SECTION NAME

ISSUE 8 May 19, 2009

In This Issue
Founding Father Q&A
There are few managers in high-frequency trading and even fewer with a long track record. We are delighted to present insights from Roy Niederhoffer, one of the rare longtime practitioners of this intriguing niche strategy .................................................... 2

Human Capital Advantage

One very noticeable thing about people in hedge funds and other financial businesses is how knowledgeable they are. I have to admit to often being awed by the skills and intelligence one encounters in the industry. But even by high standards, Roy Niederhoffer is exceptional. Theres his early fascination with computers, resulting in his building a computer game business while in high school. Then theres his foray into computational neuroscience in college. These skills came together in designing high-frequency trading programs. This issues Founding Father contains his insights about this intriguing but not well known strategy. In Futures Lab his colleague Susan Roberts another person who makes one think of the amazing skill level in the industry documents the distinctive features and advantages of short-term trading. When you say brain trust, Renaissance Technologies is the name that probably first pops to mind by free association. We have an interesting bit about Renaissance in News Briefs. Talking with people, it is clear that human capital has to be closely allied with technology to succeed in something as complicated as high-frequency trading. We were lucky to have an Insider Talk with Trading Technologies Tom Haldes and Elise Fleischaker on the two-way interaction between automated trading and investment strategies. For Practitioner Viewpoint we drew on a lot of high-end human capital to get a sense of where commodity markets are going and what it means for investors. Who, by the way, have been moving to global macro and managed futures strategiessee Index Tracker. Chidem Kurdas Editor kurdas@opalesque.com

Futures Lab

Susan Roberts of R.G. Niederhoffer Capital analyses the distinctive features of shortterm trading compared to long-term trend following. What effect do these have on an investors portfolio? ................................ 5

Insider Talk

The latest perspective on the two-way street between automation and investment strategy, from Trading Technologies executives .............................................. 9

News Briefs

Renaissance Technologies, Carbon permits and more ...............................................13

Practitioner Viewpoint

Several views on the outlook for commodity investing, including forecasts from a report from Nouriel Roubinis RGE .................... 14

Index Tracker

Asset flows and various indexes .............16

Top Ten

CTAs with the smallest drawdowns ..........17

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OPALESQUE FUTURES

ISSUE 8 May 19, 2009

FOUNDING FATHER Q&A

The High-Frequency Artist

Short-term trading is not easy to understand and we can infer that it is extremely hard to practice, because few people engage in it and even fewer survive for a long time. We are delighted to present a practitioner with one of the most distinguished and substantial track records in this intriguing niche strategy. R. G. Niederhoffer Capital Management offers hedging in the original sense of protecting investor portfolios in downturns. One trading program has the specific goal of hedging a portfolio against equity market and fund of fund losses. That program returned 55% in 2008. Founder Roy Niederhoffer possesses diverse skills that are seldom found in one person. In his office there is a wall of computer screens with fastchanging symbols and numbers, but also two surprising objects: a violin and a piano. Hes been playing since childhood and is a serious enough musician to play violin in the Park Avenue Chamber Symphony (www. chambersymphony.com). But music was only one of his youthful interests. He encountered computers as a teen when his brother Victor, whose ups and downs as a fund manager are well known asked him to help unpack one of the early microcomputers. Roy immediately took to the computer. Within a year he wrote a video game, started a computer game business and had his high school friends working for him, creating games. It says something about short-term trading that the strategy brought together Mr. Niederhoffers diverse skills. Below he tells us his story and discusses the high-frequency approach. In the Futures Lab article that follows, his colleague Susan Roberts compares high-frequency trading to other strategies and presents evidence.

Roy Niederhoffer

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ISSUE 8 May 19, 2009

FOUNDING FATHER Q&A

Opalesque Futures Intelligence: How did you get into short-term trading? Roy Niederhoffer: I studied computational neuroscience at Harvard and planned to go into that field. But in 1987, my brother Victor invited me to join him, and from 1987 to 1992 I worked for his firm. He was an early innovator in the high-frequency trading space and trained a number of successful managers. While I was there, I developed computer programs to analyze high frequency price data and used them to develop and test my trading ideas. In 1992, I left to start my own firm, with the goal of building an institutional, highly-quantitative asset management business. I had already run a successful 30-person computer game development business in high school, so I had some useful experience being an entrepreneur. OFI: Did your interest in the brain science have any effect on your career? RN: In time I realized that there is an overlap between my interests in neuroscience and in trading. The structure of the brain drives behavior, including market behavior, in predictable ways. Understanding that helped me refine my trading approach. OFI: Do those behavioral patterns show up in futures trading? RN: Definitely. My early forays into trading were quite discretionary and not very successful. I fell into many trapsholding losing trades too long, being emotional about my decisions, letting recent experience influence me too much. Our strategy now is based on the idea that because of certain cognitive biases hard-wired into the human brain, the behavior of market participants, and therefore prices, can be predicted. OFI: How can you predict what people will do? RN: When people are emotional, they revert to instinctive behavior patterns that result in nonrandom price movements. Our research attempts to identify those situations and capitalize on them. OFI: For how long a period can you predict? RN: It is much easier to forecast prices in the short-term than, say, a year from now. We do have some accuracy at predicting what will happen in the next hour or day, perhaps out to a week or two. We test rules with hundreds of thousands of individual observations, so we have a moderate-to-high degree of confidence in the rules that make it all the way through our trading process. OFI: How long do you hold positions? RN: Our trades range from a few minutes to a few weeks in duration, but our effective duration is about one or two days. Economic fundamentals tend to be swamped by psychological factors in the short-termthere are waves of exuberance or panic that drive markets up or down, and we take advantage of that. But psychology cant swamp fundamentals indefinitely and eventually prices reflect fundamentals relatively accurately. OFI: Dont some trend followers look for similar patterns? RN: The rationale for our trade entries and exits tend to be different from trend-following, so our results are different. We are very comfortable taking positions opposite the trend. OFI: Do you trade the same instruments as commodity trading advisors? RN: We trade many of the same markets as trend followers, but like many short-term traders we are generally more focused on the equity sector. Historically, trend-followers have had greater allocations to fixed income, foreign exchange and commodities than most short-term traders, who tend to trade a higher percentage of equity index futures. OFI: Why equities? Foreign exchange markets must be liquid enough for short-term trading. RN: Since our strategy attempts to capture the effects of human emotion on price movements, it stands to reason that it might be more successful in a sector like equities where there is a higher percentage of retail money, than, say, foreign exchange. But we believe our models should be successful in that sector as well. OFI: Why are there so few high-frequency traders? RN: It is a difficult strategy to get started in. We have maybe a million lines of proprietary computer code that weve developed over the years. There are many dead ends and pitfalls we managed to fall into them particularly in our early years. After 16 years in the business,

There is a high barrier to entry, but there is an even higher barrier to long-term survival in the highfrequency space.

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ISSUE 8 May 19, 2009

FOUNDING FATHER Q&A

weve learned many of the things to avoid! A newcomer starting from scratch has a lot to learn. There is a high barrier to entry, but there is an even higher barrier to long-term survival in the high-frequency space. OFI: If more money comes in, will short-term trading become crowded? RN: Capacity constraints are an issue in any strategy, but obviously high-frequency managers are more susceptible because of their higher volumes. Since our strategy is more than 50% mean reversion, we end up doing the opposite of the majority of managers, so crowding is less of an issue. In addition, shortterm traders are much less similar to each other than managers in other strategies, possibly because there many ways to trade, not just a few trends to follow. But it is still very important for a short-term manager not to get too big. Thats probably the reason there are no giant short-term funds. To go from, say, $2 billion to $20 billion would be almost impossible with this kind of trading. It is extremely important for a short-term manager not to compete for assets by offering lower feesthe greatest cost to a client of a short-term trader is the other assets managed by that trader, not the managers fee. Its not just beneficial to the manager to have higher fees and less assets under management; its better for the clients too, because the market impact of a smaller manager is so much less. A lot of people dont realize that. OFI: How do you control the risk? RN: Everything we do can be calibrated to the volatility of the market were trading and its relationship to other markets. This is so for all CTAs but particularly for short-term traders, who can keep their volatility stable over time perhaps better than any other hedge fund strategy. Because your trades last only a few days and you have so many positions, you can adjust to any change in volatility daily or even intra-day. Risk management is not separate from our process, it is integrated into our process. Our quantitative models incorporate factors like historical and implied volatility, correlation, and expected trade duration in determining the size and risk of our trades. OFI: Isnt short-term trading volatile relative to other strategies? RN: You rarely see surprises from managers in highfrequency trading. Many hedge fund styles have low volatility most of the time, and then, as in 2008, volatility suddenly explodes. While people may think of managed futures as a relatively volatile strategy, actually managed futures is merely a strategy with consistent volatility. Almost every CTA, both short-term and longterm, had about the same volatility in 2008 as they did in 2007, 2006, and 2005. Moreover, when you have a strategy like ours that is negatively correlated to most portfolios in which it is included, the more volatility you have, the less overall risk the portfolio can have. OFI: What do you see for the future? RN: You have to be constantly vigilant and constantly develop your system, because markets evolve and some trading strategies stop working. We have 21 people working on developing new models and trade execution strategies. Including the technology people, 31 out of the 41 people at the firm work on investment strategy. Im now more involved with the research than the trading. On a daily basis, the strategy is run by my head trader, who has been with me since 1993. OFI: Is trade execution difficult with a high-frequency strategy? RN: Trade execution is done automatically, by algorithms. Very little is done on a discretionary basis. Nevertheless, it is important to have an experienced person reviewing trades just in case there is an unusual event, like a surprise event or a particularly illiquid period. Because of this consideration we are about 5% discretionary. OFI: Why should an investor consider a high-frequency strategy? RN: Most hedge fund styles are highly correlated with one another, and also to the portfolios in which they are included. In contrast, high-frequency traders tend to be different from each other have low inter-manager correlation and also tend to have fairly consistent negative correlation to investors portfolios. As a result, they tend to fit very well. We actively aim our strategy to directly improve our clients portfolios by focusing not only on making money but on when we make money. OFI: What should investors look for when evaluating managers? RN: One way to assess managers is to look at their performance during benign and difficult periods. It was much easier to be up in 2005 and 2006 than in 2008. My view is that a hedge fund should be able to provide a true diversification during difficult periods, so I feel that if you have two funds with the same standalone return and volatility, the fund that had its best year in 2008 is far preferable than one that was down in 08 and had its best year along with everyone else in 2005.

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ISSUE 8 May 19, 2009

FUTURES LAB

Key Features of Short-Term Strategies

The following analysis is by Susan Roberts, senior managing director at R. G. Niederhoffer Capital Management Inc. Ms. Roberts joined RGNCM in March 2008 and is responsible for interdisciplinary initiatives involving investment, strategy and business development. She has an extensive background in hedge fund and private equity fund of funds management, portfolio construction and manager selection, and served most recently as deputy director of banking and corporate finance at the Hearst Corporation. Ms. Roberts analyses the distinctive characteristics of high-frequency trading compared to commodity trading advisors in general and effect of these programs on an investors portfolio. The expression high-frequency trading is used here interchangeably with short-term trading.
Short-term trading programs have distinctive qualities that are not well known. Yet these features can be important for investment decisions. Comparing short-term trading to long-term trend-following and other hedge fund styles is a good way to demonstrate its distinct characteristics. We will start with a description of the strategy, then do a comparative analysis of returns and discuss the implications for investors. Traders are typically classified as short-term if they have an average holding period of less than ten days. These trading programs are often systematic, developed using a broad range of quantitative methodologies. The instruments traded generally include a subset of the most liquid futures markets worldwide, including equity indices, fixed income, currencies and commodities, and may also include individual stocks, options and cash foreign exchange. Trade frequency can be quite high and many programs trade more than 10,000 round turns per year per $1 million traded. Because of the highly liquid nature of the strategy and the short average holding period, many managers are able to offer attractive liquidity terms to investors, with some even providing daily liquidity.

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ISSUE 8 May 19, 2009

FUTURES LAB
A Small Universe

Short-term trading is an evolving hedge fund strategy. The number of active managers is quite small and there are relatively few firms with long-term track records. We estimate that there are fewer than 50 firms with more than $50 million in assets. It is also a capacity-constrained strategy, with only one firm (that we know of) managing more than $8 billion. In January 2008 Newedge introduced the Alternative Edge Short-Term Trader Index, which tracks the daily performance of a group of 27 high-frequency traders. The broader Newedge CTA index, which includes 20 constituents, also contains a few (5) high-frequency managers.

Short-Term Trading vs. Trend-Following

Trend-following CTAs and short-term traders tend to thrive in different types of market volatility. The ideal environment for trend-followers is a market moving smoothly in one direction, with relatively low daily volatility. Put another way, trend-followers are long long-term volatility. Short-term traders, by contrast, do not tend to take positions dependent on the long-term direction of markets. The ideal environment for short-term traders is high intra-day and day-to-day volatility; they can be thought of as long short-term volatility. Performance profiles reflect this fundamental difference. To illustrate the difference between these two strategies, we compared the historical performance of two hypothetical portfolios. The first portfolio includes the 20 core constituents in the AlternativeEdge Short-Term Trader Index, and the second portfolio includes the constituents in the 2009 Newedge CTA Index, excluding the five short-term traders. The manager returns in each portfolio were equally weighted since 2000 or inception using monthly data (through April 2009). As you can see below, the portfolio of short-term traders had higher annualized returns over this 9 year period. Much more interesting, however, is the enormous difference in annualized volatilitythe portfolio of short-term traders was much less volatile:

The reason for this is the extremely low correlation among high-frequency managers. There is a huge variation among strategies, For example, some managers trade only a single asset class, while others trade many; some managers focus on intraday trading while others tend to hold trades for a week. The chart below shows the distribution of correlations between managers in the short-term trader portfolio (in blue) and the trend-follower portfolio (in red). You can see that trend-following CTAs tend to

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ISSUE 8 May 19, 2009

FUTURES LAB

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be highly correlated to each other (correlation more than 0.6%), while short-term traders are not. In fact, many short-term traders are actually negatively correlated to each other. Because of the low correlation among managers, it can be quite effective to invest in many different short-term traders, whereas with trend-followers, investing in a small group of managers may provide adequate diversification.

One drawback to the enormous diversity among short-term traders is that it can make the due diligence process more challenging for investors. Making side-by-side comparisons can be quite difficult.

Protective Effects of Short-Term Traders

Many short-term trading programs are negatively correlated to other hedge fund styles as well as to major markets. Hence short-term trading provides protection during difficult times for other strategies. We can see this by looking at the ten worst months for funds of hedge funds since 2004. During those months, fund of funds lost 3.5% a month on average. Short-term traders (including all managers in the AlternativeEdge STTI, equally weighted) were up in all ten of these months, with an average monthly return of 1.4% (Table).

10 Worst Months for Fund of Funds, January 2004-January 2009

DATE
Oct. 08 Sep. 08 Nov. 08 Jul. 08 Aug 07 Mar. 08 Nov. 07 Jan. 08 Oct. 05 Apr. 05 Average Data Source: HFR, Newedge
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FoF Global Hedge Fund

-9.3% -6.9% -3.0% -2.8% -2.5% -2.5% -2.4% -2.1% -1.9% -1.8% -3.5%

Short-Term Traders
2.4% 1.2% 0.9% 0.1% 2.5% 1.4% 1.5% 1.3% 0.3% 2.2% 1.4%

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ISSUE 8 May 19, 2009

FUTURES LAB

Many short-term trading programs are negatively correlated to other hedge fund styles as well as to major markets. Hence short-term trading provides protection during difficult times for other strategies. Adding several short-term traders to a portfolio of trend-following CTAs can also be a powerful diversifier. The chart below shows the annualized return and volatility of an equally weighted portfolio of (i) all twenty 2009 Newedge CTA constituents (left); (ii) the fifteen constituents that are not shortterm traders (middle); and (iii) the five short-term traders in the index (right). Again, performance data is monthly since 2000, through April, 2009. When the five short-term traders are removed from the portfolio, you can see that the volatility jumps nearly 2%.

In summary, short-term traders tend to improve portfolios by providing diversification and reducing volatility. Some short-term programs are designed to address specific risks. But investors should keep in mind that many managers have not been tested in a variety of market conditions.

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ISSUE 8 May 19, 2009

INSIDER TALK

A Two-Way Street Futures Strategies and Automated Trading

Talking to high-frequency traders makes you more aware of the central role of technology. Roy Niederhoffer says his shops trading is 95% automatedthe head trader watches whats going on and adds a human touch when theres an unusual event. Some managers rely 100% on automated trading.
Tom Haldes

We wanted to understand how the ongoing development of automation is affecting investment strategies and vice versa. Tom Haldes and Elise Fleischaker of Trading Technologies give us the latest perspective on the interface between automation and strategy. Mr. Haldes knows the issues from both the technology developer and user sideshe headed global market data development at Citadel Investment Group earlier in his career. Electronic trading has opened up a host of possibilities. Modelers can choose among different levels of automation. A black box a fully automated program sends thousands of orders a day to markets and implements the circuit breakers and failure detection mechanisms indicated by the trading strategy without anyone lifting a finger. A grey box is a hybrid that incorporates more user control.

Elise Fleischaker

Opalesque Futures Intelligence: Whats next for electronic trading? Tom Haldes: Dramatic as the growth of electronic trading has been in the past few years, it shows no sign of letting up. TT is developing next generation, best-ofbreed automated trading systems for high performance execution. This is a very fast changing area.

Elise Fleischaker: When TT was founded in 1994, electronic trading was in its infancy and there were questions as to whether it would catch on. In the past several years the number of markets we connect to has more than doubled. Initially we were known for our point-and-click, manual trading interface - which is still an important component in our platform - but automated trading

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ISSUE 8 May 19, 2009

INSIDER TALK
technologies have become increasingly important for our customers and as such, that is where much of our new development resources are focused. OFI: What kind of improvements do traders want? TH: Probably the biggest factor is the speed of trade execution. People create black boxes and use grey box tools for automation. Thats all fine, but if your trade order hits the market half a second after someone elses order and they get the price you wanted, the automation is not working for you. OFI: Does automation create new strategies or are the strategies pushing automation? TH: Automation and trading strategies feed on each other. For example, consider a black box application developed for index arbitrage--a strategy to gain from price anomalies between a basket of securities that is a proxy for an index and the index itself as it trades in the futures market. A black box routes an order to buy or sell, depending on whether the price of the index is below or above the theoretical price indicated by the model. This is a fairly common strategy, so likely therell be another trader with a similar model. When the price discrepancy shows up, both traders submit orders for the index. The order that hits first gets filled before the price moves, while the later order misses the price. So everybody wants their automation to be as fast as possible. The big trend in all the markets is reducing latency. submit an order within hundreds of microseconds. Thats how latency-sensitive the business has become. OFI: Which strategies does the issue of latency really matter for? TH: If you rely on automation either in part or totally through a black box to execute your strategy, reducing latency is important for you. There are traders who might have a broker manually working on their order and in that situation the milliseconds dont count. Manual trading is a different story, but if youve embraced automated trading, speed matters, and even more so in arbitrage strategies.

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OFI: When you say fast, how fast do you mean? TH: The standard used to be seconds, recently it became milliseconds and now the game is being played at the microseconds level. There are systems that can respond to changes in the market and re-

OFI: How is latency reduced? TH: Take the delay in getting connected to an exchange because it is physically distant. In this case, the latency exhibited by the trading system is largely the result of the geographic separation of the order routing logic and the matching engine. Traders want to trade as quickly as they could if they were in the same place as the exchange, even if theyre in another continent! Were creating server-based platforms that remove this type of delay. With high volatility in markets, milliseconds can make the difference between a successful trade and a failed one, and if youre executing a strategy on a matching engine located somewhere across the globe, you need a proximity-based solution to eliminate the geographical latency. OFI: Would you give an example? TH: For instance, in calendar spread trading, where you go long one futures contract and short another,

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ISSUE 8 May 19, 2009

INSIDER TALK Automation and trading strategies feed on each other.

the system enters a quoting order for one leg while leaning in the other market for the hedge leg. As the hedge market moves, the quoting order needs to be re-quoted to preserve the target implied spread price. If youre in London and the exchange is in Chicago, the implied spread price may change several times during the interval of time it takes to receive your market data update and respond with an updated re-quote. Thus geographical latency can make your spread trading less effective. Our popular spread trading application, Autospreader, was initially developed for desktop computers. Were developing new technology that will move the execution logic very close to the matching engine, eliminating geographical latency. This means the trader in London trading on an exchange in Chicago can see his quoting order update in less than a millisecond after the lean market has moved, just as if he were physically located in Chicago. OFI: How does a researchers quantitative model work with your trading software? TH: Traders can execute their strategies using applications like Autospreader. But very complex quantitative models and algorithms may not fit any stand-alone tool. We have special applications for writing programs and creating black boxes. These are used in conjunction with our exchange gateways to submit orders and receive prices. By combining the tools, a sophisticated quant shop can build any model they want and link it to our trading platform. OFI: What else do traders need, besides speedy order execution? TH: In the race for performance, huge amounts of market data are being generated. Exchanges are quoting prices thousands of times a second. How will the ever-growing volume of data be managed? Traders, exchanges and telecommunication providers are all grappling with that question. If the data gets queued in the pipeline, then your system will lag in responding to market movements. So a corollary of automated trading is how to accommodate whats come to be known as the market data tsunami. OFI: How would a shop that does not have a big IT department manage the technology? TH: Hence there is a growing trend for hosting services. Traders and brokers want access to dozens of exchanges but dont necessarily want to manage all the lines, circuits, gateways to the exchanges, servers, etc. A hosting provider gives you highspeed access for trading markets worldwide. That way, you focus on your core business and not on the technology. EF: Customers that use our TTNET hosting service outsource the management of their trading network and telecommunications infrastructure. We deploy, monitor and upgrade their network, including the gateways. The trend towards outsourcing is not focused on small firms--some of the largest global banks use our service.

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We dont believe in one-size-fits-all.

Dedicated services for hedge funds and CTAs. Multi-asset prime brokerage, cross margining tools, cutting-edge risk calculation, start-up services and in-depth market intelligence. We work with you to develop customized solutions that match your needs. To help power your performance worldwide.

EXECUTION CLEARING PRIME BROKERAGE

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ISSUE 8 May 19, 2009

NEWS BRIEFS
Renaissance Liked Goldman, Annaly

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Renaissance Technologies held relatively big positions in certain financial firms in the midst of the financial sector meltdown in the first quarter of the year, according to the most recent holdings report. Financial stocks bounced back strongly in the rally since early March. Among Renaissances holdings were Annaly Capital Management Inc. an asset manager and Goldman Sachs. The hedge fund also had positions in pharmaceutical companies Abbot Labs and Wyeth and tech companies Apple and Google. Energy giant ConocoPhillips and tobacco biggie Lorillard Inc. were other stand-outs in the portfolio as of March 31st. Renaissance, with around $20 billion in total assets, is possibly the largest quantitative shop with a short-term trading orientation.

US Carbon Permit Plan Proceeds

A cap-and-trade bill that is the first step in creating national carbon allowance trading and related futures markets is moving through Congress. Last week President Barack Obama praised Representative Henry Waxman, chairman of the Energy and Commerce Committee and sponsor of the bill, for having brought together stakeholders from all corners of the country and every sector of our economy to reach an historic agreement on comprehensive energy legislation. Controversy rages, however, as to whether the newly created emission permits should be given away free or auctioned.

Las Vegas Commodity Pool Operator Charged with Fraud

The US Commodity Futures Trading Commission got a court order freezing the assets of Gordon Driver and his Las Vegas-based companies Axcess Automation and Axcess Fund Management. The regulator says Mr. Driver fraudulently solicited commodity pool participants, misappropriated funds, and issued false statements in a $13.5 million fraud involving more than 100 participants in the US and Canada.

MF Global Disagrees with Verdict

Futures brokerage MF Global says it will appeal a UK judges decision with regard to Parabola Investments, even though insurance will cover most of 20 million in damages the judge ordered the firm to pay a plaintiff. The case involves a broker who joined MF Global through an acquisition in 2001 and that year misrepresented a clients account performance and balance. The firm says it is a different company under a different management structure now and in the last year alone invested over $200 million to improve employee training, compliance and risk management.

ICE Futures Volume Up

IntercontinentalExchange, an operator of futures exchanges and over-the-counter markets, reported that the April 2009 average daily volume for all ICE futures contracts is up 14% to 983,928 from a year ago. ICE Futures Europe, a London-based energy futures exchange, had a reduction in total contract volume compared to 2008 but open interest was higher. Volume and open interest records were established for several coal and emissions contracts during April.

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ISSUE 8 May 19, 2009

PRACTITIONER VIEWPOINT

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Commodity Investing Outlook

Long-only investments in commodity futures could get hit by a one-two punch this year. With the G10 in recession and many emerging economies slowing sharply, further demand destruction is likely for most commodities in 2009 and may continue to outpace production cuts, says a report from Nouriel Roubinis RGE. Admittedly, Professor Roubini is on the gloomy end of the forecast spectrum. But price declines are not the only risk. Those betting on rising oil prices face a contango futures marketthat is, theyre losing money from selling expiring contracts and buying longer-dated contracts. The roll yield, sometimes a source of positive return, is negative. The contango (albeit narrowing) in the oil futures curve suggests further stockpiling of oil in anticipation of higher prices in the future, is how RGE explains pattern of distant-dated contracts being more expensive than near-dated contracts. Demand for oil continues to fall in the OECD and even in emerging economies like China the big source of added demand in recent years oil demand is likely to shrink in 2009 because of economic weakness, the report points out. That picture certainly does not favor across-the-board passive investing. On the other hand, there may be upward pressure on the prices of some agricultural commodities due to continuing supply shortage. RGE points to sugar and cocoa: Despite a 27% rise in 2008, sugar prices will rise further in 2009 due to a widening global sugar deficit, notwithstanding slower ethanol production growth due to lower fossil fuel prices. Similarly, a cocoa supply shortage due to poor weather may offset a retrenchment in chocolate demand due to consumers higher debt servicing costs, falling wealth and lousy employment outlook. But overall, RGEs outlook is negative: Across the commodities group, inventory buildup and falling demand creates conditions ripe for extending the current bear market, despite the fact that most commodities seem to have fallen below production costs for new supplies. We asked people in managed futures what they see happening. The conditions that are a disadvantage for commodity index investments can benefit long/short managers. Davide Accomazzo, managing director at Cervino Capital Management LLC, told us: Inflation or deflation that is the looming question! Certainly these are complex times and any kind of economic analysis, more than usual, is subject to revisions forced by significant policy or systemic changes. It would seem like the cumulative effect of all the government programs and the extremely

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ISSUE 8 May 19, 2009

PRACTITIONER VIEWPOINT
aggressive monetary policy implemented so far should seriously weaken the dollar. The US dollar has a high inverse correlation to commodities and therefore we should eventually see commodities rise. In the shorter term, however, we are still dealing with a large gap between output and demanda deflationary dynamicwhich has been pressuring commodity prices to the downside. In the final analysis, this will be a traders market for quite sometime. Not a bad place to be for flexible CTA programs. Mack Frankfurter, chief investment strategist at Managed Account Research Inc., says investors should ask where the return comes from in commodities: Obviously commodities are going to rise and fall in line with dollar weakness and strength. What I think is more interesting is the behavioral dynamics set in play because of the speculative boom-bust in commodity prices last year. Any rise in price is going to cause a more sensitive reaction by long hedgers, the consumers of commodities, to hedge their forward needs. At the same time, producers of commodities or short hedgers are going to be more inclined to lock in rising prices to ensure positive operating margins. This is going to result in range-bound trading driven by fundamental factors, which in fact is a sign of healthy commodity markets, unlike in 2008. CTAs who know how to actually trade these markets are going to outperform passive commodity exposure. Truth is, I believe managed futures did well last year exactly because securitized commodity products were the dumb money from which CTAs ultimately took excess premia. Futures is a zero-sum game and the source of return has to come from somewhere when speculating in commodities. Thats the question investors should be asking. Long/short commodity managers are finding opportunities. Lars Steffensen, managing partner at Ebullio Capital Management, describes the recent trades that made money for him: Tin, nickel, crude and cocoa outright along with the lead/zinc relative value spread and tin calendar spreads were the star performers. Copper was the only noticeable laggard due to us turning into non-believers of the rally too soon. We believe that the grotesquely bad industrial production and GDP figures from the rest of the world are right and that the figures from China are wrong; call us cynics, but we just dont believe that China can keep reporting electricity output down 25% or 30% with the rest of the economy going ahead unchanged or even allegedly growing. We will be short on the way down and remain vigilant for real signs of recovery or the printing of money on a massive scale in order to get long for the long term. What is for certain is that the markets will stay extremely volatile and changeable and therefore, in our mind, very tradable. Ebullio returned 4.5% April and 10.5% year to date. The firm invests in all commodity markets via futures, options and some physical trading, using a discretionary approach along with technical and fundamental signals.

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OPALESQUE FUTURES

ISSUE 8 May 19, 2009

INDEX TRACKER

16

Managed futures as a whole continued to lose in April, as the Newedge, Barclay and Credit Suisse / Tremont indexes indicate. To see whats happening at a more granular level, take a look at Australian Fund Monitors indexes, which cover more than 200 absolute return and hedge funds managed in Australia.
This database breaks out commodity and currency CTAs separately from managed futures. Australian commodity managers were about flat for the month while FX performed strongly. When it came to new allocations, investors favored managed futures and global macro. According to Barclay Hedge, $31.4 billion left hedge funds in March, the fifth largest outflow on record, bringing first quarter redemptions to $137 billion or 12.6% of industry assets. But CTAs posted their first inflow in seven months, getting $695 million (0.4% of assets). Global macro was the only other sector that had a positive asset inflow. Other databases point in the same direction, though the exact numbers differ. A report from Credit Suisse /Tremont says that overall assets under management by hedge funds declined to $1.3 trillion as of March 31st. While investors, in particular institutions, are expected to return to hedge funds in time, Over the short term, we anticipate increased attention will be focused on specific sectors such as global macro, convertible arbitrage and managed futures. Here is what Credit Suisse /Tremont says about investors interest: Despite finishing the first quarter down 2.9%, funds in the managed futures space, which represented the best performing hedge fund sector last year, continue to build on the interest they generated in 2008. The liquid, trend-following nature of this strategy typically allows managers to react quickly to changing market conditions, which in turn has historically enabled managers to capitalize during periods of increased market volatility.

April and Year-to-Date Returns, Various Indexes

Apr Australian Fund Monitors: Commodities/CTA Currency/FX Global Macro Managed Futures All Hedge Funds 0.16% 1.68% 0.17% -0.83% 3.09% -0.20% 1.92% -0.63% 1.35% 4.01% YTD

Newedge CTA Index

-1.96%

-4.0%

Barclay CTA Index

-0.51%

-2.34%

Credit Suisse /Tremont Managed Futures Hedge Fund Index -3.24% 1.68% -6.03% 2.55%

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OPALESQUE FUTURES

ISSUE 8 May 19, 2009

TOP TEN

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We feature top managers from a different database every issue.

We decided to do something different for this issues Top Ten. Instead of the programs with the highest returns, ManagedFutures.eu picked the programs with smallest drawdowns. These commodity trading advisors have track records of more than two years. The average rate of return refers to the track record.

Ranking Based on Drawdown, from ManagedFutures.eu database and CTA Index.

CTA and program QuantMetrics Capital Management LLP QM Multi Strategy Fund (EUR) Conservative Concept Portfolio Management AG CC Athena OS Fund LTD (USD Instit.class) QuantMetrics Capital Management LLP QM Premier Strategy Da Vinci Invest Ltd. Da Vinci Arbitrage Fund DynexCorp Ltd. Dynamic Currency Alpha Geo Economic Management System Ltd. Low-Leveraged FX Model Hyman Beck & Company Volatility Analytics Portfolio *QEP only* John Locke Investments S.A. Cyril High Frequency Program Quantam S.A. Global Statistical Arbitrage 1x Quaesta Capital AG Quaesta Capital FX-MMP Drawdown Average RoR

0.11 0.56 1.06 1.27 1.82 1.87 1.90 2.84 2.84 2.94

33.34% 12.90% 10.29% 46.38% 5.46% 9.93% 8.54% 5.49% 5.00% 3.05%

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PUBLISHER Matthias Knab - knab@opalesque.com EDITOR Chidem Kurdas - kurdas@opalesque.com ADVERTISING DIRECTOR Denice Galicia - dgalicia@opalesque.com EDITORIAL ADVISOR Tim Merryman - tmerryman@opalesque.com CONTRIBUTORS Bucky Isaacson, Frank Pusateri, Pavel Topol, Ty Andros, Walt Gallwas. FOR REPRINTS OF ARTICLES, PLEASE CONTACT: Denice Galicia dgalicia@opalesque.com

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