SECTION NAME

ISSUE 6 21 APRIL, 2009

In This Issue
Founding Father Q&A
How does a quantitative team develop trading models and technologies? Pascal Magnollay, founder of DKR Fusion, part of DKR Capital Inc., lifts the curtain and explains the process of innovating and diversifying strategies ............................... 2

Futures Lab

Diversifying Through Innovation

Technological advances have radically altered trading in the past decade, opening the way to strategies like DKRs model for automated high-frequency FX trading. Pascal Magnollay, founder of DKR Fusion, told us his team built a back-testing technology that is capable of quickly testing even very sophisticated models. With the technology, he can develop the diverse models he believes are necessary to survive over market cyclesread his story in this issues Founding Father. To see the diversity that technological and scientific progress have given rise to, just look at the list of managed futures trading methods in Futures Lab. New technologies raise the question of human capital. Jonathan Kleisner of Rex Capital argues that technological savvy should be part of any commodity trading advisors skill set. Trade execution makes all the difference, he explains in Practitioner Viewpoint. Other developments also foster novel strategies. Insider Talk guest Chris Jones of Diamond Peak says investing with newer niche managers is less risky with managed accounts. And Regulators and Courts looks at a potentially huge new market. Chidem Kurdas Editor kurdas@opalesque.com

Within the managed futures industry there are many approaches and techniques, with different strengths and weaknesses. A study from Man Investments highlights some key differences ................................................4

Index Tracker

Comparing the March performance of different hedge fund sectors confirms that managed futures returns correlate negatively with equity markets. We see the downside of this typically desirable attribute. .................8

Practitioner Viewpoint

Jonathan Kleisner, managing director at Rex Capital Partners, argues that CTAs should have the skill set to understand the opportunities new technologies offer for better trade execution ................................9

Insider Talk

Christopher Jones of Diamond Peak Capital, a fund of funds firm, has been investing in CTAs via managed accounts. He shares his experience and insights ...........................11

Regulators & Courts

Carbon trading could become a $2 trillion new market if the US enacts a national cap-and-trade system. The CFTC says it is ready to regulate environmental futures and options, as exchanges gear up with new contracts ................................................14

Top Ten

Three-year rankings and compounded annual returns for systematic and discretionary programs ............................16
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OPALESQUE FUTURES

ISSUE 6 21 APRIL, 2009

FOUNDING FATHER Q&A

Diversifying Quantitative Strategies

DKR Capitals quantitative strategies group demonstrates the pivotal role of technology and model development in managed futures over the past decade. Pascal Magnollay joined DKR Capital Inc. in 1999 to manage quantitative strategies and founded DKR Fusion. Since then he has overseen the building of a range of systematic models to trade in some 100 markets and the technology used to test strategies. Here he discusses the development process and argues that diverse models are crucial for making money in varied conditions. Dr. Magnollay has a Ph.D. in theoretical physics, a field that has given rise to a number of quantitative money managers. He worked at AT&T Bell Laboratories and started his trading career at Mint Investment Management Company, Man Groups first futures program. He was with a proprietary trading group at Morgan Stanley before co-founding KM Advisors. The DKR Quantitative Strategies program made about 18% in 2008 and has very low correlation to major market indexes and other hedge fund strategies, including even managed futures strategies. In 2005, for instance, while a managed futures index showed a loss for the sector overall, DKR Quantitative Strategies gained 6.4%.
Opalesque Futures Intelligence: How did you develop the systems you use? Pascal Magnollay: Ive been trading and doing research on futures and FX since 1988. When I joined DKR I had a couple of models. Then over the years we built a quantitative team, now numbering 14 programmers, traders and researchers. We started with two broad strategies, now we have six strategies and 15 trading models just in our flagship product. OFI: You said you started with two original strategies. How do you distinguish between strategies? PM: We define broad strategies in terms of their correlation. Two ideas that generate two

Pascal Magnollay

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ISSUE 6 21 APRIL, 2009

FOUNDING FATHER Q&A

uncorrelated return streams are separate strategies by this definition. Originally we had a typical trend-following CTA product and an FX yield model that did carry trades. Both have a medium to long-term time frame. OFI: How do the later strategies differ from the original models? PM: Weve expanded on all fronts. Now we trade everything and operate in all time frames, including within the hour, daily and long-term. OFI: Why do you need so many models? PM: Our goal from the beginning has been to diversify risk not only across a wide range of markets but also across strategies. The strategies weve introduced in the past five years are uncorrelated with trend following and other hedge fund strategies. Just as important, they are also uncorrelated with each other. For instance, high-frequency FX is uncorrelated with short-term FX momentum which is uncorrelated with the original yield model. OFI: Wouldnt it be better to have one model that always works? PM: Markets present a puzzle and one trading system is only one piece of the puzzle. I dont believe any single model can make money all the time. We have more tools now to take advantage of markets from different angles, in many different time frames. By adding more pieces of the puzzle, you can get a more complete picture of the market. We try to develop trading models that can handle all kinds of market situations, whether trending or range-bound, high- or low-volatility. Thanks to this diversity weve been very effective in managing downside risk. In almost 10 years of trading, only one month we lost more than 5% and that was only slightly more than 5%. OFI: How do you allocate capital among the models? PM: There are two levels of allocation. One, we work to develop a mix of strategies that will perform fairly well in all kinds of market situations, approaching allocation from a very long-term perspective over many business cycles. We dont try to time markets or forecast what the next quarter may bring, but target an allocation that is likely to produce positive returns in many different environments. Then at any given time, the models themselves indicate where we want to be. When a model finds a lot of opportunity, thats what we trade. OFI: How do you decide which markets to focus on? PM: We trade only in the most liquid markets. With quantitative strategies, it is crucial to be able to go in and out of markets with minimal impact on the market. It is very important that the trading track closely the back-testing and research. Slippage due to market impact would cause a divergence from what we expect on the basis of the research. Thats why we trade only major global futures markets and currencies. OFI: Which strategies worked better last year? PM: Interestingly, in 2008 we found opportunities in different places. Not surprisingly, our long-term trend following did very well because the trends were so clear in the 2008 crisis. But we also found great opportunity in the very short-term time framehigh-frequency, intra-day FX trading strategies did really well. OFI: How is trading affected by recent conditions? PM: From a trend-following view, the trends have not been as clear this year. So far there have been trend reversals and choppy markets. But trend-following represents only about 25% of our overall portfolio. We have many mean-reverting type strategies, which in a way are the opposite of trendfollowing and do fairly well in range-bound markets. OFI: Are there fewer trading opportunities this year? PM: Even though volatility has dropped from the highs of last Fall, the recession will probably last a bit longer than many people expect. I would not be surprised if we see another short burst of volatility in the Spring before things calm down. There will probably be some interesting momentum again, though it may not be as clear as the 2008 trends. In any case, we dont just rely on trends. Were well-balanced between momentum and mean-reverting strategies. OFI: How does that combination help? PM: When there is a market inefficiency, either prices revert to efficient prices or they have a momentum going in the other direction. To profit from the inefficiencies, you have to understand both types of situation and have tools to deal with both. Last year we made 75% of our profit on the momentum side of the portfolio and 25% on the mean-reverting side. In a year like 2008 its very hard to make money with meanreverting strategies, so were proud of that. OFI: Do you worry that youll run out of inefficiencies? PM: Were finding many more market inefficiencies, even in FX markets, which are known for being extremely efficient. In our research program we tackled challenging strategies like highfrequency FX trading. It took us almost five years of research to get to implementation with that model. Now we have it running 24 hours a day. We built a back-testing technology that is capable of testing even very sophisticated models quickly. There are cycles for strategies and through the cycles theres a weeding process. Weaker traders go out of business. Using diverse strategies, youre more likely to survive through the strategy cycles. We have a competitive edge.

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ISSUE 6 21 APRIL, 2009

FUTURES LAB

Understanding Managed Futures Sub-Strategies

Managed futures covers a wide range of trading techniques and approaches. These perform differently in varying market environments and have different advantages/disadvantages. Understanding the differences should help investors make better investment decisions. The discussion of substrategies below comes from a longer and more detailed study by Man Investments, an arm of Man Group. The edited excerpts highlight the main distinctions. A previous issue of OFI presented a review of risk controls from the same study (February 24, 2009). The terms managed futures and commodity trading advisors are used interchangeably here.
The first managed futures managers used classical technical trading patterns that were fairly simple, including head and shoulders, support and resistance and break-out. Head and shoulders, for instance, is a chart formation that rises to a peak and subsequently declines, then rises above the former peak and declines again and finally rises once more. By the early 1990s new analytical software and the technological revolution had brought entire libraries of technical indicators to the trading floor. Many indicators had become readily available and were offered by most financial data vendors. This sparked a wave of strategy testing and development among aspiring traders. Computerization allowed traders to sample more data in a far shorter time period. This increased the scope of their trading, allowing them to perform such tasks as finding the most profitable moving average length for a price series. By 2000, the success of systematically driven CTAs was attracting researchers from a variety of scientific fields. They started to research continuous trading, price forecasting and portfolio optimization, which contributed to the continuing success and sophistication of managed futures traders. As a result, the technical trading concepts that dominated the earlier stage of the industrys development have become less important and are now used in combination with more scientific approaches. In the past decade, technological and scientific progress have massively increased the spectrum of strategies available to managed futures traders. Investors can build portfolios containing diverse sub-strategies.

Trading Methods
The managed futures universe can be broadly divided into systematic and discretionary strategies. Systematic strategies make use of historical price data and/or historical relationships that can be tested and which may help to anticipate future price movements. These strategies rely heavily on computer generated trading signals. Conversely, discretionary traders rely on the judgment of the managers and their expertise in a particular market to make investment decisions. Both methods have their advantages and disadvantages; however, they are complementary as they tend to experience losses at different points of a market cycle. The more prevalent systematic approach relies on the application of statistical analysis to evaluate

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ISSUE 6 21 APRIL, 2009

FUTURES LAB
A sample of CTA trading methods
TECHNIQUE Serial correlation analysis Trading of volatility break-out Position measuring based on volatility Conditional execution Term structure trading Reversal pattern Trading Probability signals: position weighting Algorithmic trading/high frequency trading/ execution robots Non-parametric approaches Dynamic sector allocation Behavioral finance Fundamental methods DESCRIPTION

Correlation of a variable with itself over successive time intervals. Managed futures traders use serial correlation to check to what degree past prices predict future prices. When the percentage price move of an asset exceeds a certain threshold. Positions are sized as a function of volatility. In a high volatility market, positions are scaled down and vice versa. Trading signals are placed in the market with pre-defined conditions attached to them, i.e. buy at market if volatility is below x and price above 100. Analysis of interest rate differentials as well as term structure premia in the markets. One implementation of this is the popular carry trade in the currency markets. Predictive strategy that tries to time significant market reversals. If statistically favorable probabilities of a directional move are measured, then position sizes are increased. Traders are replaced by computers which execute the trades automatically, often generating very short-term (intra-day) trading. Reduce the reliance on a particular time frame in order to derive more stable performance. Trading is also spread out to a larger time frame in order to reduce market footprint. Allocation to different market sectors such as commodities or currencies are adjusted in size, depending on opportunities and/or trends. Strategies that rely on persistent errors in the marketplace driven by biases of the human behavior. Econometric models that value certain markets in relationship to the economic cycle.

the movements of markets. Such information may include daily, weekly or monthly price fluctuations, volume variations and changes in open interest. System-driven trading represents the lions share of futures trading volume. CTA managers use a vast range of different trading techniques. The table above is not intended to be exhaustive but gives a snapshot of some of the techniques used today. Systematic trading is based on computerized quantitative models that use moving average prices, break-outs of price ranges or other technical rules to generate buy and sell signals for a set of markets. The approach relies heavily on computer generated trading signals to maintain a disciplined approach. With the emergence of electronic trading, the execution of these strategies is becoming increasingly automated. A number of sub-strategies can be identified within the systematic category. Here we focus on just three: Trend following seeks to capitalize on medium to long-term trends in a variety of markets. Trend reversal seeks to capitalize on key turning points in liquid futures markets. Contrarian (counter-trend) aims to sell near market tops and buy at market bottoms.

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ISSUE 6 21 APRIL, 2009

FUTURES LAB

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The figure below shows the entry points for the three different systematic trading strategies. These can be used to construct highly diversified portfolios through the combination of multiple systems and time frames to reduce overall volatility.

Entry points of different systematic trading strategies

Trend Reversal (sell) Contrarian (buy)

Trend following (buy) Trend reversal (buy)

Time Differences
Systematic trend followers, a sub-category within systematic strategies, can pursue opportunities across many different time periods. The time horizon for medium-term trades lasts on average twelve weeks and long-term trades typically exceed nine months. For example, a long-term systematic trend-follower might use a simple channel breakout strategy applied to gold futures, where a price channel is created using 30-day high and low prices. Long and short trading signals are generated as the price reaches the upper or lower boundaries. By contrast, short-term trades typically last between three to five days, but they can be as short as intraday or as long as a month. These trades try to capture rapid moves. The managers base their activity on swift fluctuations in prices. They rely heavily on liquidity and high volatility for returns and typically have a low correlation to long-term CTA managers. Differences in time horizon result in major differences in sub-strategy performance in various environments. In particular, strong, persistent trends benefit long-term CTAs but hamper shorter term traders because such periods tend to offer fewer short-term price fluctuations.

Taking Advantage of Market Changes

Quantitative and directional strategies respond to price movements across a diverse range of global markets encompassing stock indexes, bonds, currencies, short-term interest rates and commodities. For example, a systematic directional trade can generate returns by taking both long and short positions in a currency pair. Managers will typically use a number of different signals in combination to determine trade entry and exit points. It is likely that allocation size will not remain constant during the life of a trade, as

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ISSUE 6 21 APRIL, 2009

FUTURES LAB

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managers may vary the size and degree of leverage of their position based on contract volatility. In addition, managers have to roll the contracts, which results in small additional transaction costs being incurred. As part of the risk management process, a manager will typically scale down positions when market volatility rises and vice versa. In addition, instrument, sector and regional exposures may be adjusted to stay within predefined limits. In general, managed futures managers tend to view price trends as a function of supply and demand for a particular commodity or financial instrument or as shifts in risk premia for different asset classes. CTAs can benefit from changes in market perception of risk and return. There are a large number of factors that can lead to such shifts in risk premia, such as the changing state of the economy, specific events, market news, or the emergence of information not yet incorporated in the current price. Market participants have different expectations of the future, so adjustments to expectations and the inclusion of new information in the price tends to be a gradual process. CTAs often employ strategies that are constructed to take advantage of such movements. In most cases the strategies do not seek to understand the source of the change, but rather, aim to exploit the change in the prices. Trend followers, for example, dynamically manage exposure to emerging trends. They attempt to identify the beginning of a trend, take a position and exit it as it ends. Trend reversal strategies look for turning points. The focus is not on what may have caused the movements. Market drivers and events continuously change over time. Trying to find the unknown source of an event is an approach that eventually becomes less stable as a forecasting tool. However, by identifying changes in risk premia through prices, a strategy may become more robust over time. This is an important factor regarding the potential long term profitability of managed futures.

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ISSUE 6 21 APRIL, 2009

INDEX TRACKER

March Returns, Managed Futures and Other Strategies

March provided evidence that managed futures returns correlate negatively with equity markets. This is a boon for diversifying a portfolio, but it has a downside. Last month demonstrated the downside. Commodity trading advisors were down around 2% by most indexes while equity hedge funds rose with the stock rally. HFRs equity hedge index gained almost 3% and emerging markets index gained 4.5%.
The month was difficult for both long- and short-term managed futures strategies. The AlternativeEdge Short-Term Traders Index shows the daily performance of a portfolio of short-term, diversified CTAs who have an average holding period of less than a 10 days. Among the 27 constituents of the STTI, three posted positive returnsBanyan Capital Management, Cabana Capital Management and Crabel Capital Management (Multi-Product). In the Newedge CTA Index, which tracks a pool of the largest CTAs, only two out of the 20 constituents posted gains: QFS Asset Mgmt. (QFS Currency) and Eagle Trading Systems (Yield). March was a unique month in that there were a large number of managers that posted negative returns but the depth of drawdown remained relatively shallow, according to Brian Walls of Newedge. Trend followers in particular were whiplashed by reversing trends. The US Federal Reserves willingness to employ quantitative easing helped to drive interest rates and the US Dollar lower, while propelling prices for stocks and agricultural commodities higher, according to Sol Waksman of BarclayHedge. Trend-followers, as a group, were on the wrong side of these markets when they changed direction mid-month. The one CTA strategy that gained in March was Barclays discretionary traders, who apparently made correct judgments about the market reversals and are up 0.90% for the first quarter. Managed Futures: HFRI Systematic Diversified HFRX Systematic Diversified* Credit Suisse/Tremont Managed Futures Greenwich Futures AlternativeEdge Short-Term Traders (STTI) Newedge CTA Index Barclay Hedge Managed Futures total Discretionary Traders Diversified Traders Systematic Traders ManagedFutures Europe CTA Index Autumn Gold CTA Index Selected Hedge Fund Strategies HFRI Equity Hedge (Total) HFRI Fixed Income-Convertible Arbitrage HFRI Emerging Markets (Total) 2.93% 4.39% 4.54% - 1.16% 0.24% - 1.93% - 1.61% -0.45 -1.35% -2.06% -2.35% - 2.18 - 2% - 2.19 - 2.41%

* HFRI are equally weighted composites of constituent funds whereas HFRX are constructed according to a special model to represent the performance of a larger hedge fund universe.

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ISSUE 6 21 APRIL, 2009

PRACTITIONER VIEWPOINT

New Skill Set for Trade Execution

Jonathan Kleisner, managing director of investment strategies at Rex Capital Partners, a commodity trading advisor, discusses the opportunities created by innovations in trading technology and the challenge of getting the most benefit. Mr. Kleisner began his career at age 17 as a floor clerk on the old NY Futures Exchange and started to trade commodity index futures in 1991.
It is essential for a CTA to have as robust a trading technology as possible. There are two broad issues that managers and investors should be aware of. One is the speed of the data flow. If your information lines suffer from slowness or latency, that is a major problem. Setting up your own dedicated lines has become almost part and parcel of the CTA business. If you dont have fast flow and dont get the data quickly, trading suffers. The second issue is the efficiency of the execution. You want to avoid leaving an imprint on the market that will cause prices to move against youthe slippage problem. Theres the risk that as you try to place a large order, other traders will move away in order to force you to accept a higher price if youre buying and a lower price if youre selling. A critical goal is to keep your trades anonymous, the so-called ghosting to hide your foot print in the market as you get in and out of trades. For instance, theres the iceberg strategyshowing the marketplace only a small piece of the position youre trying to put on. With little tricks you can add to the trading system, youre able to put a shadow on your orders so that people dont see what youre doing. This is particularly important for CTAs. Certain commodity futures, like the soft agricultural commodities we trade, are small markets. The punch of a large order is significant and learning how to disguise those punches has become an essential part of the business. The danger not just when you place orders but also when you liquidate trades. If others realize you have to get out, they can make it more difficult.

Sea Change
There is a growing choice of trading software, including auto-trading software, algorithmic trading software and certain enhancements. After futures trading went electronic, just in the past couple of years, new systems have been introduced. There has been a race among vendors to come up with the most robust and trader-friendly technologies. These types of products did not exist before.

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ISSUE 6 21 APRIL, 2009

PRACTITIONER VIEWPOINT

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The sea change in trading technology is continuing. We hear about new enhancements all the time, whether a specialized feature for a certain type of contract or a change that makes possible large-scale integration with exchanges. Many are internet based, so you can access your trade information from wherever you are. The right tools can enhance your efficiency tremendously. You can set up software to search for the conditions you want while you do other things. Auto-spreader software looks in the market for certain spreads and automatically trades those spreads when it gets the right parameters. You can have 16 auto-traders working for you while you concentrate on one. New systems are expensive. But for us it is a net cost saving because the improvement in efficiency of execution saves probably three to five times as much as what we pay. Old-fashioned pit traders were very resistant to entering the technology age. CTAs tried to continue the old ways, getting on the phone with a broker. But the world has changed and to trade successfully in todays markets, you need to be technology savvy. Investors doing due diligence should make sure that a CTA is knowledgeable about internet service vendors and software choices. Id push traders toward more efficient technologies. If I were an investor looking for a CTA, Id put technical expertise on the top of the list of requirements. People often ask us which systems we use and how we like certain products. Investors are concerned about the robustness of systems and disaster recovery. Where are the redundancies in your trading technology software? Thats a top question we get. Clearly, every aspect of trade technology is important and the standard CTA skill set needs to contain the requisite knowledge.

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ISSUE 6 21 APRIL, 2009

INSIDER TALK

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An Investors Experience with Full Transparency

After the Bernard Madoff affair and frozen redemptions in the 2008 crisis, many investors do not want to be in a commingled fund and prefer to have a separate account that provides full transparency. With raising capital as hard as it is, even the largest hedge fund managers have become more willing to manage separate accounts. Christopher Jones, founder of Diamond Peak Capital with Steve Sapourn, has experience using managed accounts to control risk and invest with emerging managers as well established managers. Here he shares his insights. Mr. Jones was previously at Sapourn Financial and Dekker Capital and was involved with quantitative futures trading. He oversees his portfolio while living by the beautiful Lake Tahoe. Diamond Peaks CTA- and futures-focused multi-strategy portfolio was one of a small group of fund of funds that made money in 2008. The company started in October 2007 and returned 8.7% in its first fifteen months.
Opalesque Futures Intelligence: Why do you invest via managed accounts? Christopher Jones: Investing through managed accounts is a core part of our business model. There are situations where a managed account is not feasible and we decide to invest in a pool, but ultimately we dont want limited partnership investments in our portfolio. We want to be a fund of managed accounts. OFI: In terms of your portfolio, does having a separate account make a significant difference? CJ: Unquestionably, it makes a big difference. You have 100% transparency with a managed account. Any time during the trading day you can access your account and see whats going on. We use sophisticated risk management software to import daily position data, usually direct from the Futures Commission Merchant or broker. With that information, we manage our portfolio a lot more effectively than we could otherwise. OFI: How does having managed accounts change your risk controls? CJ: One can look at the portfolio in a much more detailed way. If we see a risk imbalance in a certain area or sector risk is escalating across managers, we have the option to hedge by putting on a short or long position to offset that risk. This model has been corroborated by how unpredictable and volatile markets have been over the past 18 months. Since starting our fund, weve had positive returns in 70% of the

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ISSUE 6 21 APRIL, 2009

INSIDER TALK
months, despite this being the most challenging environment in living memory. I dont think we could have managed risks as well without the transparency provided by managed accounts. OFI: What strategies do you invest in? CJ: Were focused on trading strategies, not exclusively commodity trading advisors. Were willing to look at managers in any space. But weve invested more with CTAs because they tend to be directionally oriented and quantitative, which is also our orientation. Plus, we like them in the current environment. In times of major economic dislocation they tend to perform better. OFI: Why do they do better in times of turmoil like last year? CJ: Part of the reason is that many of them follow short or long-term trends and in the recent past there have been strong trends to follow. Also, there are now so many different, tradable futures markets, they can be less exposed through broader diversification than, say, long/short equity managers who trade fewer asset classes. OFI: Are there other reasons you concentrate on CTAs? CJ: Futures markets are very liquid. We dont want to be in anything thats hard to trade or value. We want to be able to liquidate the portfolio within a couple of hours if need be, not have to wait weeks or months. And we pass on the liquidity to our investors. Our strong intention is that they wont have to face gates or other barriers to redeeming their hard-earned capital. OFI: Do quantitative traders have an advantage? CJ: We gravitate to quantitative traders because in our experience they are more apt to do well over long time periods. Then we watch to make sure they stay in the strategy we invested in. The real-time trading has to match our range of expectations. Abnormally large positions or discrepancies in trades versus the strategy raise a red flag. Thats reason to call the manager and have a talk. Investing through a separate account allows us to do that. OFI: When you invest with managers in other countries, where are the accounts located? CJ: We hold accounts in the US. We have trades

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occurring on foreign exchanges or markets but our FCM or brokerage accounts are in the US. OFI: Do you provide seed capital? CJ: We dont typically invest with a manager on day one after his launch, but we do invest with emerging managers. Were not afraid of emerging managers because were investing via managed accounts. Its another advantage that we can take on potential risk with a relatively new manager because we have aggressive daily oversight of the trading. Theres in fact not much more risk for us than is the case with established managers. But we typically dont seed traders within our fund. An ideal candidate for us is someone who has been trading for many years but is perhaps starting a new program. If the person has a strong background and most importantly has shown the ability to make money, we may invest at a very early stage. OFI: What is important for you besides a traders track record? CJ: You cant just go by a long track record any strategy can stop working at any time! A manager may end up with too much AUM for the strategy, or lose the edge due to changing markets. One manager we know with a great 10-year record could not handle the massive volatility swings in 2008 and did much worse than youd expect from the history. Managers with short records served us better, for various reasons. We watch the trading day by day. The daily return stream is what matters for tight risk management. OFI: Are newer managers more on their game? CJ: Emerging managers tend to be hungrier and more focused compared to someone whos already sitting on a large pool of assets, earning hefty management fees. Also, capacity is an issue. Managers will tell you they wont take on too much AUM, but if they do well and institutional investors discover them, they end up overwhelmed with assets. Often that dilutes their return stream. They go from $200 million to $800 million and suddenly they no longer make the double-digit returns they made before. With the transparency we have, were comfortable investing with newer managers.

Lake Tahoe

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Partnership
Hedge Funds and CTAs

In todays volatile markets, you want to maximize your opportunities and minimize your exposure. We work with you to understand your strategies, anticipate your needs and optimize your resources through our ongoing investments in expertise and infrastructure. We offer prime brokerage services spanning all major asset classes, with cross-margining tools, cutting-edge risk calculation, start-up services and in-depth market intelligence all geared to taking you where you want to go. Newedge committed to helping you reach your goals.

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Newedge refers to Newedge Group and all of its worldwide branches and subsidiaries. Only Newedge USA, LLC is a member of FINRA and SIPC (SIPC only pertains to securities-related transactions and positions). Newedge Group (UK, Frankfurt and Dubai) do not deal with, or for, Retail Clients (as defined by MiFID and Dubai Financial Services Authority). Only Newedge Canada Inc. is a member of the CIPF. Not all products or services are available from all Newedge organizations or personnel. Consult your local office for details.

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ISSUE 6 21 APRIL, 2009

REGULATORS & COURTS

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Futures in a $2 Trillion Carbon Market

Last Friday the United States Environmental Protection Agency made news by publicizing its finding that six greenhouse gases, including carbon dioxide, may endanger public health and welfare. This supports an attempt by Congressional Democrats to pass a cap-and-trade bill that is expected to reduce emissions of carbon dioxide and other heat-trapping gases by lowering the caps on industrial emissions and allowing companies to trade pollution permits. If the legislation goes through, it will bring about a national cap-and-trade system in the US. But some states have already implemented their own system. The Regional Greenhouse Gas Initiative by ten states will on June 17th hold its fourth auction of carbon credits for more than 200 power plants. RGGIs first auction was in September 2008. Futures and options on RGGI credits are trading on the Chicago Climate Futures Exchange, which last week announced a new daily trading record for RGGI and other environment-related derivatives. The 18,381 futures and options contracts traded represented a 66% increase from the previous record, set the previous week. CCFE is designated by the Commodity Futures Trading Commission to offer standardized and cleared futures and options contracts on emission allowances and is supervised by the National Futures Association. Its parent company also runs the European Climate Exchange, a participant in the European Union Emissions Trading Scheme. In other words, environmental futures and options have made some headway but will really get going if the Democratic majority passes cap-and-trade legislation. As it stands now, the House bill aims to reduce American greenhouse gas emissions 20% by 2020 and 83% by 2050. That would require a lot of capping and trading. regulate the trading of derivatives associated with carbon dioxide allowances, extended its energy committee to include environmental markets. CFTC Commissioner Bart Chilton says the mission, mandate and membership of the committee is being expanded to ensure that we are ready for what could be a $2 trillion market in the future. The commission has experience in this areait regulated environmental markets such as the sulfur dioxide derivatives market that came into existence after Congress tackled acid rain. We have a proven track record as a sure-footed regulator of environmental markets since 1995, Mr. Chilton said in a statement. The US is following the European Union, which launched a cap-and-trade system in 2005. Bu the ECs experience has demonstrated how difficult it can be to make such markets work. Im hopeful we in the US can learn from the European experience to ensure that these markets take off in an orderly, efficient and effective fashion, Mr. Chilton said.

Legislation vs. Regulation

It is not clear whether the cap-and-trade bill will become law. Republicans remain opposed and not all Democrats are expected to support it. Congress is to begin hearings this week. EPA Administrator Lisa Jackson seconded President Barack Obamas call for a low-carbon economy and strong leadership in Congress on clean energy and climate legislation. In addition to the effects of greenhouse gases on health, her agency emphasized that climate change poses a national security risk for the USby increasing resource scarcity, global warming can incite violence in destabilized regions. The EPA did not propose regulations against climate change and its finding has to be subjected to public comments. Both the President and Ms. Jackson favor comprehensive legislation to address the global warming issue rather than a regulatory approach. But if legislation is not forthcoming, regulation is almost certain,

Preparations
In the meantime, futures regulators are looking to oversee what could become the largest commodity market. The Commodity Futures Trading Commission, which expects to monitor and

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OPALESQUE FUTURES

ISSUE 6 21 APRIL, 2009

REGULATORS & COURTS

whether through a market instrument like cap-and-trade, new direct controls or a combination of methods. The US Supreme Court ruled a couple of years ago that if human health is threatened, the EPA has the authority to regulate emissions that cause global warming, and ordered the agency to study the effects of heart-trapping gases. Environmental initiatives are a priority for the White House. In addition to environmental goals, the administration looks to create jobs in alternative energy. President Obama has presented combating climate change as a way to boost the ailing economy. He will probably play a big role at the international meeting that will convene in Copenhagen this December to negotiate a follow-up carbon-capping agreement to the Kyoto Protocol.

15
18th? Both industrial and financial players were in the market, according to the exchange. On the financial side, participants included C-Quest Capital LLC, Digilog Global Environmental Master Fund, Environmental Capital Management, Green Fund LLC, Infinium Capital Management LLC and the Royal Bank of Canada. They traded forty-two contracts, representing 42,000 metric tons of carbon dioxide allowances. It was a modest start, but the way the political winds are blowing, it looks like environmental markets will get an immense stimulus from Uncle Sam.

Global Market
With the US leading the way, other countries are likely to follow. There are already indications that this will happen. A Canadian government panel that gives advice on environmental issues said that Canada will have to put a price on carbon and set up a national cap-and-trade system, given that President Obama wants to have a US cap-and-trade system in place by 2012. The Canadian panel said the price of carbon should be around $83 a metric ton by 2020 and double from that level by 2050, according to a report from Reuters. Canada is the largest supplier of energy to the US. Australia is another country that is planning to go this route. The Australian government proposed a cap-and-trade system to start operating in mid-2010. Climate exchanges have geared up by introducing new products. In November CCFE listed futures contracts based on emission allowances under the anticipated US greenhouse gas program. Contracts that expire in December 2013, 2014 and 2015 were traded, with prices ranging from $11.75 to $15.00 per metric ton of carbon dioxide. CCFEs Carbon Financial Instrument-US Allowance Futures call for the delivery of greenhouse gas emission allowances that would be usable for compliance under a mandatory federal cap-and-trade program. If such a program is not enacted by the time the contracts expire, the delivery of other specified mandatory CO2 allowances would be required. Richard Sandor, chief executive of Chicago Climate Exchange, said that the customers requested a tool for hedging US carbon policy and allowance prices. Who traded the first US Allowance Futures on November

Chicago Climate Futures Exchange - Listed Futures and Options

California Climate Action Registry - Climate Reserve Tons Futures and Options Certified Emission Reduction Futures Carbon Financial Instrument Futures and Options CFI-US (CFI Futures Contracts expiring 2013 or later) Dow Jones Sustainability World Index Futures ECO-Clean Energy Index Futures IFEX Event Linked Futures (U.S. Tropical Wind) IFEX Event Linked Futures (Florida Tropical Wind) IFEX Event Linked Futures (Gulf Coast Tropical Wind) Nitrogen Financial Instrument (Annual) Futures and Options Nitrogen Financial Instrument (Ozone Season) Futures Connecticut Renewable Energy Certificate Massachusetts Renewable Energy Certificate New Jersey Renewable Energy Certificate Voluntary Renewable Energy Certificate Regional Greenhouse Gas Initiative Futures and Options Sulfur Financial Instrument Futures and Options

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ISSUE 6 21 APRIL, 2009

TOP TEN

16

We feature top managers from a different database every issue.

Managed Account Research Inc. has a wide variety of interesting rankings of long-term performance. Here we present winners from three-year rankings through February 2009. Weve picked the top five systematic and top five discretionary programs. Managed Account Research also ranks CTAs for five and 10 years, as well as for short periods, across various sub-strategies. The database has detailed descriptions of the advisors and programs.

Systematic and Discretionary Programs for the Past Three Years

Manager and Program Three-Year Compounded Annual Return Last 12 Months as of February

Systematic Traders
Pere Trading Group Pere Trading Program Global Wealth Analytics Inc. Global Weath Class B Pardo Capital Ltd. XT-99 Diversified The Barbashop LLC Managed Account Clarke Capital Mgt. Inc. Jupiter Program 51.5% 45.9% 44.9% 37% 36.3% 91% 8.3% 50% 32.6% 43.6%

Discretionary Traders
NDX Capital Mgt. Shadrach Rosetta Capital Mgt. Rosetta Program Golden West CTA Options Royal Oak Commodity Advisors Cypress Capital Mgt. Cypress Classic Program 48% 25.6% 21.3% 19.3% 18% 55% -4.4% -3% -0.9% -1.6%

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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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