Generally, a CTA fund is a hedge fund that uses futures contracts to achieve its investment objective. CTA funds use a variety of trading strategies to meet their investment objectives, including systematic trading and trend following.
What is CTA Strategy?
There is one characteristic that defines a fund as a CTA fund and that is its investment strategy. CTA funds will establish positions in futures contracts that generally have short-term and active maturities. In addition, CTA managers will also make bets on the change of the value of the futures contracts they own or sold short by using options.
The focus of CTAs is to take advantage of volatility in the asset classes they trade by leaning towards futures contracts which have more efficient rollover rates. Going long on the futures contracts, then, is the bread and butter of CTAs and is expected to deliver us the fastest gains and risk-adjusted performance.
CTA funds have 2 main characteristics that make it distinct from other types of hedge funds:
The main target of a CTA fund is equities and commodities. CTAs generally aim to generate profits from the creation of the futures contracts that they believe will gain leverage on the fluctuations in an asset class.
The most common types of futures that CTAs use are currency futures, equity futures, and commodity futures. Investments in the FX futures market is much bigger than those invested in the equity and commodity markets. As a result, CTAs are also more dependent on the fluctuations of currencies for making money. CTA funds in the US and Canada, as well as Japan, all wait and see the events of what happens in the FX futures market, then they follow by making investments in the other futures markets.
The funds become exposed to a high degree of leverage and risk, which explains why they often charge high management fees.
The target type of the CTA fund
The CTAs target market are typically investments for retail and institutional investors and is governed by the Commodity Futures Trading Commission (CFTC). Unlike other funds, the CTAs don’t have benchmarks against which they are evaluated, which makes it harder for investors to find a specific CTA that matches their investment objectives.
A Brief History of CTA
The original trend-followers, managed futures funds, were established in the US in the 1970’s, making it the one of the oldest forms of hedge fund. However, even before the 70s, many investors were already making bets on the changing prices of commodities. It is often informally said that the US both won the World War II and the cold war to the advent of the technology that was created during both time periods.
With the help of computers and technology, futures trading became one of the most viable options for investment and people realized that it is very efficient and cheaper to use leverage when trading. It is because of this that the popularity of managed futures funds grew quickly, especially after 1982 when the US congress made it legal for banks to make the policies for the futures market more flexible.
The CTA Industry Today
Today, managed futures funds employ a huge amount of people from around the world. There are a lot of CTA funds and they have significantly grown over the past decades.
Because of the leverage that they use, and also the recognition of their strategies, CTAs are highly profitable. This also means that they are highly risky because of the huge gains and losses that come with it.
How to Navigate Through the Noise in an Opaque Market
In the last couple of years, CTA investments have become a much-coveted asset class. Many asset managers and hedge funds would like a piece of the action. Moreover, CTA funds are some of the costliest alternatives available today as well. Why? Because they require a huge amount of regulatory resources and also because they have a high degree of risk and are largely illiquid.
What’s more is that in the US, these funds are also largely unregulated. Information about CTAs are hard to come by – which is in keeping with the “opaque” description of the industry.
To add to the frustration, CTAs today are not structured in a standardized way. Some CTAs make extensive use of derivatives, while others don’t do much investing at all. In addition, some CTAs focus on specific global regions, while others tend to place their bets on the US markets.
As mentioned, the next problem that investors have to deal with is the high costs. While CTAs could run off with the moolah and not invest anything, they actually do (mostly) but not in a way that gives you some sort of a return.
Instead of investing into some positions, CTAs are mostly trading even existing positions, then over and over again. Having all these costs, trade execution fees, the high cost of capital and everything, they produce are so small that they can’t hardly cover the fees you’re charged.
Since their return streams are so small, they trick you by giving you these figures called “tracking errors”. These numbers are supposed to show you all the gains and losses of your portfolio in the past and how they would have been if you didn’t invest in a CTA fund.
The important note about tracking errors is that they are the same across the board, meaning that no matter what their actual CTA fund did, you will see the same number every year.
You might be shocked to know that one of the CTAs in our comparison pays us 0.56% as a tracking error. This means that in the 11 years that this CTA has been in the market, it has only returned an average of 0.56%. You might say that the time period is too short for a fund, but reality looks awfully different.
The Tracking Error Scam
Because of how they are designed, tracking errors tend to look dramatically lower as time goes by. That’s in spite of the fact that we have almost zero to no idea about how they make money. This is why they are unlike other investment vehicles, and why researching is so important. How can you make sense of how a fund makes money and whether or not it is worth it?
The good news is that we deal with this problem by using simulations. Based on that, we’re able to give you the monthly returns of the fund in the past. We’re able to see if it had a great run or if it was simply a bull or bear market.
In the case of CTAs, we’ve discovered that across the board, all CTAs we reviewed perform poorly over the long haul.
In fact, the performance is so bad that all of them have a hard time keeping up with the returns that you’ll get from an S&P 500 index fund. (More information about our methodology can be found in the “methodology” section).
The Types of CTA Funds
Now that we know that CTA funds are pretty scammy, how about we look into the different types of CTA funds to make sure we know what we’re buying into. There are actually 3 main types of CTA strategies.
CTA Type 1 – Systematic Trading
This refers to CTA funds that have computerized trading platforms which automatically take positions based on some sort of an algorithm. These type of strategies are systematic trading as they are based on a set of rules which they follow, even when there are changes in the market.
You might think that with computers in charge, you don’t have to worry about the mental ability of the fund manager. However, the truth is that most of the time, the CTA fund manager will still take a position to make sure that the fund will not fall apart.
The problem is that the positions that he takes are often based on predictions rather than actual calculations. So what you basically are doing is hiring the CTA manager to make the right bets based on whatever he or she thinks the market will do well.
CTA Type 2 – Specialist Trading
These CTA strategies are based on the analysis of news. The main goal of the fund manager of a specialist CTA strategy is to get an edge by “predicting” what the market is going to do. This is because the markets aren’t really predictable and the CTA manager wants to be able to profit from predictability.
The most common way to do this is to study a piece of information that is about to hit the market and bet right before it goes public. Then, the trader will monitor how the market is reacting to this piece of information, looking for the trends. These are called technical and sentiment indicators, respectively.
The problem with this strategy is that it’s almost impossible to get an edge like that. And even if you can, it’s almost impossible to beat the rest of the market.
Investopedia defines the “most efficient” market as the one where there is a complete lack of barriers to entry and exit. This makes it a liquid market which can hence be considered a fair market.
However, there are always opportunities to have an edge. For example, if you have an advantage in the way you record data, you can possibly find some gems in the data. Generally, the main point is that there is no clear way to effectively predict the future, even if you can gain some advantages.
In the end, the best thing you can do is to accept that the market is a market, and not a casino.
What’s worse is that with specialist trading, there are way more losers than there are winners. Why? Because the market is very large and it’s basically impossible to get all the data and manipulate it to give you a picture of what is really going on.
CTA Type 3 – Macro Trading
The last type of CTA strategies are macro-based strategies. Macro trading taking a look at how interest rates, currencies, and other stuff move and respond to news and immediate events.
Obviously, these underlyings don’t change on a daily basis, and the CTA manager knows that. This is why macro trading takes a look at the longer term. However, the longer term can be a lot shorter than people might think.
The trend of opinions in markets, over a large sample of data, is what macro trading is based on. However, opinions are inconsistent and are gradually changing. That’s why most macro-based CTA funds are also very stand-alone strategies. That way, they can take advantage of any new opportunities in the market.
Is a CTA Fund Worth It?
In the beginning of this review, we said that it’s important to conduct independent research about a fund before deciding to buy into it. There are relatively low costs of running these strategies since they don’t require money for liabilities (like you would find in other funds).
However, these strategies still take up a substantial chunk of the money that you put in. That’s why it’s so important to do your thorough research about what each CTA strategy relies on, the past performance of the CTA and everything else.
The majority of the CTA funds that we took a look at have a long trail of underperformance and a low level of transparency. This makes it difficult to predict whether or not they are going to actually make you money.
CTA funds also take your money and place it into various funds that the CTA puts together. You might think that they do this because they have better returns, but that’s not the case. The problem is that in order to find out which investments you’re placing in, you have to pay. And for that, you’ll have to contact the fund manager.
For most CTA funds nowadays, registering some sort of an API with them is considered a privilege. They don’t want people to have a way of checking and comparing performance easily.