At this time, many investors thought they had achieved sufficient diversification with their investments in long/short equity and event-driven hedge fund strategies, or other alternatives such as high-yield debt and real estate. It turned out of these investments were highly correlated to equity markets, and investors found their alternative investments falling in lockstep with their traditional investments.
As a result, investors learned the hard way that portfolio diversification doesnt come from the number of managers or positions in a portfolio. Diversification comes from building a portfolio of fundamentally different return streams and managed futures offer diverse drivers of positive and negative returns.
Institutions and high net worth individuals have taken note, by boosting total investment in managed futures to its current level of over US$200 billion in assets under management. BarclayHedge estimates the figure to be as high as US$291.4 billion making it the largest hedge fund strategy in Europe.
This shift in investor sentiment twinned with a changing regulation landscape and specific macro-economic themes have been the drivers behind the growth in CTAs.
Prior to 2009 very few institutions and pension funds allocated to CTAs despite the fact the strategy represents approximately 15% of the hedge fund industry and is one of the oldest and most regulated of all the hedge fund strategies. In some cases there was little understanding of how the systematic models worked, and investors struggled to evaluate which firms model was superior.
These investors have now been drawn by the uncorrelated historical return stream, the institutional structure of the leading firms in the strategy and the high level of transparency and liquidity in the underlying investments. CTAs in general trade only in highly liquid, price-transparent futures and currency contracts and typically allow their investors monthly liquidity. Some CTAs have even begun to offer weekly or daily liquidity.
These attributes are all extremely compelling to institutional investors which have lead to the large increase in their allocations to CTAs.
Adaptive Nature of CTA strategies
Another draw for investors is that by their very nature, managed futures excel during bouts of uncertainty that challenge traditional investments. CTAs generate positive returns and uncorrelated variance through the exploitation of trends and other price behaviours that accompany large macro dislocations and event-driven spikes in volatility. As stocks and bonds often perform poorly during such periods, managed futures are able to provide downside protection.
The rise of CTAs has also seen a number of investors enter via a managed accounts structure Managed accounts are outside the remit of the looming AIFMD (Alternative Investment Fund Managers Directive). While many hedge funds reluctant to take on separate accounts, CTAs typically welcome separate accounts and offer full transparency of the underlying securities.
In parallel with this interest in managed accounts, many CTAs have structured fund products designed to attract institutional funds. This involves the appointment of independent third party specialist fund administrators, prime brokers (or FCMs), auditors, as well as paying agents and independent directors.
There has also been a significant increase in highly regulated products (side by side with the classic offshore vehicles) resulting in new requirements for more frequent and detailed reporting to regulators and investors, which they feel will generally benefit from a greater scope in terms of distribution. Within this more regulated range of fund products, there have been UCITS compliant funds created, which although they cannot hold commodity futures contracts directly, have achieved commodities exposure through a total return swap product, enabling funds to take synthetic exposure to a financial index, whose underlying consists of a diversifies range of liquid contracts, including commodities.
Recent fiscal policy and economic factors during the second half of 2010, notably the second round of quantitative easing from the U.S. Federal Reserve and the Euro-zone sovereign debt issues, have made exposure to commodities, interest rates and foreign exchange more desirable.
In different ways, the events of 2008 illustrated the need for the very best of what the managed futures industry has to offer, specifically transparency, liquidity and uncorrelated returns. Throughout the recent financial crisis, the global futures markets continued to perform well and investors with exposure to futures realised the benefits of diversification into these markets.
While we continue to live in a world where market volatility can spike as a result of political and social events, natural catastrophic events, or market glitches that precipitated for example the flash crash of May 6, 2010, managed futures may well be an essential component of the well-balanced, long-term investment portfolio capable of withstanding the financial shocks of the future. As a result we are confident that we are only in the initial stages of seeing significant assets flow from investors into this strategy.
John McCann is the managing director of Trinity Fund Administration