Master of One: The Specialist CTA Jeffrey Roy Chief Investment Officer County Cork LLC October 2014 Over the past 10-20 years the client/broker relationship has fully evolved from a transactional one to a consultative one and appropriately to the client’s benefit. Where commissions and fees used to be major elements of the sales cycle, now portfolio construction and access to alpha are key selling points toward attracting and maintaining investors. This combined with an expanding universe of managed futures investments to choose from have brokers and advisors, now more than ever, charged with sourcing new and differentiated Commodity Trading Advisor (CTA) strategies and then building balanced, stable portfolios out of them. Given this evolution and for ease of communication I will use the terms ‘portfolio advisor’ or just ‘advisor’ to indicate the person building the multi-CTA portfolio and ‘CTA’ to indicate the constituent Commodity Trading Advisors that are combined to form the portfolio. In this article we will: 1. Define two basic types of CTA strategies 2. Discuss the implications for each with regard to the construction and management of multi-CTA portfolios 3. Give two examples of specialist CTA strategies There are several ways to divide the universe of CTA Managed Futures strategies into categories. For our purposes we will divide them into two basic groups, generalist CTAs and specialist CTAs. Generalist CTAs are those that employ one or more general strategies across a large basket of diverse futures markets. General strategies would include trend following, momentum, mean reversion and others with the basket of markets typically numbering forty or more and spanning several sectors. Specialist CTAs are those that employ one or more strategies on one specific market or well-defined sector. Specialist CTAs can employ any number of strategy types, often more esoteric in nature, with the primary differentiator being their narrowly-defined focus on one market or sector. The title borrows from the figure of speech “Jack of all trades, master of none” which personifies the antithesis of the specialist CTA who, unlike the Jack of all trades, demonstrates a focus on, and presumed mastery of, one trade or market/sector. This is not to suggest that specialist CTAs are more effective than generalist CTAs on an individual basis but rather we will explore some of the distinct advantages offered by specialist CTAs within the specific framework of multi-CTA portfolio construction and management. When building a robust portfolio one of the most basic considerations is that one balance allocations across different exposures, presumably offering diversification on multiple levels. When building a futures portfolio this consideration is often addressed by allocating across the large number of distinct futures markets available. To accomplish this with a multi-CTA portfolio the portfolio advisor has a basic choice to make – whether to allocate to a number of generalist CTAs who each represent exposure to many markets/sectors within each of their individual programs or to allocate across a number of different specialist CTAs, each specializing directly within the markets and sectors the portfolio advisor wishes to have exposure to. To make an effective comparison of these two different portfolio approaches we need to isolate the salient considerations for both the construction and ongoing management of such a portfolio and then discuss each briefly. Construction • Specific market and sector exposures • Access to managers and ability to evaluate • Low correlation between components Management • • • • Concentration risk Autocorrelation of portfolio components Risk management Style drift Specific market and sector Exposures Diversification is a time-tested technique for lowering portfolio volatility so this consideration is important given the portfolio advisor would like to have a sufficient degree of control over the portfolio’s exposure to a variety of markets and sectors to insure it is balanced and effectively diversified. Access to managers and ability to evaluate To access these diverse exposures the advisor needs to be able to source managers that can provide them and then to be able to perform effective due diligence on those managers. There are some key differences between generalist CTAs and specialist CTAs with regard to sourcing and due diligence. Low correlation between components To maximize the benefits of diversification, namely a higher portfolio return and a lower portfolio drawdown and volatility, the portfolio components selected should have a low empirical and, if possible, low theoretical correlation to one another. Concentration Risk With the portfolio constructed thoughtfully, diversified and balanced across exposures, the portfolio advisor then needs to manage the concentration risk that can occur as allocations to various exposures change and as common themes may develop simultaneously across multiple markets or sectors. Having a high degree of control over the allocation to each market and strategy exposure benefits the advisor in this effort. Autocorrelation of portfolio components Once the portfolio has been constructed of historically non-correlated components the ongoing management of the portfolio will ideally include provisions should those components become correlated in the future. Autocorrelation is the term that gained popularity after 2008 when so many individual futures markets that historically had low correlation to one another began exhibiting a much higher correlation for an extended period of time, to an extent nullifying the benefits of diversification in those portfolios. Risk management Similar to managing concentration risk, managing the overall risk in a portfolio is benefitted by having a high degree of control over the risk budget afforded to each strategy and each market or sector. Style drift Part of the ongoing management of the multi-CTA portfolio is to assess potential style drift, or, a material deviation in a CTA manager’s approach. Style drift is important generally due to its potential for changing the expected behavior of that portfolio component unbeknownst to the portfolio advisor. The advisor’s ability to conduct an effective style drift assessment on a generalist CTA portfolio is quite different than with a specialist CTA portfolio. Having identified the salient considerations for building a multi-CTA portfolio, the portfolio advisor still needs to answer the question as to whether to build a portfolio of generalist CTAs or a portfolio of specialist CTAs. To help answer that question, the table below compares a portfolio of generalist CTAs to a portfolio of specialist CTAs within the framework of the above 7 considerations for multi-CTA portfolio construction and management. Portfolio Consideration Specific market and sector exposures Access to managers and ability to evaluate Low correlation between components Concentration risk Autocorrelation of portfolio components Generalist CTA PORTFOLIO CONSTRUCTION Market and sector allocation balancing is embedded in the CTA program = advisor has little control over diversification of portfolio. Generalist CTAs are typically easier to source and are mostly systematic trend-following which requires fairly standard due diligence. Generalist CTAs given their tendency toward systematic trendfollowing tend to be fairly correlated with one another and with the CTA indices, often exhibiting correlations > 40%. PORTFOLIO MANAGEMENT Generalist CTA programs have market, sector and strategy allocation balancing embedded and can change without notice = advisor has little control over concentrated exposure to one market, sector, strategy or theme. Due to the overlap in trading styles and markets traded it is likely that a meaningful move in one market will have each generalist CTA exposed to that market in a meaningful way which can result in undesirable market or theme concentration at the portfolio level. A portfolio of generalist CTA programs that were relatively Specialist CTA Each specialist CTA offers a narrowly defined market or sector exposure = advisor has a high degree of control over market or sector allocation balancing, i.e., diversification. Specialist CTAs are harder to find and can be systematic or discretionary which typically requires enhanced due diligence. Specialist CTAs given their narrow market or sector focus and more esoteric strategy types tend to exhibit low correlation to trendfollowing and to the CTA indices. Specialist CTA programs are narrowly focused with regard to market or sector = advisor has complete control over his allocation to that exposure relative to the total multiCTA portfolio. A portfolio of specialist CTAs can still be vulnerable to Risk management Style drift uncorrelated when the portfolio was constructed is vulnerable to those constituent CTAs becoming highly correlated when the underlying markets that each CTA trades exhibit autocorrelation. Trade level and portfolio level risk management are embedded in generalist CTA programs and generally highly dependent upon diversification which is out of the control of the portfolio advisor. Style drift assessments on a generalist CTA can be difficult given that they are generally trading a large number of markets with one or more strategies. autocorrelation to some degree depending on how varied and esoteric the strategy types are across the constituent CTAs. Trade level and portfolio level risk management are included within a specialist CTA program as well. The portfolio advisor has the added benefit of complete control over the risk budget afforded to that specific exposure provided by the specialist CTA Style drift assessments on a specialist CTA are typically more effective given their more narrowly-defined market or sector focus. For many of the reasons already stated, we at County Cork have a deep appreciation for the specialist CTA model. Founded in 2002 by Robert J. O’Brien, Jr., former President and current board member of R.J. O’Brien & Associates, we have embraced this model from the beginning. We pride ourselves on offering differentiated, niche exposures that are attractive absolute return vehicles independently but that also complement almost any existing portfolio of stocks, bonds, alternatives and other CTAs. Two examples of our specialist CTA programs open to outside investment are the RLA I Soybean Crush Program and the Fusion Equities Program. RLA I RLA I is a fundamental discretionary program narrowly focused on the three markets of the soybean complex: soybeans, soymeal, and soybean oil. Ron Anderson manages the program and brings over 40 years of commercial oilseed industry experience to that effort. Mr. Anderson’s themes are expressed generally in soybean crush spreads, soybean options and soymeal calendar spreads. The RLA I Program really epitomizes the term ‘specialist CTA’ in that it gives the investor exposure to all three markets of the soybean complex via a multi-faceted approach actively managed by a veteran of the commercial grain and oilseed industries. Please use the link below to view the RLA I Program fact sheet. RLA I fact sheet The RLA I program is active at 2,700 round-turns per million per annum, maintains a low 8% average margin to equity ratio, and has nearly 0 correlation to the Newedge CTA index making it a cash efficient addition to an existing CTA portfolio. Fusion Equities Fusion Equities is a multi-strategy systematic program narrowly focused on the domestic stock index futures and only during the day session, holding no positions overnight. 30+ individual models are aggregated spanning several distinct trading styles including momentum, pattern recognition, breakout, reversal, support/resistance, sentiment and contrarian. Each model signal is an input into a dynamic portfolio consensus algorithm which generates the portfolio entry and exit points and the position size. Please use the link below to view the Fusion Equities Program fact sheet. Fusion Equities fact sheet The Fusion Equities program is active at 5,500 round-turns per million per annum, requires little to no actual margin given that it only trades intraday, and has a slightly negative correlation to the Newedge CTA index making it a cash efficient addition to an existing CTA portfolio. We appreciate the opportunity to work with the evolving brokerage community as they embrace their increasingly important role as portfolio advisors. Please reach out to me directly to discuss. Jeff Roy Chief Investment Officer County Cork LLC 5215 Old Orchard Road, Suite 800 Skokie, IL 60077 847-324-7392 x229 office 312-719-5769 mobile jroy@countycorkllc.com Futures trading is speculative and may result in losses. Past performance is not necessarily indicative of future results.
