Commodity Trading Advisors E-Book

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 543

Veröffentlichungsjahr: 2011

Beschreibung

Authoritative, up-to-date research and analysis that provides adramatic new understanding of the rewards-and risks-of investing inCTAs Commodity Trading Advisors (CTAs) are an increasingly popular andpotentially profitable investment alternative for institutionalinvestors and high-net-worth individuals. Commodity TradingAdvisors is one of the first books to study their performance indetail and analyze the "survivorship bias" present in CTAperformance data. This book investigates the many benefits andrisks associated with CTAs, examining the risk/returncharacteristics of a number of different strategies deployed byCTAs from a sophisticated investor's perspective. A contributedwork, its editors and contributing authors are among today'sleading voices on the topic of commodity trading advisors and averitable "Who's Who" in hedge fund and CTA research. Greg N. Gregoriou (Plattsburgh, NY) is a Visiting AssistantProfessor of Finance and Research Coordinator in the School ofBusiness and Economics at the State University of New York.Vassilios N. Karavas (Amherst, MA) is Director of Research atSchneeweis Partners. Francois-Serge Lhabitant (Coppet, Switzerland)is a FAME Research Fellow, and a Professor of Finance at EDHEC(France) and at HEC University of Lausanne (Switzerland). FabriceRouah (Montreal, Quebec) is Institut de Finance Mathématiquede Montréal Scholar in the finance program at McGillUniversity.

Leseprobe

Contents

Preface

Acknowledgments

About the Editors

About the Authors

Introduction

Part One: Performance

Chapter 1: Managed Futures and Hedge Funds: A Match Made in Heaven

Introduction

Managed Futures

Data

Stocks, Bonds, Plus Hedge Funds or Managed Futures

Hedge Funds Plus Managed Futures

Stocks, Bonds, Hedge Funds, and Managed Futures

Skewness Reduction with Managed Futures

Conclusion

Chapter 2: Benchmarking the Performance of CTAs

Dealing with CTA Index Heterogeneity

Cta Performance at a Glance

Managed Futures in the Asset Allocation Process: Return Enhancers, Risk Reducers, or Both?

Overview of Key Performance Drivers of CTAS

Conclusion

Chapter 3: Performance of Managed Futures: Persistence and the Source of Returns

Introduction

Data

Regression Test of Performance Persistence

Monte Carlo Study

Historical Performance as an Indicator of Later Returns

Performance Persistence and CTA Characteristics

Regressions of Returns Against Lagged Returns

Does Investing in Losers Make Sense?

Practical Implications

Conclusion

Chapter 4: CTA Performance, Survivorship Bias, and Dissolution Frequencies

Introduction and Literature Review

Database

Survivorship BIAS

Methodology

Performance Analysis

Persistence in Performance

Dissolution Frequencies

Conclusion

Chapter 5: CTA Performance Evaluation with Data Envelopment Analysis

Introduction

Risk Measures and Performance Evaluation

Data Description

Methodology

Results

Conclusion

Chapter 6: The Performance of CTAs in Changing Market Conditions

Introduction

Data and Sample Period

Explaining CTA Returns

Performance Measurement

Conclusion

Chapter 7: Simple and Cross-Efficiency of CTAs Using Data Envelopmennt Analysis

Introduction

Methodology

Data

Empirical Results

Conclusion

Part Two: Risk and Managed Futures Investing

Chapter 8: The Effect of Large Hedge Fund and CTA Trading on Futures Market Volatility

Introduction

Data

Conclusion

Chapter 9: Measuring the Long Volatility Strategies of Managed Futures

Introduction

Brief Review of the Managed Futures Industry

Demonstration of a Long Volatility Strategy

Fitting the Regression Line

Mimicking Portfolio

Value at Risk for Managed Futures

Risk Management Using Long Volatility Strategies

Conclusion

Chapter 10: The Interdependence of Managed Futures Risk Measures

Introduction and Review of the Literature

Methodology

Data

Empirical Results

Conclusion

Chapter 11: Managing Downside Risk in Return Distributions Using Hedge Funds, Managed Futures, and Commodity Indices

Introduction

Describing Downside Risk

Managing Downside Risk with Hedge Funds

Managing Downside Risk with Commodity Futures

Conclusion

Part Three: Managed Futures Investing, Fees, and Regulation

Chapter 12: Managed Futures Investing

Introduction

Regulatory Issues

Hedgers Versus Speculators

Risk Management

Timing Considerations

Conclusion

Chapter 13: The Effect of Management and Incentive Fees on the Performance of CTAs: A Note

Introduction

CTA Compensation Structure

Data

CTA Compensation Parameters and Performance

Conclusion

Chapter 14: Managed Futures Funds and Other Fiduciary Products: The Australian Regulatory Model

Introduction

Fiduciary Futures Products and Managed Investment Schemes

Conclusion

Part Four: Program Evaluation, Selection, and Returns

Chapter 15: How to Design a Commodity Futures Trading Program

Introduction

Trade Discovery

Trade Construction

Portfolio Construction

Risk Management

Leverage Level

Unique Contribution to the Investor’s Overall Portfolio

Conclusion

Chapter 16: Choosing the Right CTA: A Contingent Claim Approach

Introduction

Moment-Based Efficiency Measure

Efficiency Gain/Loss Measure

Market Data Used

Results

Conclusion

Chapter 17: CTAs and Portfolio Diversification: A Study through Time

Introduction

CTAs

CTAs and Portfolio Optimization

Conclusion

Chapter 18: Random Walk Behavior of CTA Returns

Introduction

Data and Methodology

Empirical Analysis

Conclusion

Chapter 19: CTA Strategies for Returns-Enhancing Diversification

Introduction

Literature Review

CTAs, Hedge Funds, and Fund of Funds

Data and Methodology

Findings and Observations

Analysis of the Findings

Conclusion

Chapter 20: Incorporating CTAs into the Asset Allocation Process: A Mean-Modified Value at Risk Framework

Introduction

Mean-Modified Value at Risk Framework

Characteristics of CTA

Incorporating CTA to the Asset Allocation Process

Conclusion

Chapter 21: ARMA Modeling of CTA Returns

Introduction

Methodology

Data

Results

Conclusion

Chapter 22: Risk-Adjusted Returns of CTAs: Using the Modified Sharpe Ratio

Introduction

Literature Review

Data and Methodology

Empirical Results

Conclusion

Chapter 23: Time Diversification: The Case of Managed Futures

Introduction

Commodity Trading Advisors

Time Diversification

Empirical Test

Conclusion

References

Index

John Wiley & Sons

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding.

The Wiley Finance series contains books written specifically for finance and investment professionals, as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation, and financial instrument analysis, as well as much more.

For a list of available titles, visit our web site at www.WileyFinance.com.

To my mother Evangelia, and in memory of my beloved father Nicholas—G.N.G.

To my parents Virginia and Nikos—V.K.

To the ones I love—F.S.L.

To my parents Jacqueline and Jean, and in loving memory of my grandfather David—F.R.

Copyright © 2004 by Greg N. Gregoriou, Vassilios N. Karavas, François-Serge Lhabitant, and Fabrice Rouah. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax [phone], or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax [phone].

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax [phone].

Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books.

For more information about Wiley products, visit our web site at www.wiley.com.

Library of Congress Cataloging-in-Publication Data

Commodity trading advisors: risk, performance analysis, and selection / [edited by] Greg N. Gregoriou . . . [et al.].

p. cm.

ISBN 0-471-68194-6 (cloth)

1. Commodity trading advisors. I. Gregoriou, Greg N., 1956–HG6046.5.C66 2004

332.64’4—dc22

2004007925

Preface

The idea for this book came about when we realized that a collection of managed futures articles dealing with quantitative and qualitative analyses of commodity trading advisors (CTAs) could be a useful and welcomed addition to existing books on the subject. The chapters that follow introduce readers to many of the issues related to managed futures that we believe are vital for proper selection and monitoring of CTAs. These issues include performance assessment, benchmarking, and risk management of managed futures investing, evaluation and design of managed futures programs, CTA management and incentive fees, and regulatory considerations.

All chapters in this book are written by leading academics and practitioners in the area of alternative investments. Although some chapters are technical in nature, we have asked the contributors of those chapters to emphasize the impact of their analytical results on managed futures investing, rather than to focus on technical topics.

We, therefore, believe this book can serve as a guide for institutional investors, pension funds managers, endowment funds, and high-net-worth individuals wanting to add CTAs to traditional stock and bond portfolios.

Acknowledgments

The editors would like to thank Richard E. Oberuc Sr. of Laporte Asset Allocation System (www.laportesoft.com) and Sol Waksman of the Barclay Trading Group, Ltd. (www.barclaygrp.com) for providing data and software. As well, we thank www.alternativesoft.com for their use of Extreme Metrics and HF Optimizer software. We thank Allison Adams at Institutional Investors Journals for allowing us to reproduce one of their articles (Chapter 18). We also thank Mr. Chris Bonnet at Peritus Group (www.peritus.ca) and everyone at Schneeweis Partners.

In addition, we would like to thank Bill Falloon, senior finance editor, and Liam Kuhn, editorial assistant, both at Wiley, for their enthusiastic support and constructive comments; this book could not have come at a better time. We also extend sincere and warmest thanks to Alexia Meyers, senior production editor at Wiley, for her wonderful assistance in editing and meticulously reviewing the manuscript.

About the Editors

Greg N. Gregoriou is Assistant Professor of Finance and faculty research coordinator in the School of Business and Economics at Plattsburgh State University of New York. He obtained his Ph.D. in Finance and his M.B.A. from the University of Quebec at Montreal and his B.A. in Economics from Concordia University, Montreal. Dr. Gregoriou is the hedge fund editor for the peer-reviewed journal Derivatives Use, Trading and Regulation based in the U.K and has authored over 35 articles on hedge funds and CTAs in various U.S. and U.K. peer-reviewed publications along with 20 professional publications in brokerage and pension fund magazines in Canada. He is also an Associate at Peritus Group, a Montreal-based consultancy.

Vassilios N. Karavas is currently Director of Research at Schneeweis Partners in Amherst, Massachusetts. His research focus is on alternative optimization techniques ranging from disequilibrium market models to hedge fund portfolio selection. Dr. Karavas holds a Ph.D. in Operations Research from the University of Massachusetts at Amherst, an M.Sc. and a Diploma in Industrial Engineering both from the Technical University of Crete, Chania, Greece. He is also a research associate of the Center for International Securities and Derivatives Market.

François-Serge Lhabitant is Head of Research at Kedge Capital, U.K., a Professor of Finance at Hautes Etudes Commerciales (HEC), University of Lausanne, Switzerland, and a Professor of Finance at the Edhec Business School, France. He was previously a Director at UBS/Global Asset Management in charge of quantitative analysis and a member of Senior Management at Union Bancaire Privée (UBP), Geneva, responsible for all quantitative research and risk analysis of UBP’s alternative asset management group. Dr. Lhabitant received a Ph.D. in Finance, an M.Sc. in Banking and Finance, and a B.Sc. in Economics, all from the University of Lausanne, as well as a degree in Computer Engineering from the Swiss Federal Institute of Technology. He is the author of two Wiley books on hedge funds investing and emerging markets, and has published more than 300 articles in leading academic journals, edited books, and newspapers.

Fabrice Rouah is an Institut de Finance Mathématique de Montréal (IFM2) Scholar and a Ph.D. Candidate in Finance, McGill University, Montreal, Quebec. Mr. Rouah is a former Faculty Lecturer and Consulting Statistician in the Department of Mathematics and Statistics at McGill University. He holds an M.Sc. from McGill University and a B.Sc. in applied mathematics from Concordia University, Montreal, Quebec. Mr. Rouah specializes in the statistical and stochastic modeling of hedge funds and managed futures, and is a regular contributor to peer-reviewed academic publications on alternative investments. Mr. Rouah is also an Associate at Peritus Group.

About the Authors

Paul U. Ali is a Senior Lecturer in the Faculty of Law, University of Melbourne, and member of the University of Melbourne’s Centre for Corporate Law and Securities Regulation. He is also a principal of Stellar Capital, a private investment firm in Sydney. Dr. Ali previously worked for several years as a finance lawyer in Sydney. He is also a coauthor of Corporate Governance and Investment Fiduciaries (Sydney: Lawbook Co., 2003), which examines the corporate governance aspects of managed investment products.

Mark Anson is the Chief Investment Officer for the California Public Employees’ Retirement System (CalPERS). He has complete responsibility for all asset classes in which CalPERS invests, including domestic and international equity and fixed income, real estate, corporate governance, currency overlay, securities lending, venture capital, leveraged buyouts, and hedge funds. Dr. Anson earned his law degree from the Northwestern University School of Law in Chicago, his Ph.D. and Master’s in Finance from the Columbia University Graduate School of Business in New York City, and his B.A. from St. Olaf College in Minnesota. Dr. Anson is a member of the New York and Illinois State Bar associations and has earned accounting and financial designations. He is the author of four books on financial markets and has published over 60 research articles on the topics of corporate governance, hedge funds, real estate, currency overlay, credit risk, private equity, risk management, and portfolio management. Dr. Anson is on the editorial boards of five financial journals and sits on Advisory Committees for the New York Stock Exchange, the International Association of Financial Engineers, AIMR’s Task Force on Corporate Governance, the Center for Excellence in Accounting and Security Analysis at Columbia University, and the Alternative Investment Research Centre at the City University of London.

Zsolt Berenyi holds an M.Sc. in Economics from the University of Budapest and a Ph.D. in Finance from the University of Munich. His research focus includes the risk and performance evaluation of alternative investments, hedge funds, and leveraged and credit funds. After working years for Deutsche Bank, Dr. Berenyi currently is working as a consultant in the area of asset management for various leading European financial institutions.

B. Wade Brorsen is a Regents Professor and Jean and Patsy Neustadt Chair in the Department of Agricultural Economics at Oklahoma State University.

Daniel Capocci is a Ph.D. student at the University of Liège in Belgium. His areas of research are hedge fund performance and performance persistence. He has published theoretical and empirical articles on hedge funds in several Belgian, English, French, Swiss, and Luxembourg journals and presented his work in various university-sponsored conferences. His main contribution is the development of a multifactor model to analyze hedge fund performance. Since September 2001, and independently of his academic research, he has worked for an international Luxembourg bank. Mr. Capocci received his Master’s in Management Science from the University of Liège and his Master’s in Finance from the Hautes Etudes Commerciales (HEC) Liège.

Manolis Chatiras holds an M.B.A. from the University of Massachusetts at Amherst with a concentration in finance. He received his B.S. (cum laude) in Business Administration from the University of Maine in Orono. He is currently a research associate at the Center for International Securities and Derivatives Markets at the University of Massachusetts, where he conducts research that focuses on the international diversification and risk management potential of hedge funds, managed futures, and CTAs.

Robert Christopherson is Associate Professor and Chair of Economics and Finance at the School of Business and Economics, State University of New York, (Plattsburgh). He received his Ph.D. in Economics from Wayne State University in 1990. Dr. Christopherson is a coeditor and contributing author of The Virtuous Vice: Globalization, published by Praeger in 2004, and has numerous articles, papers, and book reviews to his credit appearing in journals, books, and trade publications.

Gwenevere Darling holds a B.S. in Actuarial Mathematics and Management Engineering with a concentration in Quantitative Finance from Worcester Polytechnic Institute.

Fernando Diz is the Whitman Associate Professor of Finance at the Syracuse University Martin J. Whitman School of Management. He also has been Visiting Associate Professor of Finance at the Johnson Graduate School of Management, Cornell University, where he taught courses on derivatives and financial engineering. Professor Diz is also the Founder and President of M&E Financial Markets Research, LLC. He specializes in managed futures, money management, market volatility, and the use of derivative securities in investment and speculative portfolios as well as distress and value investing. His research has appeared in numerous peer reviewed and industry publications. Professor Diz has presented his research at academic forums as well as industry forums such as the American Stock Exchange Derivatives Colloquium, the Managed Funds Association’s Forum for Managed Futures, and the Chicago Board of Trade Research Seminars. Professor Diz received his doctorate from Cornell University.

Joseph Eagleeye is Cofounder and Portfolio Manager at Premia Capital Management, LLC, in Chicago. Premia Capital specializes in detecting pockets of predictability in derivatives markets by using statistical techniques. As a principal of the Quartile Group, Mr. Eagleeye also advises investment companies on hedging strategies, benchmark construction, index replication strategies, and risk management. He has been involved in the commodity markets since 1994. Prior to joining Premia, he developed programmed trading applications for Morgan Stanley’s Equity Division and proprietary computer models for urban economics. From 1994 to 1998 he worked in the Derivative Strategies Group of Putnam Investments where he researched, back-tested, and implemented relative-value derivatives strategies. Mr. Eagleeye holds a degree in Applied Mathematics from Yale University and an M.B.A. from the University of California at Berkeley.

Andrew Green graduated in March 2004 with an MBA degree in Finance from Thunderbird, the American Graduate School of International Management. He is a former Research Assistant at the High Energy Particle Physics Lab of Colorado State University.

Bhaswar Gupta is a Ph.D. candidate in the Department of Finance at the University of Massachusetts and a Research Associate at the Center for International Securities and Derivatives Markets. He is currently working on his dissertation and is editorial assistant for the Journal of Alternative Investments. He is also a research associate with the Chartered Alternative Investment Analyst Association, a nonprofit educational association that focuses on alternative investment education and is the sponsoring organization for the Chartered Alternative Investment Analyst designation.

James Hedges IV is the Founder, President, and Chief Investment Officer of LJH Global Investments, LLC, in Naples, Florida, and San Francisco, California, and President of LJH Global Investments, Ltd., in London. LJH provides access to hedge fund managers who have been subjected to rigorous due diligence by hedge fund research analysts. The LJH organization also includes professionals in client development, sales force training, client service, and operations/reporting. In addition, LJH provides fund of hedge funds products for direct distribution to qualified investors.

Ho Ho, Quantitative Portfolio Manager in the Global Equity Unit for the California Public Employees’ Retirement System (CalPERS), is responsible for research and development of internal active strategies for equity portfolios, hedge fund risk management, quantitative models for hedge fund risk attribution, manager monitoring, quantitative portfolio construction model development, and a team member of CalPERS’ hedge fund program. He is also responsible for system and model validation of CalPERS’ enterprise wide risk management system. Prior to joining CalPERS, Mr. Ho was derivatives manager for Transamerica Life Insurance Company. He also worked for KPMG as manager of their Structure Finance Consulting Group. He holds an M.B.A. in Finance from the University of Chicago and a B.A. (Phi Beta Kappa) in Economics from the University of California, Irvine.

Bryce R. Holt began his education at Brigham Young University, where he earned his B.S. in Economics. As a part of his graduate studies at the School of Agricultural and Consumer Economics at the University of Illinois, he accepted an internship position at Kraft Foods and for four months performed fundamental analytical work in the coffee, sugar, and grain markets. After finishing his M.S. degree, he returned to Kraft Foods as a Commodity Analyst and was quickly promoted to Associate Risk Manager. In early 2001 he accepted a position as Corporate Purchasing and Price Risk Manager with ACH Food Companies, where he now has full supply chain and risk management responsibilities for commodity ingredients, energy, currency, and ACH’s High Oleic Sunflower Oil program.

Georges Hübner holds a Ph.D. in Management from INSEAD. He is the Deloitte Professor of Financial Management at the University of Liège and also teaches finance at Maastricht University and EDHEC (Lille). He has taught at the executive and postgraduate levels in several countries in Europe, North America, Africa, and Asia. He has written two books on financial management and has authored several peer-reviewed research articles on hedge funds and derivatives. He was the recipient of the prestigious 2002 Iddo Sarnat Award for the best paper published in the Journal of Banking and Finance in 2001.

Scott H. Irwin earned his B.S. in Agricultural Business from Iowa State University and his M.S. in Agricultural Economics and Ph.D. from Purdue University. After completing his Ph.D. in 1985, Dr. Irwin joined the Department of Agricultural Economics and Rural Sociology at the Ohio State University. From 1993 to 1994 Dr. Irwin was a Visiting Scholar in the Office for Futures and Options Research at the University of Illinois. In 1996 he was named the first holder of the Francis B. McCormick Professor of Agricultural Marketing and Policy at the Ohio State University. In 1997 Dr. Irwin joined the Department of Agricultural and Consumer Economics at the University of Illinois. In 2003 Dr. Irwin was named the Laurence J. Norton Professor in Agricultural Marketing at the University of Illinois. He currently serves as the team leader for the farmdoc Project, is codirector of the AgMAS Project, and is an Associate in the Office for Futures and Options Research. His recent research focuses on the performance of farm market advisory services, investment performance, and market impact of managed futures, the value of public information in commodity markets, and the forecasting accuracy of corn and soybean futures prices. His work has been published in leading academic journals. In 2002 he received the Distinguished Group Extension Award from the American Agricultural Economics Association as part of the farmdoc team.

Harry M. Kat is Professor of Risk Management and Director of the Alternative Investment Research Centre at the Sir John Cass Business School City University, London. Before returning to academia, Professor Kat was Head of Equity Derivatives Europe at Bank of America in London, Head of Derivatives Structuring and Marketing at First Chicago in Tokyo, and Head of Derivatives Research at MeesPierson in Amsterdam. He holds MBA and Ph.D degrees in Economics and Econometrics from the Tinbergen Graduate School of Business at the University of Amsterdam and is a member of the editorial board of the Journal of Derivatives and the Journal of Alternative Investments. He has coauthored numerous articles in well-known international finance journals. His latest book, Structured Equity Derivatives, was published in July 2001 by John Wiley & Sons.

Francis Koh is Practice Associate Professor of Finance at the Singapore Management University. He is concurrently Director of the M.Sc. in Wealth Management Program. He holds a Ph.D. in Finance from the University of New South Wales and an M.B.A. from the University of British Columbia. Prior to joining Singapore Management University, Dr. Koh worked with a multibillion-dollar global investment company based in Singapore.

Maher Kooli is Assistant Professor of Finance at the School of Business and Management, University of Quebec, in Montreal. He also worked as a Senior Research Advisor at la Caisse de dépot et placement du Québec (CDP Capital).

Nicolas Laporte is a Member of the Investment Analysis and Advise Group at Citigroup Private Banking. He is involved in portfolio optimization and asset allocation. He was previously an Analyst with the Equity Research Group at Morgan Stanley Capital International. On the academic side, Nicolas Laporte received his M.Sc. in Banking and Finance from HEC Lausanne (Switzerland).

David Kuo Chuen Lee is Managing Director and Chief Investment Officer, Ferrell Asset Management. He holds a Ph.D. in Econometrics from the London School of Economics. He is also a guest lecturer specializing in alternative investments with the Centre for Financial Engineering and Faculty of Business Administration, National University of Singapore.

Lionel Martellini is a Professor of Finance at Edhec Graduate School of Business and the Scientific Director of Edhec Risk and Asset Management Research Center. A former member of the faculty at the Marshall School of Business, University of Southern California, he holds Master’s degrees in Business Administration, Economics, and Statistics and Mathematics, and a Ph.D. in Finance from the Haas School of Business, University of California, Berkeley. Dr. Martellini is a member of the editorial board of the Journal of Alternative Investments and the Journal of Bond Trading and Management. He conducts active research in quantitative asset management and derivatives valuation, which has been published in leading academic and practitioner journals and has been featured in the Financial Times and the Wall Street Journal, and other financial newspapers. He is a regular speaker in seminars and conferences on these topics.

L. Joe Moffitt is a Professor in the Department of Resource Economics at the University of Massachusetts, Amherst. His research interests include the application of biology-based, quantitative-based methods to economics and econometrics. He holds a Ph.D. from the University of California, Berkeley.

Kankana Mukherjee is an Assistant Professor of Economics in the Department of Management at Worcester Polytechnic Institute. She received her Ph.D. from the University of Connecticut. Her principal research interest is in production analysis and issues relating to mergers, productivity, efficiency, as well as regional differences in competitiveness and productivity growth. Her published work has appeared in several peer-reviewed journals.

Nicolas Papageorgiou is an Assistant Professor in the Department of Finance at the Hautes études commerciales (HEC), University of Montreal, Canada. His main research interests and publications deal with fixed income securities, specifically the pricing of structured products and the analysis of fixed income arbitrage strategies used by hedge fund managers. Dr. Papageorgiou has taught graduate-level courses in Canada and the U.K. and has presented at numerous academic and practitioner conferences in North America, Europe, and North Africa.

Kok Fai Phoon is Executive Director Designate, Ferrell Asset Management. He holds a Ph.D. in Finance from Northwestern University. Prior to joining Ferrell, he first worked with Yamaichi Research Institute, and subsequently at a multibillion-global investment company based in Singapore. He teaches courses on hedge funds, portfolio management and investment at the Centre for Financial Engineering, National University of Singapore, and the Singapore Management University.

Stephen E. Satchell is a Reader of financial econometrics at the University of Cambridge and specializes in financial econometrics and risk management. He is the editor of Derivatives Use, Trading and Regulation and the Journal of Asset Management, two leading peer-reviewed journals. He also acts as a consultant and academic advisor to a number of financial institutions.

Hilary Till is cofounder and Portfolio Manager at Premia Capital Management, LLC, in Chicago, which specializes in detecting pockets of predictability in derivatives markets by using statistical techniques. Ms. Till is also a Principal of Premia Risk Consultancy, Inc., which advises investment firms on derivatives strategies and risk management policy. Prior to Premia, Ms. Till was Chief of Derivatives Strategies at Boston-based Putnam Investments, where she was responsible for the management of all derivatives investments in domestic and international fixed income, tax-exempt fixed income, foreign exchange, and global asset allocation. Prior to Putnam Investments, Ms. Till was a Quantitative Equity Analyst at Harvard Management Company (HMC) in Boston, the investment management company for Harvard University’s endowment. She holds a B.A. in Statistics from the University of Chicago and a M.Sc. in Statistics from the London School of Economics. Her articles on derivatives, risk management, and alternative investments have been published in several peer-reviewed academic journals.

John P. Townsend is currently Dean of Agriculture and Assistant Professor of Agribusiness at Oklahoma Panhandle State University in Goodwell, OK. Dr. Townsend teaches undergraduate courses in agribusiness, mathematics, and risk management and serves as Rodeo Club advisor in addition to his administrative duties. Dr. Townsend obtained his B.S. and M.S. in Agricultural Economics from New Mexico State University, and his Ph.D. in Agricultural Economics from Oklahoma State University.

Mathieu Vaissié is a Research Engineer at Edhec Risk and Asset Management Research Center, where he is in charge of the production of Edhec Alternative Indexes. Mr. Vaissié holds a Master’s Degree in Business Administration from Edhec Graduate School of Business and is a Ph.D. candidate in Finance at the University Paris 9 Dauphine. He specializes in multifactor models and their use for benchmarking hedge fund returns.

Kathryn Wilkens is an Assistant Professor of Finance at Worcester Polytechnic Institute. She received her Ph.D. from the University of Massachusetts at Amherst. Her research analyzes asset allocation and portfolio performance issues and the bases of relative performance among alternative investment strategies. She is a research associate at the University of Massachusetts’ Center for International Securities and Derivatives Markets and has published articles in several peer-reviewed journals. In collaboration with industry experts, she is also on the Chartered Alternative Investment Analyst curriculum committee.

Introduction

One of the key results of modern portfolio theory as developed by Nobel laureate Harry Markowitz in 1952 is that one can obtain a greater number of efficient portfolios by diversifying among various asset classes having negative to low correlation. The performance attributes of the various asset classes are independent among themselves and are not highly correlated. Commodity trading advisors (CTAs), which typically exhibit low and negative correlation with stock and bond markets, can help to provide downside protection during volatile and bear markets. CTAs trade managed futures using proprietary trading programs that buy and sell commodities and financial futures on options and futures markets around the world.

What makes CTAs special? They are different from hedge fund and long-only portfolio managers because they do not follow trends in stock or bond markets, but rather attempt to seize opportunities in a variety of commodity and financial futures markets. Many accredited investors today have understood the benefits of diversification by including CTAs in pension fund and institutional portfolios. The performance of CTAs can provide a better reward-to-risk ratio than equity mutual fund managers.

Recent academic studies have examined the benefits of adding CTAs to traditional stock and bond portfolios and have concluded that CTAs can reduce the standard deviation and increase the risk-adjusted returns of portfolios. Furthermore, in months where stocks markets have done poorly, CTAs have often returned positive numbers, offering a cushion in these down months.

Whether stock markets go up or down, CTAs can provide positive returns in both environments. Academic studies also have demonstrated that CTAs perform better than hedge funds in down markets. This is of paramount importance because over the last few years, volatility in stock markets has been very high and finding protection only with hedge funds may not yield an optimal investment portfolio.

PART ONE

Performance

Chapter 1 demonstrates how adding managed futures to a portfolio of stocks and bonds can reduce that portfolio’s standard deviation more and more quickly than hedge funds can, and without the undesirable consequences that often accompany hedge fund allocations. Portfolios consisting of both hedge funds and managed futures are shown to exhibit even more desirable diversification properties.

Chapter 2 presents an original methodology for constructing a representative and pure commodity trading advisor (CTA) index that addresses some of the crucial issues investors can face during the allocation process. Using this index as a reference, the chapter also analyzes CTAs’ return characteristics and the extent to which investors would be better off integrating CTAs in their global allocation.

Chapter 3 examines the many benefits to investing in CTAs. Past studies have found little evidence of performance persistence in the returns to CTAs. But these studies have used small data sets and methods with low statistical power. Larger data sets and a variety of statistical methods are used here to investigate whether some advisors or funds consistently outperform others. The analysis uses data from public funds, private funds, and CTAs and applies four distinct methods to evaluate performance persistence.

A small amount of performance persistence was found. It was stronger when a return/risk measure was used as the measure of performance. The persistence found was small relative to the noise in the data, and, therefore, precise methods and long time series had to be used to properly select funds or CTAs. Results also indicated that CTAs using long- or medium-run systems had higher returns than CTAs using short-term trading systems and that CTAs with higher historical returns tend to charge higher fees. Returns were negatively correlated with the most recent past returns, but were positive in the long run. Yet, when deciding whether to invest or withdraw funds, investors put more weight on the most recent returns.

Chapter 4 examines CTA performance, which has been analyzed by many academic and practioners. However, few studies attempt to determine whether there are significant differences in their performance over time. The study presented in this chapter investigates CTA performance using one of the biggest databases ever employed in performance analysis studies to determine if some funds consistently and significantly over- or under-perform. The chapter also analyzes the survivorship bias present in CTAs as well as the dissolution frequencies of these funds.

Chapter 5 applies data envelopment analysis (DEA) to a performance evaluation framework for CTAs. The DEA methodology allows the authors to integrate several performance measures into one efficiency score by establishing a multidimensional efficient frontier. Two dimensions of the frontier are consistent with the standard Markowitz mean-variance framework. Additional risk and return dimensions include skewness and kurtosis. The chapter also illustrates a method of analyzing determinants of efficiency scores. Tobit regressions of efficiency scores on equity betas, beta squared, fund size, length of manager track record, investment style (market focus), and strategy (discretionary versus systematic) are performed for CTA returns over two time frames representing different market environments. The authors find the efficiency scores to be negatively related to beta squared in both time periods. Results also indicate that emerging CTAs (those with shorter manager track records) tend to have better DEA efficiency scores. This relationship is strongest during the period from 1998 to 2000, but not statistically significant during the period from 2000 to 2002. For both time periods, fund size is not related to efficiency scores.

Chapter 6 examines the performance of six CTA indices from 1990 to 2003, during which time four distinct market trends are identified as well as three extreme events. The authors show that traditional multifactor as well as multimoment asset pricing models do not adequately describe CTA returns. However, with a proper choice of risk factors, a significant proportion of CTA returns can be explained and the abnormal performance of each strategy can be assessed properly.

Chapter 7 applies the basic, cross-evaluation, and superefficiency DEA models to evaluate the performance of CTA classifications. With the ever-increasing number of CTAs, there is an urgency to provide money managers, pension funds, and high-net-worth individuals with a trustworthy appraisal method for ranking CTA efficiency. Data envelopment analysis can achieve this, with the important benefit that benchmarks are not required, thereby alleviating the problem of using traditional benchmarks to examine nonnormal returns.

CHAPTER 1

Managed Futures and Hedge Funds: A Match Made in Heaven

Harry M. Kat

In this chapter we study the possible role of managed futures in portfolios of stocks, bonds, and hedge funds. We find that allocating to managed futures allows investors to achieve a very substantial degree of overall risk reduction at, in terms of expected return, relatively limited costs. Apart from their lower expected return, managed futures appear to be more effective diversifiers than hedge funds. Adding managed futures to a portfolio of stocks and bonds will reduce that portfolio’s standard deviation more and more quickly than hedge funds will, and without the undesirable side effects on skewness and kurtosis. Overall portfolio standard deviation can be reduced further by combining both hedge funds and managed futures with stocks and bonds. As long as at least 45 to 50 percent of the alternatives allocation is to managed futures, this will have no negative side effects on skewness and kurtosis.