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Managed futures: it’s the Hite club

Date: Tuesday, March 1, 2011
Author: Harriet Agnew, Financial News

There is a corner of the hedge fund industry that is a distinctly British success story. The managed futures strategy – among the least understood and most complicated – is now the biggest of the European hedge fund industry, representing almost a fifth of the market.

Fink: European growth driven by financial markets

Fink: European growth driven by financial markets

UK managers, which boast the lion’s share of the European market, are the largest managed futures managers in the world, having taken the mantle from the US, where the strategy was founded. In fact there is a direct line linking Larry Hite, one of the founding fathers of systemic trading, Mint Investments, Man Group and the founders of AHL (see story below) with the UK’s managed futures talent pool.

Although initially shunned by the institutional market, strong performance in 2008 and a good track record have persuaded investors of the merits of managed futures. On an annualised basis, the strategy outperformed the average hedge fund by 1.7%, 1.5% and 0.6% over three, five and 10 years, according to Hedge Fund Intelligence. And despite the growth, managers see further potential.

Managed futures strategies, which grew out of the physical commodities markets in the US, try to predict trends in commodities, currencies, bonds and equities. The largest differentiators between strategies are the timeframes across which they trade and their use of leverage.

Most managed futures strategies are computer-driven, leading to them being described as black box funds, and uncertainty surrounding how they work has put off some investors. Matthew Beddall, chief investment officer at Winton Capital Management, the second largest managed futures firm in the world, said: “We have had difficulty with the fact that we’re quant systematic. In the past some potential investors equated black box with black magic.”

In spite of this, the strategy has been gradually growing and on June 30 last year overtook European long/short equity as the largest strategy by assets in Europe, representing 18% of the $382bn European market, according to Hedge Fund Intelligence.

Recent growth has been driven by the events of 2008, which convinced the institutional market of the merits of managed futures. Before that the investor base was dominated by funds of funds and private clients, many of whom redeemed during the crisis.

Peter Kambolin, chief executive of New York-based Systematic Alpha Management, said: “2008 was the year that turned things around. Managed futures proved themselves to be a good portfolio diversifier as they were not correlated to equity markets or other hedge fund strategies.”

The average managed futures fund rose 14% in 2008, when the average hedge fund lost 14% and equity markets were down 40%, according to HFI.

• Transparency

The liquid and transparent nature of managed futures also found favour with investors. Managed futures was one of the few strategies where managers did not restrict outflows during 2008 by imposing gates or suspending redemptions. Initially this meant large outflows but these reversed when money returned to hedge funds.

As well as being liquid and transparent, the strategy is regulated. Futures traders must file position details with the US Commodity Futures Trading Commission, which declares the aggregate speculative positions on a weekly basis.

Growth is projected to continue, driven by inflows and the rise of Ucits funds, which are regulated by EU directives on collective investment in transferable securities.

Elena Ambrosiadou, founder and chief executive of hedge fund firm Ikos, said: “I think we will see a lot of growth in Ucits. It is an ideal structure for managed futures as the strategy is liquid and transparent.”

But the unexpected closure last year of BlueCrest Capital Management’s Ucits fund, a version of its computer-driven BlueTrend strategy, has led some to question the suitability of the structure for managed futures.

There are also concerns as to whether the types of investor who buy Ucits really understand what a managed futures fund is, and the risk of losses.

Managers said that the main challenge is to keep transaction costs down and keep the systems up to date. Capacity constraints are far off; the size of the global managed futures market is a drop in the ocean compared with the nearly $4 trillion average daily turnover in global foreign exchange markets.

Beddall said: “The idea that markets will stop trending seems unlikely. What is possible is that the performance of trend-following CTAs will be less good in the future as a result of the growing assets in the managed futures universe. There are plenty of woeful tales of clever blokes and their computers, such as portfolio insurance in 1987 and the August 2007 quant crash. The biggest challenge for the managed futures industry is that instead of spotting trends they create them.”

• The family tree: UK funds pool is Mint conditioned

The reason UK managed futures funds have the biggest share of the global market, despite the strategy having originated in the US, is partly because their managers are linked through the Mint Investments diaspora.

Founded in 1981 by Larry Hite, by 1990 Mint had the largest managed futures programme in the world. Hite formed a partnership with ED&F Man Investment Products, a sugar commodity trader that later became Man Group, and Man Group bought AHL, a computer-driven investment business named after its three founders: Michael Adam, David Harding and Martin Lueck.

In 1997 the AHL trio split up: Harding set up Winton Capital Management; Adam and Lueck co-founded Aspect Capital. But AHL’s legacy was far-reaching. Keith Balmer, a portfolio manager at AHL, said: “The backdrop to assets under management being where they are is the success of AHL and the AHL family.”

In the US managers such as Graham Capital Management, Tudor Investment Corp and Renaissance Technologies run low single-digit billions in managed futures, but by and large it remains a fragmented “cottage industry” with many smaller players offering managed accounts. In Europe, the market became much more institutionalised as growth came mainly from brokerage houses such as Man Group trying to increase their lines of business by adding futures.

Stanley Fink, former chief executive of Man Group and now chief executive of International Standard Asset Management, a joint venture with Larry Hite’s Hite Capital Management, said: “The US markets were originated in commodities, which had better diversification but more limited capacity than the European markets, which were rooted in financial contracts. In the 1990s the strongest trends were in financial markets, especially interest rates, rather than commodities. This drove growth in Europe.”

Balmer said AHL spawned a more sophisticated, research-driven approach in Europe. He said: “The AHL DNA is rooted in academia and constantly evolving and upgrading the models.”
The US had a lot of legacy technology systems whereas London developed from scratch. Guaranteed funds – a structure pioneered by Man, where the principal and a minimum return are guaranteed – also drove growth in the European market.