An Institutional Product? Active Managed Futures Strategies
In recent years, the vast majority of current assets under management in the managed futures space are with active CTA managers. Active managers in the managed futures space have traditionally charged hedge-fundlike fees (base investment management fees plus performance fees) for the prospects of generating exposure to a managed futures program.
CTAs tend to be perceived as a complex and an almost scientific sector of the investment management industry, but the general objective of many of these strategies is to simply follow trends. Surveys show that upward of 70 percent of CTAs report that they make trend-following or momentum-based trading decisions.6
While managers employ a variety of proprietary processes and techniques to identify and capture price trends, the general objective does not change. Active managers justify their high fees by claiming they generate meaningful alpha,7 but academic research suggests that CTA returns comprise a significant amount of systematic exposure to trend-following strategies.
The academic paper by Professors Gorton, Rouwenhorst and Bhardwaj had a provocative title: “Fooling Some of the People All of the Time: The Inefficient Performance and Persistence of Commodity Trading Advisors.” They write:
We estimate that CTAs on average … captured most of their performance through charging fees. Yet, even before fees we find that CTAs display no alpha relative to simple futures strategies that are in the public domain. We argue that CTAs appear to persist as an asset class despite their poor performance, because they face no market discipline based on credible information. Our evidence suggests that investors’ experience of poor performance is not common knowledge.
This research suggests that exposure to simple trend-following strategies can explain most of the average outperformance of CTAs before fees.
In Search Of A Managed Futures Benchmark
If the majority of CTA performance can be attributed to systematic exposure to the market, then how does one identify that exposure?
Investors have grown accustomed to comparing investments within asset classes to a representation of the asset class, but does such a representation of CTAs exist? While there are certainly indexes that claim to represent returns of the asset class going back to 1980, such as the Barclays CTA Index8 or the CASAM/CISDM CTA indexes (equal weighted and asset weighted),9 these indexes have two main drawbacks in estimating returns from managed futures strategies:
- Returns may be biased upward: The returns for indexes of CTA managers tend to be biased upward as a result of the voluntary nature of self-reporting performance. A CTA with poor performance for a period of time is less likely to report unfavorable returns to these types of databases, resulting in an index that includes mostly favorable performance.
- Lack of a natural measuring stick: Other asset classes like equities or bonds have a natural benchmark for performance reporting. Market-capitalization-weighted benchmarks for equities or bonds mathematically represent the average return in aggregate to investors in the equity or bond markets. These are meaningful performance measures. How would one apply that to the managed futures space?
CTAs are providing exposure to various asset classes—from equities, bonds, currencies and commodities. In the end, a benchmark for managed futures must systematize the type of exposure these CTAs provide.
There is much debate about the best way to measure the performance of managed futures strategies. Given the academic research that suggests CTA performance can be explained by exposure to systematic trend-following rules, we propose that a passive, rules-based selection and weighting approach based on a meaningful measure of size of the underlying constituents provides an effective representation of managed futures strategies.