Investment

Family offices should consider commodity-trading advisers in these volatile times

Commodity-trading advisers using futures to bet on price trends have roared back into contention following this year’s surge in market volatility. 

According to the SG CTA index, they returned a positive 20.8% in the year to mid-May. David Harding’s Winton Trend Fund is up 18%. Roy Niederhoffer, a champion US trader, can boast 29.8%. 

By comparison, the S&P 500 index is down – 16.1%. The Bloomberg Aggregate bond index has fallen -9.7%.  According to consultant bfinance: “For CTA and macro strategies, the environment proved near-perfect for directional views to generate some of the best quarterly returns we’ve seen in more than a decade.”

The CTA movement was started by Richard Donchian who broke away from his family’s Persian carpet business, to develop trading tools he put to use in his managed futures fund from 1949

Greg Taunt, a partner at advisory firm IASG, says: “Futures traders need to wait for their time when conditions support their outperformance. Perhaps that time is now.”

He points out the Federal Reserve plans continual hikes in interest rates to counter rising inflation. It is preparing to sell some of the bonds on its balance sheet to lift the cost of debt further. Geo-politics and rising commodity prices are also adding to business costs, eating into the capital used for investment and dividends.

However, bonds and equities remain on historically high ratings, potentially increasing the risk of more volatility spikes, as investors adjust to a painful new reality.  This, in turn, will help CTA managers, as the derivatives they use benefit enormously from the price momentum generated by volatility. Traders know that momentum in a particular direction tends to persist for far longer than you might expect. They often use leverage to generate returns even faster. 

They have fared less well in recent years, as a result of central banks crushing volatility by pushing borrowing costs to record lows. Some funds have blown up. Even so, since 2002, CTA has beaten bonds most months, and sometimes managed to beat equities as well. Family offices have often invested in CTA managers to achieve portfolio diversity, and insure against a market slump, even though it is hard to keep up with algo-driven trading created by their “black box” strategies.

The CTA movement was started by Richard Donchian who broke away from his family’s Persian carpet business, to develop trading tools he put to use in his managed futures fund from 1949.

Larry Hite lost interest in promoting rock music in 1983 to create a managed futures fund with Man Group, which went on to buy AHL Diversified, then co-managed by hedge fund manager David Harding.  Former Man chief Lord Stanley, who led the AHL deal, later backed ISAM, another managed futures business.

John W. Henry’s early success in CTA helped fund his purchase of the Boston Red Sox baseball team. Monroe Trout, a disciple of Ayn Rand, generated 21.5% a year at Trout Trading, prior to retiring in 2015. Few could match his risk controls or insight into the way others preferred to trade.

AHL Diversified now trades 400 liquid markets. Several managers have diversified into relatively illiquid markets. Mulvaney Capital has exposure to interesting commodity niches, like orange juice and it is up 87.6% this year, according to IASG data. Skylar Capital, up 128.7%, was helped by gas and power. 

In their early years, CTA managers benefited by employing sophisticated computer programmes which gave them an early mover advantage. Bumper returns during the slumps of 2000 and 2008 were also encouraging. AHL Diversified has produced 1505% since inception in 1996.

Latterly, however, trend followers have lost some of their technological edge. Popular sectors have become increasingly crowded by new market participants, forcing some CTA managers to seek profitable niches. Some firms, like Tungsten Capital of Germany, are using AI to manage their futures, pointing to a new generation of competitors.

Trading signals became erratic as a result of central banks flooding markets with money to prevent economic collapse but the cheap money which pumped up the price of bonds and equities prior to 2022 has also served to make their returns look relatively attractive.

Karl Rogers, chief investment officer at Elkstone Partners, a multi-family office, told Family Capital in August 2020 that family offices should consider using them in balanced strategies instead of sovereign bonds, whose yields have fallen towards zero.

He now says: “Many would have thought replacing bonds with trend following would have been insane looking back how bonds have protected over the last 30 years and how poorly trend following has done over the last 10 years. Importantly, portfolio construction and investing are about thinking of today and the next 10 years and not historically.”

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