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Why selectors need to ‘watch out’ when choosing CTAs

Why selectors need to ‘watch out’ when choosing CTAs

Managed futures/CTA (commodity trading advisors) funds have had a tough year, with the sector ranked bottom out of all the Alternative Ucits category tracked by Citywire.

Funds in this market collectively lost 2.2% in absolute terms, while, over the past three years, the average manager has only returned 1.9% in the three years to the end of July 2017.

So how do fund managers in the sector defend performance and are fears surrounding the sector and its performance warranted?

Citywire AA-rated Hans-Olov Bornemann, who manages the SEB Asset Selection fund, said it is not so surprising investors are starting to get worried after the nine-year bull market in equities and the 36 year bull market in bonds.

Bornemann said this is especially pertinent given that 80-95% of the returns of a typical client portfolio are linked to the return of the equity, credit and the bond market.

‘In addition, the world seems to be full of alpha male leaders, which does not create a great environment. While this situation represents a huge challenge for most investors, it represents a great opportunity for managed futures/CTA funds.

‘Sooner or later, extreme market valuations and/or political instability tends to cause major market trends.

'Since CTAs have a long track record of generating excess returns, not only in favourable market environments but also during bear markets, CTAs are great at boosting the Sharpe ratio of client portfolios.'

However, Bornemann (pictured below) said investors should not be fooled into believing that high correlation translates into similar returns.

‘When it comes to selecting a CTA, however, investors should watch out. There is a huge dispersion in returns among CTAs and there is no such thing as a CTA-market beta.

‘Investors should beware of unproven managers, good-looking back tests and hidden fees in products run by investment banks. To sum up, investors are better off selecting attractively-priced CTA managers with proven 10-year track records. They do exist.’

Tackling the trend

Elsewhere, DUNN Capital’s managing director, Niels Kaastrup Larsen, who helps oversee the Montlake Dunn WMA Ucits fund with Marty Bergin and William Dunn, agree with Bornemann.

However, the pair said investors should not feel they need to second guess the current or future positioning of managers, as once invested they have already accepted the approach of trend following.

‘Some investors have recently been reluctant to invest in managed futures, as they already hold significant allocations to stocks in their portfolios.

'They are concerned that allocating to managed futures and trend following, in particular, would only be increasing their stock exposure and not providing the diversifying effects that they are looking for.

‘Managed futures, especially trend following, is designed to benefit from big directional movements. Right now, stocks are demonstrating such behaviour to the upside and trend followers are reaping the rewards in that sector.

'They will still provide the ‘crisis alpha’ they are famous for if there are big directional down movements over a sustained period of time in stocks.'

Larsen (pictured below) said this is insurance that pays investors in the good times and protects them in the bad times.

But, he said, it may cost investors in the middling times when there are no big moves anywhere, similar to what the market has seen in the first half of 2017.

‘Nevertheless, you never know when you will need insurance, so most prudent people have it all the time,' Larsen said.

'As such we have seen an increase by investors across the board who now use trend following as a core part of their multi asset portfolios, which will lead to more robust portfolios over time.’

Pressure to perform

However, KeyQuant’s A-rated duo Robert Baguenault de Vieville  and Raphael Gelrubin (pictured below), who run the KeyLux Umbrella – Key Trends Ucits fund, said fee pressure could also be causing investors to turn away from managed futures.

‘There is a lot of discussion in hedge fund publications on fee pressure. The truth is that investors are no longer willing to pay high fees for a beta product. We have to consistently be able to deliver and prove our alpha.

'In our case, we have differentiated ourselves with a different approach to trend-following, which has led to outperformance to the SG Trend Index,' Vieville added.

Gelrubin added that alpha generation is not enough as clients do not want to incur business risk.

'Because of this they demand an institutional set up on such things as current regulations, daily procedures, cash management, shadow accounting and cyber-security. Investors expect redundancy across all facets of our operations.'

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