After gaining an average of 13.9% last year, managed-futures funds have come back down to earth this year as their managers sit with cash and look for signs of a discernable market trend.
Also known as commodity trading advisers, the managers of these alternative investment pools speculate on the prices of commodities by trading futures contracts covering more than 60 markets, from energy and financial futures to pork bellies and sugar.
Last year's sterling performance by CTAs — which contrasted sharply with the 38.5% decline in the Standard & Poor's 500 stock index — has become slightly tarnished. This year through July, CTAs lost 0.2% on average, while the S&P 500 rallied to a 9.3% gain.
The challenge facing CTAs, which often are touted as being able to generate positive returns regardless of a commodity's price direction, is an environment marked by regulatory uncertainty, low volatility and no identifiable trends. In short, they are without direction.
“The CTAs don't believe we're in a real bull market, so they have been reducing their leverage to protect last year's profits,” said Charles Gradante, managing director at Hennessee Group LLC in New York, which monitors hedge funds.
“Right now, most CTAs are sitting on a bunch of cash and waiting for some volatility, some trends to emerge and for the regulatory environment to calm down.”
At just under $200 billion, the entire CTA universe is often counted as a subcategory of the broader $1.2 trillion hedge fund universe.
One example of the stark contrast between this year and last for managed futures is illustrated by the popularity and performance of the Direxion Commodity Trends Strategy Fund (DXCTX), an indexed mutual fund launched in June 2008 by Direxion Funds in Newton, Mass.
Designed to track the Standard & Poor's Commodity Trends Indicator Index, the fund gained 9% from its launch through the end of 2008. This year through Aug. 12, it was down 9%.
At the same time, assets in the fund — which represent direct retail-investor access to the managed-futures category — have swelled by 1,900% during the past year to $400 million.
“[CTA] strategies usually prove to be inversely correlated to the broad markets,” said Paul Brigandi, vice president of trading at Direxion Funds.
Most CTAs that were flush with new investor cash last year are now making a case for sticking with their strategies as a hedge against what some are describing as an overbought stock market.
“I think the strength we're seeing in equities might not last, so if you've been given a gift, you should take it and get out of the stock market,” said Salem Abraham, president of Abraham Trading Co., a Canadian, Texas-based CTA firm with $450 million under management.
Mr. Abraham, whose strategy was up 30% last year but was down 2.5% this year through July, said that investors and financial advisers should consider CTAs as a way to balance the current stock market rally.
“When building a diversified portfolio, you want things that behave differently,” he said. “If you find in a market collapse that all of your investments go down, you're not diversified.”
The past decade has been good to the category. During the past 10 years, the average annual return of CTAs has been as low as 8.5% (in 2004) and as high as 21.3% (in 2000), without a negative year, according to PerTrac Financial Solutions LLC in New York.
Such historical performance can promote investor loyalty, and it can also help advisers who are familiar with the category justify sticking with it during a rare down cycle.
“We view managed futures as a way of smoothing out volatility, and we have always expected that the CTA business will act inversely to equities,” said Curt Lyman, managing director at HighTower Advisors LLC, a Chicago-based firm with $13 billion under advisement.
“In the near term, we believe CTA strategies have the potential to underperform a strong equity market,” he added. “But the jury is still out on this stock market rally, which leaves us moderately bullish against a backdrop of a system that a year ago was on the verge of imploding.”
CTAs typically identify trends and measure volatility based on the ratio of puts (options to sell at a future date) to calls (options to purchase at a future date).
Despite a 47% rally from its March low, the S&P 500 currently has a volatility index of about 20, which is considered neutral. If the index moved significantly below 20, CTAs would start buying call options to gain long exposure to the market.
In January and February, when the volatility index for stocks shot up to about 40, CTAs were buying put options to take advantage of the decline. But when the market turned suddenly upward in March, some CTAs were caught flat-footed and gave back their early-year gains.
“The great thing about CTAs is, they don't need a good economy; they just need movement and emotional investors, which is something we had in spades last year,” Mr. Abraham said. “Right now, we're seeing some commodities move three steps forward and two steps back, when you'd rather see them move six steps forward.”
E-mail Jeff Benjamin at [email protected].
