2012, according to a recent study.2 UCITS-compliant products typically help to allay investors' fears regarding transparency.

Given that the economic environment continues to favor CTA funds and large institutional investors are taking a closer look at this strategy, 2012 could prove to be a big year for CTA/managed futures fund managers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.