Commodity Trading Advisors Managed futures Dr Sheeba Kapil

Commodity Trading Advisors Managed futures Dr Sheeba Kapil 1

Managed futures o 30 yr old industry of professional money managers k/a CTAs o Objective: seek profit potential Lower portfolio risk: diversification Negative correlation : stocks & bonds Maintain positive returns even in bear markets o o o 2

1. CTAs are traders (individual, firm) qualified & licensed by the CFTC 2. Provide specific futures trading advice for commodity trading 3. Provide specific trading recommendations 4. When to establish long/ short positions in o Metals o Grains o Soft commodities 3

Regulation Held accountable, & have to comply with many rules and regulations set forth by the CFTC Register with CFTC Furnish Rigorous disclosure documents reviewed by NFA 4

HISTORY o o o o Exchange traded equity derivatives 4 -6 yrs old Future exchange physical commodities 1875 Cotton was the 1 st product to be traded, oilseeds, jute, wheat etc After independence UK 1947 set back 1952: cash settlement & option trading was banned FMC: commodity futures market began taking shape 2002: NMCE 5

Exchanges list a no. of products But trading is only in handful o o NMCE: 61 listed, 6 actively traded (jute, pepper, coffee) MCX: 9 of the 50 listed (precious metals, crude oil) NCDEX: 16 of the 39 listed (gaur & soy) NBOT: 1 of the 6 listed 6

Evaluating CTAs o Fees o Trading program (trend followers, market neutrals) Trend followers: proprietary technical or fundamental trading systems or both When to go long/short in certain futures market Market Neutral Traders: profit from spreading different commodity markets, delta neutral programs, non-directional trading strategies o o o 7

Drawdowns o o Peak to valley drawdown Largest cumulative decline in trading account How long a CTA took to make back the losses Shorter the time required to recover from drawdown the better the performance 8

Annualized rate of return o These performance numbers are provided in the disclosure document, but may not represent the most recent month of trading. o want to know, for example, if there have been any substantial drawdowns that are not showing in the most recent version of the disclosure document. 9

Risk-Adjusted Return o o o Dispersion of losses Calmar ratio Sharpe ratio Alpha coefficients Compare performance in relation to certain std benchmarks like sensex, nifty 10

Top 10 CTA- (2004 -07) Ranked compounded annual return Programme name or manager 3 - yrs comp. ann. return Chicago capital mgmt 75. 37% Pixley capital mgt Dighton worldwide Dighton capital USA Financial commodity investments 66. 59% 54. 15% 49. 36% 42. 73% AAA Capital mgt (energy) Rosetta capital mgmt CKP finance associates 42. 04% 28. 67% 28. 24% 11

Top 10 CTA- (2004 -07) Ranked by sharpe ratio Programme name or manager K 4 Capital mgmt 3. 03 Chicago capital mgmt AAA capital mgmt Financial commodity invsts Zenith resources (index options) 2. 43 2. 19 2. 12 1. 76 Witter & lester (stock index) LJM partners Newton capital partners 1. 71 1. 68 1. 57 12

Literature review o Literature on CTA efficiency non-existent (4 std) o CTAs use long/short positions coupled with leverage to enhance portfolio returns o Traditionally CTAs trade 50 -100 futures contracts on various global markets & Attempt to minimize their losses as they occur 13

o International derivatives & securities mkts database CISDM, MSCI world index, HFR hedge fund composite index, zurich CTA index o Cross efficiency model help to examine the trading efficiency of CTAs Following optimization obtained max Σur yro + uo/ Σ vixio 14

o Small CTAs trade less frequently o Are less efficient as large CTAs o Large CTAs take less risk (high fees ) o Efficient CTAs also have high sharpe ratio & spearman correlation ranking is positive significant o Amount of leverage is related to performance 15

o Simple efficiency, Cross efficiency & super efficiency models can be used to select the CTAs o CTA have been found to reduce the volatility of portfolio in down markets o CTAs improve portfolio's mean variance characteristics, reduce incidence of kurtosis 16

o CTAs provide greater shelter than hedge funds, mutual funds in bear markets because of their negative correlation to markets o All investors benefit by allocating resources via CTAs o SEBI must provide for adequate role of CTAs in Indian market 17

o The CTAs must be encouraged to participate in Indian market directly o They must ensure the benefit of the investors o They must be designed to add benefit to portfolios in downside market as shown by empirical results o Efficiency of CTAs must be monitored with help of efficiency models to 18

o The government must sponsor studies on CTAs as trading advisors and their role in India o These studies must assess the need, relevance and efficiency of CTAs in Indian capital market o These studies should aim at maximizing the return to the individual as well as the institutional investor o With protection during downside market and lesser volatility, CTAs will definitely provide a thrust to portfolio returns for both government as well as the private institutional portfolios. 19

o Thank you 20