Managed Futures Strategies

April 23, 2012

The Rise Of Systematic Trading Approaches In CTAs
While discretionary CTA managers still exist, today approximately 80 percent of the universe of managed futures trading advisors comprises strategies that rely on systematic, computerized approaches to generate market-trading decisions.5 In theory, systematic trading strategies strive to eliminate any element of luck in generating alpha. As with most investment decisions, there are strengths and weaknesses associated with systematic strategies:

Strengths

  • Decisions are determined by computer models, which help maintain a consistent and disciplined investment approach by removing emotion and reliance on manager discretion
  • Allows for the historical study of price data to research, develop and test strategies that results in a repeatable process that can be quantified and studied to improve consistency
  • Portfolio construction using various markets and sectors to increase diversification
  • Investing in a passive manner diminishes the impact of some of the traditional obstacles to investing in CTAs and also lessens the burden of how to find and monitor the best CTA managers

Weaknesses

  • Systematic trading systems cannot adapt to news or environments that are different from past environments from which the models were initially derived

Constructing A Systematic Approach To Managed Futures
In constructing a passive approach, two index design decisions must be made:

  1. What constituents to include
  2. How to weight them

While other index-based approaches exist in the market, we will focus on the Diversified Trends Indicator (DTI) in this piece for illustration. Developed by Alpha Financial Technologies LLC10 the DTI comprises 24 liquid commodity and financial futures contracts that are grouped into 17 sectors with 50 percent exposure to commodity futures and 50 percent exposure to financial futures (defined as currency and interest-rate futures only).

While equity futures certainly are some of the most actively traded futures contracts, there is a reasonable debate about whether they add value to a managed futures program if the goal is creating a noncorrelated vehicle to the traditional equities futures and bond portfolios. In our judgment, leaving equities out of the constituent list lowered correlation of a managed futures strategy to traditional equity allocations.

Figure 1 illustrates the futures composition of the DTI; note this is a long/short index based on trends. In the DTI, energy can only be long or flat, never short. When energy is flat, the allocations are spread pro rata to the remaining sectors.

The weights for the commodities subsectors are designed to reflect and approximate the relative production value and liquidity of the various commodities, one of the most natural ways of measuring their performance. Meanwhile, for currencies and interest rates, the weights reflect and approximate the various country exposures to global GDP.

DTI Component & Sector Weights

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