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Opalesque Futures Intelligence

Insider Talk: 2011 and beyond: Opportunities and risks in futures markets. The Triton Capital team looks ahead.

Friday, January 07, 2011


Richard Singer

2011 Opportunities and Risks

We asked Richard Singer, Jay Ramey and Stephen Klawitter what they expect in the new year. Messrs. Singer and Ramey are managing directors of Triton Capital Advisors and Mr. Klawitter is senior vice president at the firm. Below they talk about managed futures performance, strategies and investors.

Triton, founded in 2009, helps clients select commodity trading advisors. The executive team previously worked together at Altegris Investments as well as other firms. Mr. Singer was a CTA from the 1970s into the early 1990s.



Opalesque Futures Intelligence: What's in store for futures markets?
Richard Singer: Today there are many more futures markets and participants than there were when I started trading futures in 1971. Then it was more of a natural resource environment which included grains and metals (no gold, though). But there were no futures for stock indexes, interest rates, energy and currencies. Investing in the commodity markets started to change dramatically in 1970s, when we experienced poor global grain production while worldwide demand for grains expanded. That, coupled with a falling stock market, led to more people entering futures trading and new markets evolved. Futures became a very viable investment vehicle. In the 1980s commodities took a back seat as equities came out of their long bear market, but world demand and markets kept on growing. I expect new players will continue to enter futures markets as China and other third world countries fuel global economic growth and raw materials demand.

OFI: Where is futures growth coming from?
Jay Ramey: Bullish commodities trends continued in 2010, primarily in non-cyclical commodities like gold and agriculture, with some of the highest growth in futures trading volume coming from China and other emerging markets. Emerging markets have a long way to go, which bodes well for futures markets.

RS: The impetus is not only from China but more broadly from emerging markets, in particular India and Brazil, even some frontier economies. Emerging markets will certainly remain a strong theme into next year. Industrialization fuels demand for futures. We should see markets expanding even further.

Performance

OFI: What helped CTAs in 2010?
Stephen Klawitter: There were strong trends and broad-based trend rotation amongst futures sectors throughout the year. The first half was about financials such as currencies and bonds, while the second half was dominated by strong momentum in commodities as well as currencies. In currencies, CTAs made good money trading the euro, yen, Australian dollar and Canadian dollar. One broad theme is cross-currency relationships between developed economies and emerging markets, which is commodity related. Another is the direct commodity story. Either of those themes can be profitable for managed futures but in the near term the commodity story is stronger.

JR: We saw a gradual increase in energy prices while wheat and other grains rose rapidly in the third and fourth quarters. Higher commodity prices seem to be supported by fundamental demand now, rather than resulting from the weakening dollar. We think these price trends in global markets will continue in 2011, offering CTAs trending volatility to execute their strategies. We may continue to see the dichotomy of weak developed economies while commodity inflation is fueled by strong EM growth. However, US demand for raw materials could re-balance after two years of weakness, while China deals with inflationary concerns.

RS: Judging from a similar scenario in the 1970s of commodity price spikes, such trends can last for some time. But as prices accelerate, volatility rises and price corrections can become steeper. There are so many interesting possibilities. With fast-growing demand for grain there's always the looming fear of poor weather conditions. We could have a very explosive situation developing. The effect of this alone on global inflation would show up in interest rates, currencies and other commodities. That is one of many potential scenarios that would create trends the CTA community should be able to take advantage of.

OFI: Do commodities still offer opportunity?
SK: Commodities were a major contributor in the second half of 2010. To a degree the expected decoupling of EM from developed economies is finally happening. With demand from fast-growing emerging economies a dominant factor, commodity markets have become fundamentally-driven rather than a technical function of US dollar sentiment. That is a boom not only for EM suppliers of raw materials but also futures traders. While the majority of CTAs are systematic, they can take advantage of the fundamental commodity story by catching the price appreciation and trends. This EM market commodity theme will probably continue for years, but we will see intermittent periods of high volatility coupled with pullbacks, which has been the pattern in commodities for years. I can't imagine several of individual commodities not going much higher, though.

OFI: What are the dangers for managed futures?
RS: We could enter an environment like 2009, which lacked sustainable trends. Trends that did break out were ephemeral and there was a lot of noise. It has been a smoother ride this year, but sudden changes in direction can adversely affect CTAs.

JR: CTAs tend to lose money when markets suddenly change direction and established trends reverse. November was a perfect example. Between fears of European debt contagion, the confrontation between North and South Korea and China raising interest rates to curb inflation, everything pulled back. The reversals and disrupted trends were problematic for many CTAs.

SK: Trends tend to last three to six months. While there may be a multiple-year bull market in commodities, within it there will be consolidations and pullbacks. Then the trends will resume. The world economy is rebalancing between developed countries and EM. This dynamic will create the impetus for trends and momentum and thus opportunities for CTAs, but the process will be bumpy, not smooth. Investors that understand this characteristic and are willing to stay with the investment have a good shot of making money over time.

OFI: Does 2011 pose special challenges?
RS: Toward the end of 2011 the US will move into the 2012 election mode. Figure out the risks from that. CTAs have the ability to be flexible in high volatility environments. As trends come and go, patient managed futures investors will benefit.

JR: I feel more confident now than I did at the end of 2009. The markets have generally reverted back to trending conditions in both financial futures and traditional commodity markets. The global economy remains uncertain and we believe managed futures offers the flexibility investors look for to participate in global price trends.

Strategies

OFI: Do you like systematic or discretionary strategies?
JR: The managed futures industry is comprised primarily of systematic traders. We prefer systematic strategies and believe it should be the core trading style within a diversified managed futures portfolio. We believe in systematic trading because it is free of human biases. A diversified managed futures portfolio should also contain discretionary managers but we give more weight to systematic traders. In 2010 systematic trend followers were winners- a change from the previous year.

SK: Most of the capital allocated to managed futures is in systematic trend-followers, because they have proven longevity and the strategy works. The diversification and non-correlation benefits of managed futures largely comes from its systematic nature- the ability to go long and short in a completely agnostic fashion. So it complements most other investments which are mostly discretionary.

OFI: How about short-term traders?
RS: The problem there is that they trade more and can get whipsawed more than trend followers. There is a time and place for all investments, but you need to start with trend following as the core.

JR: There are good, established short-term managers but they are few and far between. I find that there is more rotation among short-term traders than among trend followers. You see more short-term managers come and go. We do, however, feel short-term traders have a place within a diversified portfolio.

SK: Short-term trading is a very difficult space to be successful in. There are a lot of things that can go wrong when you trade on a short time frequency versus following long-term trends. Positioning short-term traders in a portfolio requires care. It's not as simple as selecting a group of short-term traders and expecting them to make money when trend followers don't. We pay a lot of attention to the weight of short-term traders versus trend followers in a portfolio.

Investors

OFI: What do investors want?
RS: The mantra is liquidity and transparency. And people want greater diversity. Futures meet all those needs.

JR: Over the last three years we have seen extreme market conditions and as a result investors are looking for better risk-adjusted returns. We've seen a shift in institutional portfolios to increasing allocations to alpha-driven managers. Investment advisers and individual investors want liquid and transparent global investments that have the potential to enhance the returns of their portfolio. Managed futures is part of that broader shift.

SK: Over time managed futures has migrated to more traditional investment settings and earned a place in conventional stock/bond portfolios. This will continue to happen, albeit slowly. Managed futures is one of the few investments that are truly uncorrelated to tradition asset classes. But investors must understand the characteristics of managed futures. Otherwise there is a real risk that they will get into the asset at the top and exit at the bottom. There is a cycle to the strategy just like there are market and economic cycles. Because of unrealistic expectations clients may liquidate their managed futures investment that is down say 10%, but hold onto an equity investment that is down 50%! That kind of sentiment will change but it takes time. At Triton we spend a lot of effort on investor education. I don't see that changing.

OFI: Are there new investors coming into managed futures?
SK: Institutions, pensions, endowments have been investors in managed futures for years. Individual sophisticated investors have been buyers for a long time as well. We work with a number of such individuals. But investors below the $1-to-$2 million net-worth level tend to have much less experience in alternatives, including managed futures. How to invest in managed futures is an important question, because there are different access points - managed accounts versus funds - and a wide disparity between the quality of firms, pedigree of talent and length of track record.

JR: We also work with registered investment advisers who are looking for a competitive approach to finding and accessing premier managers. Financial advisers understand that you need both buy-and-hold investments and absolute-return trading strategies like managed futures.

OFI: Do clients prefer separate accounts as the best way to invest?
SK: A lot of people in the industry probably won't agree with this, but we don't think managed accounts are practical for most investors, particularly newer ones. Trading commissions tend to be high, over-leveraging can be a troublesome, and it does not typically lead to a long-term successful investment experience. To get the best use of a managed account we think an investor should thoroughly understand how it works and it's the responsibility of professionals in this industry to cover this with their clients. We focus on managers, programs, and access points that we think will help keep our clients invested in managed futures for the long haul.

Regulation

OFI: Will new rules change managed futures?
RS: It don't think so. Regulators will make noise to keep everybody in line - which is good in that it brings a sense of order to the marketplace - but futures markets work well and are driven primarily by supply and demand. I can't see how additional regulation can improve futures markets in any meaningful way or change the way free markets operate, short of shutting them down.



 
This article was published in Opalesque Futures Intelligence.
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