Managed Futures Today Magazine

Investors and money managers interested in diversifying into managed futures are often attracted to the daily transparency and better liquidity over the typical hedge-fund structure. However, with hundreds of Commodity Trading Advisor (CTA) programs to choose from, it can be daunting to know where to start analyzing this arena. One place to begin is with CTA indices, which compile and track performance of different CTA programs.

However, you quickly discover there are also differences between the various CTA indices in terms of construction methodology, the number of CTA programs tracked, financial audit requirements, and minimum-asset requirements.

Diversification opportunity
Sol Waksman, president of BarclayHedge, an Iowa-based managed money research firm, has been tracking CTA performance since 1987. The Barclay CTA Index is the industry’s oldest CTA benchmark. While Waksman admits there are differences in index construction and methodologies among the various CTA indices, one key point remains: “I would guess that all of the CTA indices show a very low level of correlation to equities,” he says. “The addition of managed futures provides significant diversification benefits.”

According to Bob Dubuque, vice president at CTA-tracking firm IASG, CTA indices can help investors who are looking at commodities as an asset class. “It can give you an idea of the correlation to other asset classes,” he says. “Commodities as an asset class have really evolved into a much more mainstream investment vehicle.”

In addition to its CTA Index, BarclayHedge also calculates several sub-indices, including the Agricultural Traders Index, the Currency Traders Index, and the Systematic Traders Index. Other popular CTA indices include the Dow Jones Credit Suisse Managed Futures Index, the Newedge CTA Index, the Altegris 40 Index, the Stark 300 CTA Index, the CISDM CTA Equal Weighted Index and the IASG CTA Index. “CTA index snapshot” provides an overview of these indices.
 

Benchmarking
When investors begin their foray into the managed futures arena, there is one issue that is important to understand about benchmarking, or evaluating the performance of a particular CTA program vs. a benchmark index. Managed futures simply may not lend themselves to benchmark analysis as well as other asset classes, primarily because of the number of distinct, non-correlated markets being traded, as well as the broad range of strategies utilized to trade those markets.

“Managed futures are extremely diverse and there are all sorts of strategies and techniques,” says Ranjan Bhaduri, chief research officer at AlphaMetrix LLC.

Barclay’s Waksman adds: “A major concern is whether the index is a relevant benchmark to your portfolio. If your portfolio is comprised of currency traders only, would it make sense to benchmark it against the CTA Index? Is that a really relevant index given that CTAs could be long crude oil and short cotton? No.”

Similarly, is there any value in comparing a CTA index to a widely watched commodity index, such as the Goldman Sachs (GSCI) commodity index?

“To use the GSCI as a benchmark is inappropriate,” Bhaduri explains. “It’s a pure commodity index, heavily weighted toward energy.”

In addition to differences in market composition, commodity indices are passive (long-only), while CTAs can trade from both the long and short side.

Another way
The next step is to understand how a money manager can use a CTA index to aid an investing approach.

“An index is a tool,” Waksman notes. “Which tool to use depends on what you are looking to do.”

As mentioned, some CTA indices and tracking firms offer sub-indices or the ability to strip out all the discretionary CTA programs and analyze, for example, the performance of only trend-following traders. “We find indices that break down trend-following, systematic managers or discretionary managers more interesting,” says IASG’s Dubuque. In addition to the IASG CTA Index, the firm offers a trend-following strategy index, a systematic trader index, a discretionary trader index, an agricultural trader index, a diversified trader index, a stock index trader index, and an option strategy index.

“AlphaMetrix is introducing [in February] several indices that cover different types of strategies,” says Bhaduri. “We’ve broken it down and it makes it much more appealing.”

The firm’s indices will also be available with real-time data later in the first quarter, he notes.

Survivorship bias
Another issue to understand is the so-called survivorship bias, which is an inherent part of any index. “In very general terms, survivor bias results in data from the firms that do not survive being removed from an index,” Waksman explains. “As you go forward in time your sample size is decreasing. Taking an average of a smaller number does introduce some bias, because it is only an average of the winners.”

Here’s how BarclayHedge handles CTAs that close up shop: “If a manager goes out of business in June, in July we input a zero rate of return for them for the rest of the year. Once they go out of business, some people may elect to delete their performance from January to June. We do not,” Waksman says.

AlphaMetrix’s Bhaduri believes some critics have been very unfair to CTA indices in regard to survivorship bias. “The same problem exists in the S&P,” he notes. “Enron is no longer part of any equity index. This can especially occur when you are dealing with investable indices.”

Bottom line when it comes to using CTA indices? “From an education and research perspective, [investors need to look at] how clean the data is and how possible it is for the indices to be investable,” Bhaduri says.