Virginia is one of several regional areas throughout the world where innovative alternative investment theory is practiced. This is evidenced not just by the presence of some prolific managed futures CTA and long / short equity minds in the Atlantic region, some of whom enjoy questioning Wall Street consensus. It is discernible when managed futures CTA thought processes are on display. One such example recently took place in Midlothian, Virgina. This is where Barrett Capital Management is currently on the hunt for noncorrelated market exposure.
Barrett Capital – Central bank “divergent” policies are a snap-back concern
Barrett Capital is currently seeking funds that ” are better able to capitalize on current divergent central bank policies,” Bloomberg Brief’s Hema Parmar first reported. That means managed futures CTAs and currency-focused hedge funds
With this first topic, the fund’s chief investment officer Russell Lundeberg demonstrates to features of the noncorrelated investor. The first has to do with “whisper topics” that are often restricted in their discussion, such as “divergent central bank policies” that those deep in the algorithmic trading community think are manipulating free markets to the point of breaking.
The “artificial bid” in the bond market — as Templeton Global Bond Fund manager Michael Hasenstab described it Tuesday morning on Bloomberg TV — is a very concerning. Market manipulation can lead to mean reversion that features volatility, is algorithmic analysis on the situation.
In some respects Hasenstab is expressing the same general concern as JPMorgan’s Marko Kolanovic and Elliott Management’s Paul Singer. There is a reason market manipulation is outlawed. The longer and harder markets are manipulated, the more violent the snap back to fair value becomes. This discussion, along with noncleared derivatives, are issues typically banned from the financial mainstream. That’s why they are the discussions that most interest algorithmic risk managers.
By addressing a whisper topic in public, Lundeberg not only shows market structure knowledge, but then he looks to interesting managed futures CTA analysis attributes.
His ideal match will have a “difference in process that results in a potentially non-correlated or lower-correlated return stream.”
How is such exposure found?
Barrett Capital’s Lundeberg wants to find CTAs that can deliver opportunity in smaller markets
When he rolls out his criteria must have list with the word “nimble,” Lundeberg starts by tackling a controversial topic. That shouldn’t surprise since he was willing to dive right into the Fed market manipulation conversation. As much as the larger funds dislike comparison relative to how opportunity in smaller markets fails to move the needle, it is part of Lundeberg’s must have list for a relationship.
In stating a preference for funds under $500 million in assets under management, there are trade offs that should be recognized. Risk management protocols and disaster recovery plans need to be above average along with the understanding of algorithmic market structure, for instance. The NFA provides assistance to investors in one of these areas, providing a degree of comfort knowing performance has been properly calculated to a consistent standard after fees and expenses. Many of the larger funds are exempt from such audits, but smaller public funds and upcoming talent typically benefit from having an NFA audit under their belt.
In general the larger funds have found difficulty in smaller markets, with certain allocators preferring the $100 million to $1 billion niche to find hedge fund exposure. Others have found value in funds with assets under $50 million, but such exposure is often tempered with larger funds and business risk is a consideration. At this level, the in-house technical backbone or risk management staff can be slim, so consideration of such a firm’s partnerships are important.
In addition to moving the needle in smaller market opportunities, niche funds often have a lower correlation to managed futures beta, heavily defined by trend following. Some selection and noncorrelated portfolio development management techniques determine correlation based on beta market performance drivers, with markets traded and time horizon sub components.
Barrett currently invests in 25 hedge funds and is not overly concerned with the number of constituents in a portfolio. Some noncorrelated portfolio managers use gross notional value allocation to beta market environment or, more simply, strategy type as a method to determine portfolio constituents. Some fund managers are known to have a wide variety of managers placed under a small number of categories, while other managers and some academics have recommended a portfolio constituent numbers in the upper teens.
Lundeberg likes managers with at least a two or three year track record, which can at times be dicy, particularly since the Fed stimulus driven market environment has dulled market reaction gamma. Ideally the track record is long enough to see how the formula performed during multiple market environments. Comparing the outperformance and underperformance of beta relative to market environment is a strong test, and understanding the role of upside vs downside capture in different strategy types helps model performance.
It is this last topic, the capability to model managed futures CTA performance through algorithmic market environments, that is perhaps most interesting.
Modeling managed futures through market environments helps investors set proper expectations
A recent Preqin survey shows that investors believe systematic CTAs best meet their expectations, while the discretionary CTA are in second place.
Why is this?
Traditional managed futures CTA strategies — unlike many hedge fund categories — can model performance through algorithmic market environments. When a formula is consistent and the market environment exposure is known, investors should have clear expectations for when the strategies will and will not perform. From a hedge fund investment standpoint, this can be a tremendous advantage for those who conduct algorithmic risk analysis.
This leads to a last consideration Lundeberg might want to consider as most important. Even though managed futures CTA strategies have performed during many a crisis, including the 2008 derivatives crash, they do not perform under all negative stock market circumstances. It is most important to understand when a hedge fund strategy will fail. A focus on downside deviation management is where winners are found. Let the upside deviation run free to various degrees, it is a different risk weighting.