Following commodity trading advisers

With the stock market down more than 16% in 2009, following a 38% drop last year, the idea of a non-correlated investment strategy has probably never sounded better.

The folks at AlphaMetrix LLC in Chicago are hoping to tap into the growing appetite for non-correlated performance with a strategy that could be off-putting at first, even if the numbers do seem to add up.

The $2 billion managed futures and foreign-exchange platform, which provides access to more than 60 commodity trading advisers, in January launched an investible index that tracks the performance of a pool of short-term futures traders.

February numbers aren’t yet available, but in its January debut the AlphaMetrix STTI gained 1.94%, net of fees. That compares with a 1.9% drop by managed futures strategies tracked by Lipper Inc. of New York and an 8.6% decline by the Standard & Poor’s 500 stock index.

The investible index uses 16 commodity trading advisers to replicate the performance of the AlternativeEdges Short-Term Traders Index, which was developed by Newedge Financial Inc. of Chicago.

Newedge, one of the world’s largest futures brokers, built its “theoretical” index by measuring the correlation and performance of commodity trading advisers with investment holding periods of 10 days or less.

“The argument was, with such short holding periods, the returns of these CTAs simply had to be non-correlated,” said Galen Burghardt, Newedge’s director of research.

In fact, the more than two dozen commodity trading advisers who comprise the Newedge index on which the AlphaMetrix STTI is based share a performance correlation of just 0.15. By contrast, commodity trading advisers who use more-traditional holding periods of several months generate correlations of between 0.6 and 0.8, with 1.0 representing fully correlated.

“The financial services industry is filled with people charting returns, and yet we know there is almost no predictability between past and future returns,” Mr. Burghardt said. “But we do know that non-correlated managers are likely to stay non-correlated, just as correlated managers are likely to stay correlated.”

Once it was established that these ultra-short-term traders weren’t correlated with each other, Newedge spent a year tracking the performance of 20 commodity trading advisers with at least $100 million under management, along with seven more “emerging managers,” to evaluate how the index compared with the rest of the financial markets. What they found was that as a group, the short-term traders were, in some cases, less correlated with other markets than they were with each other.

In September, for example, when the S&P 500 fell 9.2% and the Short-Term Traders Index gained 1.24%, the correlation between the two was 0.39.

Meanwhile, the correlation between the Short-Term Traders Index and the Barclay CTA Index was 0.24, and the correlation between the Short-Term Traders Index and the Lehman Bond Composite U.S. Index was 0.04.

“The idea was to create an index of short-term traders that is not correlated to anything,” said Aleks Kins, AlphaMetrix’ chief executive. “We expected short-term futures traders to demonstrate valuable diversifying properties, and we have been very satisfied with the results.”

AlphaMetrix, which licensed the index from Newedge, has so far attracted $70 million into its master feeder structure that allocates investments to the underlying commodity trading advisers.

The assets are managed by the commodity trading advisers through a separate-account format that prevents the traders from gaining access to the money, which is held by prime brokers. The separate-account structure also affords twice-monthly liquidity with three days’ notice.

The fees aren’t low, but are in line with the strategy, including a 2% management fee and a 20% performance fee at the commodity trading adviser level, and a 1% asset-based fee at the platform level.

In such a non-correlated strategy, diversification within the strategy is key, which is all the more reason to pay attention to what the 1% platform fee delivers.

“We found out last year with the hedge fund-of-funds world that due diligence was not always present,” said Matthew Tuttle, president of Tuttle Wealth Management LLC in Stamford, Conn.

As a general strategy, however, Mr. Tuttle, who manages $300 million, concurred with the logic behind focusing on short-term traders.

“The short-term traders tend to have much lower draw-downs than the long-term trend followers,” he said. “Because the best of these guys are not holding anything long enough to really take a beating.”

Questions? Observations? Stock tips? E-mail Jeff Benjamin at [email protected].