Pigeonholing Managers Can Harm Investors
Christopher Jones, founder and principal of Diamond Peak Capital, is a
thoughtful observer of the industry as well as a working commodity trading
advisor. We featured him in Opalesque Futures Intelligence two years ago, when
he talked about transparency and managed accounts-topics that get a lot of
In October 2008 he and Steve Sapourn started Northstar, a long/short equity
quantitative trading program. The talk below is based on his experience as a
stock market trader who is also a CTA.
"Some investors assume short-term trading is the same as high-frequency
trading, but we are not high-frequency traders."
Opalesque Futures Intelligence: Have investors become more interested in
Christopher Jones: It's a process, but over time the broader universe of
investors is finally considering commodity trading advisors as a unique asset
class with specific benefits. This is gratifying because the industry has been
proving, for many years and through sound research, that it is low- or
negatively-correlated to other asset classes including certain hedge fund
strategies. The top trend followers who have track records going back decades
have clearly established that managed futures is a viable asset class. Part of
investors' acceptance of managed futures, we owe to trend followers. That's the
glass half-full perspective.
OFI: What's the glass half-empty story?
CJ: Simultaneously, the managed futures space has perhaps become overly
identified with trend-following CTAs and their risk-reward profiles. So there is
a pigeonholing that sometimes occurs where other managers in the space are
concerned. Long-term trend followers tend to have volatile returns and
occasional large drawdowns, 30% or 50% for example. Having learnt that, some
investors erroneously assume that any program using futures as an instrument is
subject to big drawdowns. Investors generally associate CTAs and futures traders
with greater volatility and less consistent returns when compared to hedge fund
strategies. Given these misconceptions, investors don't particularly understand
the diversification they can get through CTAs. This potentially hurts investor
results-they could get better returns for their risk by creating a stable of
managers with distinct strategies, including all asset classes.
OFI: What effect does this have on managed futures?
CJ: It makes it more challenging for CTAs generally to raise money. A
manager can have a unique approach that happens to use futures as an instrument
and achieves low-volatility returns, but some investors won't consider it
because of these misperceptions and the over-association with volatility and
high risk. Maybe their mandate specifies that the manager can't trade in
futures, which is worth reconsidering because futures comprise a wide variety of
sectors and markets that can be used to pursue numerous strategies, many of them
having little in common with trend following.
OFI: What do you suggest?
CJ: 'Managed futures', 'CTA', 'futures trader', doesn't tell an investor
much about markets, strategy or time frame. One has to drill down into what the
manager is doing. We're simply suggesting that investors take their research
efforts case by case and avoid categorically ruling out managers who they know
little about. There's a highly diverse field of strategies within managed
futures-it's time for perspective to catch up with the universe.
OFI: Aren't people impressed by the high long-term annualized returns of
certain trend followers?
CJ: I think it is fair to say that only a small percentage of investors
are able to withstand large drawdowns, even if the long-term record is great.
OFI: What is your strategy?
CJ: We trade equity index futures using a systematic approach based on
mean reversion. You could think of it as a long/short equity investment since we
focus strictly on the stock market, however, the program is more directional and
less hedged. We are very much a multi-category manager, but since we use futures
to implement the strategy, we usually get classed as a CTA, which means we are
rejected if an investor does not want CTAs. As a result, and to avoid being
pigeonholed, we also offer the program in securities.
OFI: How does your strategy correlate with long term trend followers?
CJ: We're not correlated. For instance, 2009 was one of the most
difficult years for quantitative CTAs in a long time, but we earned 32%! Our
correlation to the CTA universe as a whole is about 20%, yet we're apt to be
regarded as similar to other CTAs.
OFI: What's the time frame of your strategy?
CJ: The program is a short-term trading strategy, best described as a
swing trading approach. Some investors assume short-term trading is the same as
high-frequency trading, but we are not high-frequency traders. High-frequency
trading relies much more on technology, speed and execution than we do. Our
average holding period is about three days. There can be an intra-day element -
holding for a few hours - but it is a small percentage of the portfolio.
OFI: Does short-term trading have an advantage?
CJ: Time frame is a key issue. While long-term investing may be right for
many people, we have found that staying within a shorter horizon enables us to
produce a good return at the right risk price. Generally speaking, the longer
you hold an investment, the greater the peak-to-trough drawdown you need to be
able to withstand over time. For us, the shorter time frame means greater
control of risk. It helps us keep drawdowns palatable, while maintaining a
higher return than the market.
OFI: How does the market look?
CJ: Short term equity trading strategies struggled in 2010 because of
erratic movements in stocks. This year so far equity markets seem to be on a
more solid footing. That has helped us. Here again, we prove to be uncorrelated,
as quantitative CTAs generally had a good 2010. Ultimately this works out fine
because according to some of the most sophisticated investors we know, it's all