A new white paper from Citi Prime Finance says that liquid CTA/Macro strategies are Moving Into the Mainstream. They are also moving away from discretionary toward a more systematic approach to trading, in part because the old pits, those schools for discretion, are no more.
Currency-focused macro hedge funds (those who aren’t included within the more thematic “Global Macro” category) and liquid CTAs can be treated as a single classification because of several common features, among them: both are positioned to generate alpha during highly volatile periods, neither trades securities, neither includes in their portfolios over-the-counter swap products; a fund of either type may be “actively engaged in 100 or more markets” because their investment approach requires both depth and diversity.
Another key point about the liquid CTA/Macro strategies is that they can incorporate discretionary as well as systematic approaches. But over time, the discretionary component is lessening. There are three reasons for this:
- The technology necessary for implementing a systematic approach to such trading has improved, in terms both of the available modeling tools and the access to exchange price data
- There has been an explosion in the quantity of futures contracts available, both in the kinds of contract and in the sheer volume traded, which has enhanced the opportunities for systematic traders to test their models and at the same time made it easiert for them to implement their orders.
- Finally, there is a perhaps-unexpected consequence of the disappearance of old-fashioned floor trading. Floor trading used to serve as a training regimen, “from which many of the industry’s leading discretionary traders originated.” Without the floors, the talent pool has dried up.
One industry participant told Citi that given this dry-up, “finding a good discretionary trader is like finding the Holy Grail.”
Citi Prime classifies the managers in the Liquid CTA/Macro subset, graphically, thus:
Assets under management in this space reached a record level at the end of 2011, the report says (citing BarclayHedge). It weighed in at $314.7 billion AUM, nearly ten times what it was in 2000.
AUM has grown along with a growth in the market for the underlying instruments. Citi relies on the FIA for some numbers here: at the end of 1998, the global turnover of futures and options was a notional $2.2 trillion. By 2010, it was $22 trillion.
Experienced managers interviewed for this paper expressed their own surprise at the speed of this expansion. One said, “We did research back in 1997 sizing the market and we thought we wouldn’t be able to get our AUM above $10 billion. We’ve realized subsequently that futures are actually much bigger and able to absorb much more.” That firm now has an AUM above $5 billion.
The market, however measured, has grown in large part because institutional investors, especially pension funds, have become ever more eager to participate. Indeed, the white paper says that the reason for this has a simple name, already in circulation among its interviewees, the “2008 effect.”
As the above chart indicates, the HFRI Systematic Diversified Program, an index that covers many of the players in this space, was up 17.2 percent in that awful year (a year in which the S&P 500 was down 37 percent). Many institutions came to see participation in Liquid CTA/Macros strategies as a critical tail-risk option.
The word Liquid in the name of this space is also of great importance to its appeal. In 2008, many institutional investors “were desperate to generate cash” in the face of “misalignments between the actual and promised liquidity of assets in their portfolios. The Liquid CTA/Macro funds are easy to exit. A manager at one CTA with between $1 and $5 billion in AUM told Citi, “We were pretty much used as an ATM in 2008 because of our liberal liquidity.”
The 2008 effect raises an obvious question, though. Will the present level of institutional interest in this space persist, or will it fade, and the space shrink somewhat, as memories of the global financial crisis become a matter for historians, and as freshly-minted MBAs without those memories enter the asset management world? CTAs have underperformed since 2009, after all. The white paper offers no firm answer to this question, noting only that views are mixed.
At any rate, new methods of raising their capital have developed over time. Since the older methods don’t go away when the newer methods come in, the result is an industry with a layered look:
- Small managers, those with less than $100 million under management, typically run an old-fashioned retail operation reliant on word of mouth
- They next layer up involves institutional distribution platforms
- A manager with assets of more than $500 million likely has built up a direct marketing team of its own.