LONDON Smaller managed futures funds able to exploit niche commodity markets and the most volatile conditions are increasingly likely to win assets from investors disappointed with returns from the big trend-followers that dominate the industry.
Managed futures, or commodity trading advisers (CTAs), attracted a wave of assets in 2009 after performing well during the 2008 financial crisis.
Mainstream institutional money flooded into some of the best-known of these small independent asset managers, so that 60 percent of total CTA assets are now with the top 10 players.
But since 2009, industry performance has been patchy as traditional trend-following models have struggled in range-bound markets in which it is hard to gain traction.
Studies have also shown that as funds grow and attract assets from more conservative pension schemes and insurance companies, performance erodes. Managers become more risk averse and too big to effectively exploit opportunities in smaller futures markets because of the limited liquidity there.
"Large or small shouldn't define the strategy out-turn but in reality it does," said John Godden, chief executive of IGS, an adviser in the alternative investment space.
He argues that an investor using just the big trend-followers will experience a high degree of correlation in their managed futures portfolio: "They are using a lot of the same tools at the same time in the same way on the same markets."
Godden said investors need to look in different corners for real decorrelation: "Getting actual commodity plays into place is something people need to be doing. There is a feeling that they have been slightly misled in terms of what part commodities are playing in these funds."
WHAT'S IN A NAME?
Despite the CTA label, many of the biggest funds generate most of their returns from currencies, interest rates and equities futures. Their size prevents them from generating meaningful returns from smaller, niche commodity markets such as cocoa and sugar, where they risk moving the market against them.
"Often the smaller managers can spend more risk budget in some of the smaller commodities markets," said Matthew Roberts, a senior investment consultant at Towers Watson.
"The larger managers may be more focused on fixed income and currency markets."
Jan Auspurg, managing director of AQ Advisors, said that smaller funds, like his Aquila Capital Spectrum Fund, which has some 180 million euros under management, are better able to exploit commodity market signals. Energy was the biggest contributor to the fund's returns in February, for example.
"The big funds recognize that these strategies work but as soon as they reach a certain size they have to stay away from most commodity contracts, because they would be the market themselves," he said.
The biggest funds also tend to attract the biggest institutional investors but this presents its own problems. Conservative pension funds and insurers have strict rules around risk exposure and cannot tolerate huge drawdowns.
"Institutions prefer lower volatility strategies, which don't have the same upside benefits but also don't have the downside - ultimately it is not as good," said Godden. "Those institutional, slightly sanitized versions don't do the job when you need it."
A study by Attain Capital Management in August 2010 found that as assets grow, returns diminish, going from an average of 22 percent a year with less than $250 million under management, to 9 percent when strategies grow to over $1 billion.
An IGS research paper looking at performance from November 2007 to February 2009 also found that many traditional CTAs scaled back their positions when volatility spiked. "A lot of CTAs pull in their horns at these moments," Godden said.
One of the biggest problems for CTAs is that their trend-following strategies, which account for the bulk of the industry, have struggled in choppy, sideways markets where few trends establish themselves long enough for managers to put on sizeable positions.
Enter the smaller multi-strategy funds hoping to capitalize on investor disenchantment. The AC Spectrum Fund has had decent returns since its launch in May 2011, up 7.58 percent last year when the Barclay CTA Index was down 3.09 percent as trend-following strategies struggled.
Auspurg attributes the outperformance to the returns generated by the fund's carry and correlation strategies. The latter examines momentum in individual contracts and asks if this is related to momentum in other markets over 24-48 hours.
"We have determined that some markets are leading others. These are larger markets and we assume a slightly quicker information diffusion," he said.
Managers who outperformed in volatile months all point to the value of using intraday timeframes or shorter term systems.
"In 2011, the quicker systems had an advantage because they could follow these relatively rough times in a better fashion," said Auspurg. "If you have a long system dominating your trend model then you have to stay in and suffer all the volatility."
But some managers are going further. Dissatisfied with the performance of its Rochester strategy, Reech AiM Partners launched Quantik in February. This uses a model that aims to adapt to changing market conditions by prioritizing the most successful sub-strategies and sidelining those that do not work.
"We have seen in 2009 and last year that unless you could adapt quickly, your models didn't work," said CEO Christophe Reech. "We are in a different world … it can change extremely quickly, so surviving means adapting."
(Reporting by Claire Milhench; additional reporting by Eric Onstad, editing by William Hardy)