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Managing the Future

Commodity trading advisor programs are a great alternative: When equities zig, CTAs zag.

It's hard to believe, but this bear market has endured so long that the five-year annualized averages of two of the three major equity indices are now negative. Only the Dow is in positive territory — but by only an average of 1.07 percent since 1998.

This state of affairs understandably has left investors dazed. But for those still willing to make some moves, commodity trading advisor programs (CTAs), also known as managed futures, can be an attractive alternative to equities. By their very nature, commodity funds excel during bouts of volatility. Of course, volatility has characterized the last few years, and it's likely to continue for at least the current year, given the specter of terrorism, war and anemic corporate earnings growth.

But CTAs can excel during the good times as well. And with many brokerages making managed futures available to lower-end retail clients, advisors are coming to realize these products are an essential component of a well-balanced portfolio.

“Commodity trading accounts offer an effective means to diversify a portfolio with a near-zero correlation with stocks and funds and a proven record of long-term profitability,” says Richard Pfister, director of the CTA tracking firm International Traders Research.

How CTAs Work

CTAs invest in futures contracts to make leveraged bets on various pieces of the global economy — currencies, energy, bonds and interest rates, stock indices and agricultural and consumer goods. They are thus are able to profit from price swings no matter which direction markets move.

While there are many huge CTAs with billions in assets, such as John W. Henry and Campbell & Company, the typical CTA is a small operation, with just one or two managers. And while discretionary management still exists, the bulk of programs are systematically traded, with investment decisions triggered not by macroeconomic events but by computer recognition of distinct trading patterns. Asset allocation, however, remains in the hands of the advisor.

The Barclay CTA index, which tracks more than 300 CTAs, was up 12.23 percent in 2002, net of all expenses. This is in stark contrast with the Dow, which lost 16.76 percent, the S&P 500, which was off 22.10, and the Nasdaq, which lost nearly a third of its value.

Over the past three year years — the teeth of the bear market — Barclay reported annualized CTA returns of 6.87 percent versus the Dow's negative 10.14 percent, the S&P's loss of 14.55 percent, and the Nasdaq's 31.02 percent nosedive.

When taking into account a couple of the market's banner years, the story doesn't change much. The CTA index is up an average of 5.24 percent per year since the beginning of 1998. This bests the Dow by 4.17 percent, the S&P 500 by 5.79 percent, and the Nasdaq by 8.43 percent. And because Barclay's index is the most comprehensive around, inclusive of 320 programs that have a trading history of at least four years, its numbers are unbiased.

The reason CTAs outperform is no secret to Perry Jonkheer, president of the Institutional Advisory Service Group, another firm that tracks CTA performances. “Most brokers are focused on finding stocks that will rise,” explains Jonkheer, “which is an inherent handicap during the kind of market we've been experiencing over the last three years.”

CTAs have a far greater freedom to profit in any kind of market for three basic reasons. First, they have a product choice that extends well beyond stocks and well beyond U.S. borders. Second, they can take short and long positions. Third, most rely on an automated trading program that implements quick stops to limit downside exposure.

“Because most CTAs don't rely on discretionary decision making,” says Jonkheer, “they have eliminated the emotional component of investing, which has cost so many investors dearly by clinging to expectations that proved unrealistic.”

When Quadriga Fund Management, based in Vienna, started up its AG Fund in March 1996, it lost 10.3 percent for the year. “We implemented a systematic trading program with the ability to override the computer when our gut told us so,” explains Quadriga CEO Christian Baha, “but we found that was a mistake.”

Since the beginning of 1997, the fund has enjoyed annualized returns of 31.5 percent. Quadriga recently opened a New York office and launched two CTAs, with only $5,000 minimums, for American retail investors.

This does not mean CTAs aren't volatile. Even though it soared by more than 38 percent in 2002, the Quadriga's AG fund experienced a monthly standard deviation of 9.50 percent, and its largest drawdown (the percent fall from a fund's peak to the bottom of a cycle) was nearly 20 percent.

However, industry averages in 2002 were much lower, according to Barclay, with a standard deviation of 2.78 percent and an average maximum drawdown of 4.75 percent. For the same year, the standard deviations of the S&P and Dow were around 6 percent with maximum drawdowns of over 27 percent. Nasdaq volatility ran at 8.4 percent, with a drawdown of nearly 40 percent.

Trends and Leverage

Because managed futures are leveraged plays, an advisor need be right only once out of every two to three bets to make money. And downside is managed through two basic techniques: tight stop-losses, and the placement of approximately half to two thirds of assets in Treasury bills as margin protection on futures positions.

Clarke Capital Management, a CTA based near Chicago, offers insight into basic investment strategy. A regular in ITR's top 40 indexes, CCM runs five managed accounts and two proprietary programs with total assets of $150 million.

Its largest account is the $52 million Millennium fund, which soared by more than 35 percent in 2002. “Our strategy is to be trend followers, not trend anticipators,” explains the firm's principal Michael Clarke. As an example, he points to his relatively late entry into a long Euro position just after the continental currency hit parity with the dollar. Of his 28 percent of invested assets, approximately one-fifth is in currencies and nearly half in various interest rate positions. But the latter bets have proved tricky, revealing the costs of trendless markets.

“We've basically been betting that medium- to long-term rates in the United States will decline,” posits Clarke. “But yields have been fluctuating so much that they end up getting us stopped out of positions.” Reflecting the risk control typical of most CTAs, a yield move of as little as 10 basis points in the wrong direction is enough for his systematic program to trade him out of a position.

Though his managed accounts have high minimum investments, one proprietary program, Atlas Futures Fund, with only a $5,000 minimum investment, gives smaller investors access to his proven skills.

Clarke does warn that “like all financial markets, commodities can be quite mercurial,” and recommends that asset allocation in such funds should not exceed five to ten percent of an investor's portfolio.

That still leaves a lot of room for brokers.

Study in Contrasts

Basic return data for CTAs and for the major market indexes

Fund Name
Net Annual Returns
Monthly Std. Dev.
Worst Drawdown
Investment Expenses
Quadriga/Series A 38.42% 26.51% 32.8% 9.5% -19.93% $5,000 6.75%
Clarke Capital/Atlas Futures 10.97 11.29 NA 7.31 -17.86 5,000 9.0
John W. Henry/Westport 27.48 13.11 9.05 6.01 -13.8 5,000/25,000 8.0
Graham Capital/Fairfield 39.14 29.42 NA 6.25 -12.77 25,000 8.0
Campbell & Co./Potomac 11.38 6.2 7.96 4.37 -9.0 25,000 8.0
Barclay CTA Index/320 programs 12.23 6.87 5.24 2.78 -4.75
DJ Industrials -16.76 -10.14 1.07 5.98 -27.03
S&P 500 -22.1 -14.55 -0.55 5.71 -28.36
Nasdaq -31.53 -31.20 -3.19 8.4 -39.91
Source:,, various CTA websites

The ABCs of CTAs

  • Traditional CTAs have large minimum investments that can start at $100,000 and range up to $5 million. New retail versions being brought to market by major brokerages — Salomon Smith Barney, Morgan Stanley, and Merrill Lynch — offer entry levels as low as $5,000.
  • Annual expenses can be in the high single digits for retail versions, but will likely fall as more firms start offering more programs. Until then, be careful to distinguish performance between the proprietary program and the retail fund due to the latter's high annual fees. Pro Forma restatement of performance is essential for determining past performance.
  • Direct investments in CTAs typically have an early-redemption fee during the first year to discourage hot money flowing in and out; retail funds have less restrictive liquidation policies. Withdrawals in either case can only be done at the end of the month, with ten days notice.
  • Advisors typically earn bonuses of 20 to 25 percent of the profit, but this is only paid when a fund's NAV exceeds its previous “highwater mark.” And returns are always net of this payment.
  • Profits are not distributed to investors in the manner of mutual stock funds, but investors do accrue tax liabilities, most of which are short-term in nature, consistent with the term of most futures contracts.
  • There are plenty of free clearinghouses that track CTA data, including International Traders Research, Barclay Group, Lind-Waldock, and Institutional Advisory Services Group.
  • Two oversight agencies, the Commodity Futures Trading Commission and the National Futures Association, help ensure industry integrity and provide investors with extensive information about the ins and outs of commodity trading.
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