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Futures Lab: A sample diversified portfolio of five CTAs.

Monday, September 20, 2010

A Diversified Portfolio

It does not necessarily take many commodity trading advisors to create a diversified portfolio. Only five may do the trick, as the example below suggests. It comes from Tyler Wood of Integrated Capital Solutions-see the interview with him in the next section. The analysis below is by Chidem Kurdas.

This portfolio is hypothetical in the sense that it supposes a managed account consisting of these CTAs during the period January 2007 through July 2010. The advisors and their individual returns are real, but they have not been trading in one account during the specified period.

Being hypothetical, the composite portfolio benefits from hindsight-it is designed with the knowledge of the traders' returns. It does not represent future performance, of course. But it demonstrates the diversity of CTAs, both from each other and from underlying markets, and thus the potential advantage of combining them.

Despite stellar performance by commodity trading advisors in 2008, investors did not immediately rush to managed futures. One reason people are slow to espouse managed futures is the impression that CTA returns are volatile.

Another reason is some investors' belief that lackluster performance tends to dominate over time. While 2008 was a great year for managed futures, 2009 was not good and the sector lost money. That raised fears as to long-term performance.

Constructing a diversified portfolio of CTAs is a solution to both these issues. Within managed futures, it is possible to find strategies with very different risk/return characteristics. Combining uncorrelated trading programs can result in a portfolio that has less volatility and better overall performance than the industry as a whole. Thus the Integrated Capital Solutions sample portfolio described here posted positive returns in 2009 as well as in 2008.

The largest component of the portfolio is a program that trades spreads between different contract months in the same market. The manager is Van Essen, a name that has recently been prominent on best-performing CTA lists.

CHART 1

Source: Integrated Capital Solutions

A notable feature of this portfolio is that it contains two option selling programs (chart 1). Option selling does carry special risks, as evidenced by sharp drawdowns at times. But option strategies have no or negative correlation to other managed futures strategies, so they add strong diversification to a portfolio of CTAs.

Demonstrating this characteristic, some option programs did exceptionally well in the past year while other strategies struggled, as we pointed out in our August 17 issue. One of the option programs profiled in that issue, FCI Credit Premium, is part of the ICS portfolio. It has negative 40% correlation to the Newedge CTA Index and negative 51% to the S&P 500 (chart 2).

The other option program in the portfolio is from White River. FX trading and multi-strategy programs round out the ICS portfolio. All the programs have low or negative correlation not only to the stock market but also to managed futures as represented by the Newedge CTA Index.


CHART 2   Correlations
--------------------------------------------------------------------------------------------------------------------------------------------------

Program

Correlation to

 

 

S&P 500

Newedge CTA Index

Van Essen, Spread Low Min

-0.04

-0.17

HB Capital, Multi-strategy

-0.17

-0.23

Portfolio FX - PFGBEST MFX

-0.12   

0.12

White River, Diversified Option

0.23

0.12

FCI Credit Premium

-0.51

-0.04

--------------------------------------------------------------------------------------------------------------------------------------------------

Combining these programs results in robust performance through the period (chart 3). Unfortunately, given the well-known limitations of hypothetical performance, the specific portfolio is not a model for the future. But the basic idea of combining uncorrelated CTA programs should be valid under varying market conditions. This exercise can be seen as an informal stress test for the idea.


CHART 3
------------------------------------------------------------------------------------------------------

Year

Sample Portfolio Return

2007

10.77%

2008

38.98%

2009

24.09%

2010

5.91% (through July)

-------------------------------------------------------------------------------------------------------
 



 
This article was published in Opalesque Futures Intelligence.
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