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Picking the Right Horses

What makes for success in selecting managers? We asked Jon Sundt, founder of Altegris Investments Inc. Mr. Sundt has an impressive track record as an investor. He picked some of the most successful commodity trading advisors early on, when they first started up their shops, and has allocated around $4 billion over the years. Here he explains how he makes investment decisions.

Like many other managed futures pioneers, Mr. Sundt is an alumnus of Man Group. Currently he is chief executive and president of Altegris as well as of an affiliate that acts as a general partner to several hedge funds and commodity pools. Among his hobbies are horseback riding and surfing

Opalesque Futures Intelligence: Why did you focus on CTAs initially?

Jon Sundt: Back in 1987, I was trading options on the S&P 500. I used to get a popular weekly newsletter. After the market crashed in 1987, I saw a videotape about Paul Tudor Jones. I was struck by how different his mindset was from the newsletter writer's. This film followed him for several months while he accumulated a position shorting the S&P 500. As I remember, he made over 110% in '87. I thought, this is the kind of manager I want to find and put my money with, a professional who has a properly audited track record and his own skin in the game. That's when I decided to go after the commodity trading advisor market, including the many global macro managers registered as CTAs.

OFI: How alike are global macro and managed futures?

JS: Global macro and managed futures have a lot of common ground, but macro managers tend to be more discretionary while CTAs are more systematic. They may trade the same instruments but the approaches are distinct. A classic trend follower looks purely at price and does not care where interest rates are going. Trend followers tend to be agnostic about the market and don't have a view. Their philosophy is that price tells you all the information you need to know. By contrast, a macro guy wants to know why the spreads are widening or why the dollar is gaining. Ask George Soros where interest rates are going and he might not tell you but he has an opinion. His macro strategy is not based purely on price.

OFI: How did you get into managed futures?

OFI: When did you start own firm?

JS: In the 1990s I worked as an independent broker, then joined a larger FCM in Chicago, which was sold to Man Group. For six years I was at Man Financial, as director of managed accounts for managed futures. We operated as a unit within the brokerage in the US and did business with some 100 CTAs, placing and clearing their trades. Institutional customers would come to us and ask for help in finding CTAs. In 2002 I left Man and rolled out my team as Altegris. We now have 62 people, over $2 billion in assets and do business with about 90 CTAs.

OFI: Please describe your experience investing in managed futures.

JS: We were early investors with major CTA players like David Harding of Winton, Michael Clark and CFM. We were Winton's first US account and Clarke's first account. When we first invested in Winton, they had just $25 million! Over the years we've probably allocated more than $4 billion to CTAs, including trend followers, high-frequency traders and discretionary traders that are typically commodities focused. We allocate to other hedge fund strategies as well.

OFI: What's the downside to managed futures?

JS: One downside to CTA investing is that there are many players in this space who are not professionals. They may seem like professionals but when you look carefully under the hood, you realize that they're not. This field has a very low barrier to entry. Someone can register, open a $100K trading account with his grandma's money, post three good years, hire a marketer and make a lot of people think he has the goods. There's a qualitative issue here, over and above quantitative measures.

OFI: What about the drawdowns?

JS: The word drawdown does not appear in mutual fund nomenclature. If it did, people would not be talking about trend followers' drawdowns, which in many cases is less than the drawdowns in the S&P 500 index. Managed futures can be a bumpy ride but you can say that about almost any investment. There's no free lunch. You'd better be prepared.

OFI: What do you look for in a manager, besides performance?

JS: Performance is an attention getter but tells you very little about a manager. Say you're looking at a classic trend follower. You want a very smart group with mathematical-statistical grounding and respect for the markets. We like to see a combination of those skills, both theoretical grounding and practical application. Applying statistical models to real markets is different from working with theoretical models. You want the generals whove been in wars, not just designed wars in boardrooms.

OFI: What's special about managed futures due diligence?

JS: Managed futures is not an investment strategy where either all the managers make money or they don't. It is not like conventional mutual funds. There is a huge dispersion between the best and worst CTAs. Different managers do different things. Active investors in managed futures have to pick the right horses. That's a continual process' you can't invest and walk away. This is not a stock index where people leave their money for decades. I don't think you will find a successful index replicator in managed futures that will beat the best managers over time.

OFI: How does investing with CTAs compare to investing with hedge funds?

JS: Ongoing due diligence for a CTA is straightforward compared to other strategies. You get a managed account at a FCM and receive statements. The contracts are standardized, so you can easily understand what they are.

OFI: Why are there so few large CTAs?

JS: Building a successful CTA business over a long period is a very difficult endeavor. The transition to running a multi-billion business is really tough. There's a major hurdle to crossing over from being a good system designer and trader to being an asset manager and building the infrastructure. Not everybody crosses over successfully. It's like the difference between designing the operating system, Windows, versus building the company, Microsoft. You no longer just tinker with systems, you have to manage people and deal with asset growth. I've seen some smart CTAs take their eye off the ball as their business grew. All decisions become more complex as the group grows and goes from one programmer to seven programmers, from an investment committee of one to a committee of five, has to decide how to allocate risk.

OFI: What do you do about that?

JS: We examine the business. How do they integrate new employees into the business, integrate new ideas with existing approaches, deal with angry investors when there's a drawdown-we do a lot of qualitative due diligence.

OFI: Can a good manager lose the ability to make money?

JS: The industry is littered with managers who had a pretty good value proposition seven or 10 years ago but do not now. We have seen some pretty good trend followers lose their edge. There are many reasons for this, they have not done research to update the models, key people have left, the owners are no longer keeping their eye on the ball or they haven't managed asset growth well. Investors need to do ongoing due diligence and ask themselves whether they want to keep their money with a particular CTA.

OFI: Is there a capacity constraint?

JS: I've heard about capacity for a long time. There are some CTAs people thought might be too big at $10 billion that are now doing well at $20 billion! Certain trades and styles, especially high frequency trading, can get crowded. But I don't see how a CTA could get too big for trends in the dollar or interest rates. While some short-term models might no longer capture the opportunities they used to, long-term trends give CTAs a lot of breathing room. Right now, with assets down in the industry because of massive redemptions, capacity is not a problem for some strategies.

OFI: What role do managed futures and macro play in a portfolio?

JS: The natural extension of any portfolio beyond long stocks and bonds is to take advantage of the macro picture. The beauty of managed futures is that you have all four major asset classes - stocks, bonds, currencies and commodities' both long and short. That is a very powerful investment. The traditional 60/40 stock and bond portfolio got crushed in last 24 months and most savvy investors are looking for diversification and noncorrelation. Futures and global macro have the potential to provide that. Also, the illiquidity problems in other strategies show the advantage of managed futures and macro, which use instruments that are exchange-traded, marked to market daily and very liquid.