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Managed Futures Strategy Focus: Systematic Multi-Market CTAs
November 10, 2008
There is something about human nature which leads us to categorizing things. You can’t just be a band anymore - you have to be pop, metal, classic rock, oldies, jazz, and so on. Likewise, there’s no such thing as a stock mutual fund anymore, it’s a small cap, big cap, growth, emerging markets, technology, etc. mutual fund now.
Despite the urge to fight this categorization of the world, we try and fit the different CTAs into different trading styles, and spotlight a certain style every now and then via our Strategy Focus newsletters. This Strategy Focus is on Systematic Multi-Market managed futures programs / commodity traders.
If you’re asking yourself what that is, don’t be embarrassed – it isn’t a category you’re likely to find anywhere else because we made it up. As you may find with a rock and roll country band or mutual fund diversified across several market sectors – there isn’t always the perfect little bucket for each type of something.
Formerly known as Trend Followers:
This is the case with systematic multi-market CTAs. Most of these managed futures programs are what once would have been called trend followers, but aren’t fitting nicely into that categorization as their strategies and the market evolve into strategies which sometimes buck the trend, trade on much shorter time frames, and more.
The term trend following is becoming a thing of the past for these reasons, although an article in the Wall Street Journal last week referring to ‘Trend Following Funds” may keep the moniker alive a bit longer.
The names mentioned in the Wall Street Journal are the bellwethers of the managed futures industry, and include names such as John W. Henry, Winton Capital, and Campbell & Co – which manage tens of Billions of dollars between them on strategies which can generally be categorized as trend following. .
The basics of trend following are to bracket the market on either side with something like Bollinger Bands or moving averages which encompass 90% of a market’s price action. The next step is to enter into a long trade when the market prices go through the upper band (signaling a new up trend) and go short (bet on falling prices) when the market’s prices go through the lower band (signaling a new down trend). Usually trend followers then stay in the trade until prices fall back to something like a 100 day moving average.
This has historically been a nice way to trade the markets, and is the basic premise behind nearly every success story in futures trading lore – from the Turtle Traders to John Henry (owner of the Boston Red Sox). But the knock on trend following, and why many of the huge firms listed above may not like that categorization anymore – is that it is a reactive strategy which is often too slow in both getting into trends and getting out of them with any profits left over. This reactive logic has been known to cause steep drawdowns as the system waits and waits to get out of a formerly profitable trade.
Indeed, a look at the track record of noted trend followers such as John W. Henry and Dunn Capital over the past 5 years shows that these types of strategies found it very tough sledding for the better parts of 2004, 2005, and 2006.
How can this be, when commodity prices were in a clearly defined trend through that entire period. Well, for one thing, those nice uptrends were not without sharp pullbacks along the way. Crude Oil, for example, had several 50% retracements on its way up to record highs.
Was it hedge funds taking profits and driving down trends which otherwise would have stayed above their moving average? Was it long only commodity funds and ETFs causing the normal supply/demand structure resulting in less “normal” trends?
Whatever it was, it sure took the luster off ‘trend following’ – with the big wigs struggling – and the number of trend following CTAs dwindling as more investors sought out strategies such as option selling which were doing well during that time.
But instead of just folding up shop and calling it quits – many managers adapted. They shortened their time frame and looked to capture trends over a few days instead of several months. They implemented new volatility filters to lessen the number of losers in low volatility consolidation periods. They went into different markets such as Malaysian Palm Oil and Japanese Rubber futures. But most of all, they merely bid their time and waited for volatility to return.
A Long Volatility Profile:
While many Systematic Multi-Market managers were rebranding themselves and coming up with ways to survive a low volatility environment, something else happened – volatility returned in a big way.
Consider that each April, Attain compares the 200 day volatility on approximately 80 markets we track against the 200 day volatility for those markets in the year ago period. As can be seen in the table below, since 2004, there have consistently been more markets which saw a decrease in volatility year of year than an increase – with only 13% of markets seeing increases in volatility 04/05, 43% in 05/06, and 28% in 06/07. – then a whopping 94% in 07/08.
# of Mkts seeing Volatility Increase
# of Mkts seeing Volatility Decrease
% Seeing Increase
It’s no coincidence that systematic multi-market models generally struggled during 2004-2007 when less than 50% of markets were seeing declines in volatility; and have done very well recently as over 94% of markets Attain tracks seeing increases in volatility. That is how good of an environment it has been, one in which 9 out of every 10 markets have seen more volatility, which can equal more opportunity.
To understand more on how this increase in volatility can help a systematic multi-market trader. Imagine that the systematic model they are using has the trader risking $1,500 on a trade. Now, it may risk that same $1,500 in 2004 as it does here in 2008. But while in 2004 the market may have only moved enough to make $1,500 for a 1 to 1 risk/reward – the market here in 2008 may be offering opportunities much greater, say $7,500 in profits, for a risk/reward ratio of 5 to 1.
This is what we mean by a long volatility profile, and one of the main reasons systematic multi-market CTAs are doing well. They are risking basically the same, but can make many times that amount when profitable. This is in direct opposition to a short volatility strategy such as option selling which looks to make basically the same amount each time by risking an unlimited amount. The other reason their doing well is that volatility is not just up in one or two markets, but essentially across the board.
Consider the table below showing the range in the soybean market in November 2006, November 2007, and November 2008. You can see that the range right now is nearly 4 times as high as it was 2 short years ago, and nearly three times as high as last November.
in Dollars ($)
This can mean there is 4 times the profit potential for a Soybean trade then there was 2 years ago. Of course, some managers position size based on the volatility of the market, and would have been doing more contracts two years ago than they are now (equaling profit potential out a bit), but the fact remains there is much more movement today than there was then.
Many of the systematic multi-market CTAs Attain has reviewed and recommends are no longer mere trend followers who depend on the old fashioned trend environments which made John W. Henry rich.
The newly rebranded systematic managers are doing much more in terms of not just when to get in and out of trends, but also on what to do when markets aren’t trending. In fact, one such manager, Claughton Capital, we’re currently doing our due diligence on actually focuses more on the consolidation periods than the trending periods, and in doing so outperformed many systematic managers in the low volatility 2006 period.
Other managers such as NuWave, Welton, and Quantitative Investment Management would likely bristle at being even associated with trend following, and are as many parts technology companies as investment firms, with people/computers poring over vast data sets with the latest in quantitative analysis and computing power to find and utilize trading models they believe will give them an edge. (Unfortunately, unless you’re in the hundreds of millions net worth category, these managers are likely out of your reach with minimums between $5 and $50 Million)
So while it may have been easy in the past to label any CTA who wasn’t doing discretionary trading, wasn’t using options, and traded across many markets as a trend follower – that isn’t the case anymore. The new breed of systematic traders generally don’t rely on a single model to see them through all market conditions, and instead are continuously expanding their research into differing methods of risk management, new markets, and future trading model development. This makes it very important to have a strong understanding of each manger’s infrastructure, research team and research process, in our opinion.
Some pros and cons of the Systematic Multi-Market strategy type are:
- Have long volatility profile in which they cut losses quickly and let winners run
- Can Capture trends across multiple time frames (without being a trend follower)
- Typically have a defined risk per trade (volatility driven or fixed)
- Offer Broad market diversification and access to traditional commodity markets
- Usually perform well in times of economic stress
- Can perform poorly in low volatility/ non-trending markets (although less true)
- Can rely heavily on research and development to maintain past risk/reward profile
- Risk of expanded portfolio volatility/drawdowns in highly correlated market conditions
- Higher minimum investment amounts even for affordable ones ($250K to $1 MM)
The systematic multi-manager programs on Attain’s recommended list include
The two APA programs (APA Strategic Diversification Program - $1 MM minimum & APA Modified - $250,000 minimum) and five Clarke Capital programs ($50K to $3 MM) on Attain’s recommended list are all systematic multi-market CTAs, but we’ve also been researching others such as Claughton Capital, Hoffman Asset Mgmt, and Robinson Langley.
IMPORTANT RISK DISCLOSURE
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Further signs of global economic weakness and ideas it could deepen in the coming months led to most sectors ending the week in negative territory once again. Ideas that global consumption and purchasing of all products will be reduced greatly from earlier expectations led most commodities down, especially energy markets. For the week RBOB Gas shed -9.89%, Crude Oil fell -9.09%, and Heating Oil lost -5.18%. Natural Gas futures ended the week a bit better on cooler forecasts for most of the U.S. and Europe.
Stock Index futures continued to be pressured by weak economic forecasts and swirling rumors on GM going bankrupt. It remained evident that, although improving, the credit sector continues to be a dark cloud over the market. NASDAQ futures -3.63% led the way followed by the Dow futures -3.35% and S&P 500 futures -3.32%. The small cap sector also ended with steep declines as the Russell futures were down -5.03% and MidCap futures lost -3.06%.
Most areas of the Metals found support on flight to quality purchases. Investors seemed to brush aside recessionary fears and ideas that the current world economics would not support current prices. Palladium +10.02% led the gainers followed by Silver +2.44%, Platinum +2.40%, and Gold +2.28%. Copper -7.32% was the loan loser in the sector as ideas that slower emerging market demand could lead to higher than expected supplies in the future.
Currencies were mixed for the week as it seemed the unwinding of the U.S. Dollar and Japanese Yen carry trades subsided for the time being. The Japanese Yen, U.S. Dollar, and Euro all ended near unchanged levels. The British Pound ended -2.77% and Swiss Franc lost -1.67% on ideas of further European rate cuts in the near future. U.S. Rate futures found support from continued signs that the credit freeze was loosening as Libor continued to downtick last week. 30-year Bond futures ended up +2.75%, and 10-year Notes futures gained +1.84%.
Most commodity and food sectors ended lower last week with pressure from world economic turmoil remaining a key market mover. The problems continue to hamper the import/export sector which has added supply to move due to the North American grain harvest being at full capacity. The grains ended lower as Corn was down -6.59%, Wheat -2.80% and Soybeans -1.70%. The soft sector was mixed as Cocoa lost -5.70% and Cotton was down -5.12%. OJ +7.33% was up on seasonal weather worries which al supported Coffee and Sugar as both settled with slight gains.
With another good month in the books (Oct), the systematic multi-market managers are looking to continue to produce positive returns in November. Market volatility remains at all time highs, and many systematic multi market programs are just now starting to dip their toes back into the market’s waters so to speak. We expect that trading activity will pick up as vol begins to subside; however until the markets calm down don’t be surprised if some managers spend more time than usual on the sidelines.
Early positive returns for the month include the APA Strategic Diversification Program (+1.86% est), APA Modified Program (+1.82% est), Dighton USA (+1.12% est) and Hoffman Asset (+1.10% est) who are posting numbers in the black.
Clarke Capital also jumped back in the game after a quiet month of October and is currently up slightly in both the Global Basic (+0.22% est) and Global Magnum (+0.33% est) programs that are tracked at Attain.
Managers that have started November slightly slower include Northside Trading (-0.27% est), Robinson-Langley (-0.29% est), DMH (-0.53% est) and Long Term Navigator (-2.17% est).
Considering the volatility still raging through the markets, most option selling mangers have remained cautious and out of the market. Here are a few estimates for November thus far; Cervino Diversified Options -0.13%, Cervino Diversified 2x -0.22%, Crescent Bay PSI -1.81%, Crescent Bay BVP -3.23%, FCI +1.20%, Raithel -0.59%, Zenith Index and Diversified are both flat.
The one exception to the above has been the Ace Investment Strategist program, which recently vowed to clients that they'll be working aggressively to limit risk yet capitalize on the current market conditions. But things aren’t going according to plan thus far, with Ace down aprox 13% to start Nov. after losing -26% in October and -54% in September. If you continue to have an account managed by Ace and would like to discuss the current risk / reward of the program please e-mail us at firstname.lastname@example.org.
In the agriculture markets trading is off to a mixed start with Chicago Capital ahead +0.52%, NDX Abednego -0.14%, NDX Shadrach -0.27%, and Rosetta down approx. -6% MTD after taking investors flat their hog spread trade. Rosetta’s drawdown from this year’s earlier equity high has now reached approximately 25%, making it an attractive point to enter into the program at a discount of sorts.
Last week was relatively slow compared to recent weeks, but still would have ranked among the most volatile weeks of the year if we were in 2004 or 2005 as markets are still extremely volatile. Volatility as measured by the VIX index has dropped by nearly 50 % from just two weeks ago but is still trading almost 50 % higher than levels seen after the 9/11 terrorist attacks. Despite a pullback in trading activity, day trading programs came out of the week positive across the board while swing trading system results were mixed.
Beginning with the day trading systems, Rayo Plus Dax had a breakout week +$18,027 on four trades. The program usually enters into positions well before any other systems have even started to scan markets for potential entries, and that strategy paid dividends last week. Elsewhere Compass SP had two trades last week for +$1,105.55 while Waugh eRL was +$1,312 on four trades. Finally, BetaCon 4/1 ESX continues to impress with another weekly rake of $871.08.
Moving on to the swing systems, Jaws US 60 lost - $631.40 on a short trade from Friday while Ultramini ES was also stopped out of a short trade on Friday for -$410.
In long-term multi-market trading, the U.S. Dollar Index has started to drift back lower after many trend following programs got in near the recent highs. Elsewhere, global stock indices slumped going in favor of most trend followers which have been holding short stock index positions for several months now.
IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.
Past performance is not necessarily indicative of future results. The performance data for the various Commodity Trading Advisor ("CTA") and Managed Forex programs listed above are compiled from various sources, including Barclay Hedge, Attain Capital Management, LLC's ("Attain") own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.
The dollar based performance data for the various trading systems listed above represent the actual profits and losses achieved on a single contract basis in client accounts, and are inclusive of a $50 per round turn commission ($30 per e-mini contracts). Except where noted, the gains/losses are for closed out trades. The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor's participation (whether or not all signals are taken) in the specified system and money management techniques. Because of this, actual percentage gains/losses experienced by investors may be materially different than the percentage gains/losses as presented on this website.
Please read carefully the CFTC required disclaimer regarding hypothetical results below.
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.