A Quantitative Analysis of Managed Futures Strategies: Lintner Revisited

LINTNER REVISITED
A Quantitative
Analysis of
Managed Futures
Strategies
JUNE 2014
RYAN ABRAMS , CFA, FRM RANJAN BHADURI, PHD, CFA, CAIA ELIZABETH FLORES, CAIA
Portfolio Manager Chief Research Officer Executive Director, Client
Wisconsin Alumni Research Sigma Analysis & Management Ltd Development & Sales –
Foundation Asset Managers
CME Group
As the world’s leading and most diverse derivatives marketplace, CME Group (www.cmegroup.com)
is where the world comes to manage risk. CME Group exchanges offer the widest range of global
benchmark products across all major asset classes, including futures and options based on interest
rates, equity indexes, foreign exchange, energy, agricultural commodities, metals, weather and real
estate. CME Group brings buyers and sellers together through its CME Globex electronic trading
platform and its trading facilities in New York and Chicago. CME Group also operates CME Clearing,
one of the largest central counterparty clearing services in the world, which provides clearing and
settlement services for exchange-traded contracts, as well as for over-the-counter derivatives
transactions through CME ClearPort. These products and services ensure that businesses
everywhere can substantially mitigate counterparty credit risk in both listed and over-the-counter
derivatives markets.
ABSTRACT:
Managed futures comprise a wide array of liquid, transparent active strategies which offer institutional
investors a number of benefits. These include cash efficiency, intuitive risk management, and a
proclivity toward strong performance in market environments that tend to be difficult for other
investments. This paper revisits Dr. John Lintner’s classic 1983 paper, “The Potential Role of Managed
Commodity-Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds,” which
explored the substantial diversification benefits that accrue when managed futures are added to
institutional portfolios. As Lintner did, it analyzes the portfolio benefits that managed futures,
offer through the mean-variance framework, but it draws on more complete techniques such as the
analysis of omega functions to assess portfolio contribution. The paper also conducts a comparative
qualitative and quantitative analysis of the risk and return opportunities of managed futures relative
to other investments, and includes a discussion as to why managed futures strategies tend to perform
well in conditions that are not conducive to other investment strategies. It provides an overview of
the diversity of investment styles within managed futures, dispelling the commonly held notion that
all CTAs employ trend following strategies. Finally, it highlights the opportunities the space offers
to pension plan sponsors, endowments and foundations seeking to create well-diversified, liquid,
transparent, alpha generating portfolios.
Dedicated to the late John Lintner

TABLE OF CONTENTS
2 Introduction
3 Revisiting Lintner
4 Managed Futures – Some Basic Properties
6 Growth of Futures Markets and Managed Futures
7 Manager Style and Selection
11 Managed Futures Risk, Return, and the Potential for Enhanced Diversification
12 Risk and Return: Omega – A Better Approach
15 Hidden Risk: The Importance of Liquidity, Transparency and Custody
17 The Lack of Correlation and Potential for Portfolio Diversification
22 Managed Futures and Performance during Financial Market Dislocations
30 Benefits to Institutional Investors
32 Conclusion
34 Conclusion in the Context of Lintner
35 References
cmegroup.com
INTRODUCTION
The Managed Futures industry is a diverse collection of active This paper also gives a brief treatment of risk management and
trading strategies which specialize in liquid, transparent, the importance of liquidity. From there, we analyze historical
exchange-traded futures markets and deep foreign exchange correlations among managed futures, traditional investments,
markets. Some of the approaches taken by managed futures and other alternative investment strategies, demonstrating the
managers exploit the sustained capital flows across asset classes diversification benefits that may be reaped from the introduction
that typically take place as markets move back into equilibrium of managed futures’ uncorrelated variance into traditional
after prolonged imbalances. Others thrive on the volatility and portfolios and blended portfolios of traditional and alternative
choppy price action which tend to accompany these flows. Others investments. We explore the proclivity of managed futures
do not exhibit sensitivity to highly volatile market environments strategies toward strong performance during market dislocations
and appear to generate returns independent of the prevailing due to their tendency to exploit the massive flows of capital to or
economic or volatility regime. This explains in part why managed from quality that tend to coincide with these events. Although
futures often outperform traditional long-only investments and managed futures strategies have often produced outstanding
most alternative investment and hedge fund strategies during returns during dislocation and crisis events, it must be emphasized
market dislocations and macro events. that they are not and should not be viewed as a portfolio hedge.
Rather, they are sources of liquid transparent returns that
This paper endeavors to re-introduce managed futures as a liquid,
are typically not correlated to traditional or other alternative
transparent hedge fund sub-style which actively trades a diversified
investments.
mix of global futures markets. We seek to dispel some of the
more common misconceptions many institutional investors hold And while most of this piece focuses on CTA’s and separately
regarding the space. We discuss the likely effects and implications managed accounts, one must be made aware of the rapid growth
of the proliferation of futures markets and managed futures assets in managed futures mutual funds over recent years. Back in 2006,
under management on the performance and capacity of trading there was under a billion in such funds. As of June 30 of 2014
managers. We also address trading manager selection and style, there were over $13 billion in Assets in mutual funds and ETFs
and differentiate among the myriad unique trading strategies that followed managed futures strategies. Both vehicles, separately
which currently encompass managed futures. An assessment managed accounts offered through CTAs and managed futures
of the performance and risk characteristics of managed futures mutual funds have great potential in the years to come.
relative to traditional investments and other alternatives is Finally, we conclude with a discussion of some of the unique
conducted, including a critique of the mean-variance framework benefits offered to pension plan sponsors, endowments and
in which many practitioners and investment professionals analyze foundations, namely, the ability to use notional funding to
performance and risk. The Omega performance measure is offered efficiently fund exposure to managed futures, diminish the risks
as an alternative to traditional mean-variance ratios since it associated with asset-liability mismatches, and capitalize on
accounts for the non-Gaussian nature of the distributions typically favorable tax treatment. We also close the loop in relation to how
encountered in finance; the Omega function was invented by Lintner’s insights on the role of managed futures in an institutional
mathematicians in 2002, and thus was not available to Lintner. portfolio have held up after more than 30 years.
2 Past performance is not necessarily indicative of future results.

A Quantitative Analysis of Managed Futures in an Institutional Portfolio
REVISITING LINTNER
The late Dr. John Lintner (1916 – 1983), a Harvard University Finally, all the above conclusions continue to hold when returns are
Professor, had an illustrious and prolific career, including measured in real as well as in nominal terms, and also when returns
recognition as one of the co-creators of the Capital Asset Pricing are adjusted for the risk-free rate on Treasury bills.” [Lintner, pages
Model (CAPM). Lintner also published a classic paper entitled 105-106]
“The Potential Role of Managed Commodity-Financial Futures
Sadly, Lintner died shortly after presenting his treatise on the role
Accounts (and/or Funds) in Portfolios of Stocks and Bonds,”
of managed futures in institutional portfolios.
which he presented in May 1983 at the Annual Conference of
the Financial Analysts Federation in Toronto. Lintner found the The objectives of this paper are not at all modest. We seek to
risk-adjusted return of a portfolio of managed futures to be higher furnish a modern-day Lintner paper, and also to dispel some
than that of a traditional portfolio consisting of stocks and bonds. common misconceptions regarding managed futures.
The Lintner study also found that portfolios of stocks and/or bonds While Lintner’s study has been applauded by scholars and
combined with managed futures showed substantially less risk at practitioners who have read it, there still seems to be a gap and
every possible level of expected return than portfolios of stocks disconnect between many institutional investors and the managed
and/or bonds alone. The following passage from Lintner’s scholarly futures space. Is this because through the passage of time the
work furnishes good insight on his findings: kernel of Lintner’s findings is no longer true? Or have some
institutional investors simply not performed their fiduciary duty in
“Indeed, the improvements from holding efficiently selected portfolios
a comprehensive manner?
of managed accounts or funds are so large – and the correlations
between the returns on the futures portfolios and those on the stock and Updating the Lintner paper will help to supply the answer to
bond portfolios are surprisingly low (sometimes even negative) – that this question. In order to do this properly, it is best to lay out
the return/risk trade-offs provided by augmented portfolios consisting the framework of what managed futures are in terms of the
partly of funds invested with appropriate groups of futures managers current landscape before exploring the impact of adding them to
(or funds) combined with funds invested in portfolios of stocks alone (or traditional portfolios.
in mixed portfolios of stocks and bonds), clearly dominate the trade-offs
available from portfolios of stocks alone (or from portfolios of stocks
and bonds). Moreover, they do so by very considerable margins.
The combined portfolios of stocks (or stocks and bonds) after including
judicious investments in appropriately selected sub-portfolios of
investments in managed futures accounts (or funds) show substantially
less risk at every possible level of expected return than portfolios of
stock (or stocks and bonds) alone. This is the essence of the “potential
role” of managed futures accounts (or funds) as a supplement to stock
and bond portfolios suggested in the title of this paper.
Past performance is not necessarily indicative of future results. 3

cmegroup.com
MANAGED FUTURES – SOME BASIC PROPERTIES
A discussion of managed futures performance, particularly during Managed futures traders are commonly referred to as “Commodity
periods of market dislocation, may be more illuminating if preceded Trading Advisors” or “CTAs,” a designation which refers to a
by a brief discussion of what managed futures strategies are and are manager’s registration status with the Commodity Futures Trading
not. As previously mentioned, these strategies encompass a variety Commission and National Futures Association. CTAs may trade
of active trading approaches which specialize in liquid, transparent, financial and foreign exchange futures, so the Commodity Trading
exchange-traded futures, options, and foreign exchange, and may Advisor registration is somewhat of a misnomer since CTAs are
be thought of as liquid, transparent hedge fund strategies. Like not restricted to trading only commodity futures. The highly
long/short equity and equity market neutral hedge fund strategies, diversified and global nature of the markets included in most
managed futures strategies may take long and short positions in managed futures programs makes the selection of a passive long-
the markets they trade, are available only to qualified investors. only index for analysis of value added through active management
They may employ leverage. An important difference, however, extremely difficult since many CTAs trade portfolios of futures
is that equity hedge fund leverage requires borrowing funds at contracts which span across all asset classes. The name Commodity
a rate above LIBOR, whereas managed futures investing allows Trading Advisor also results in the common mistake of using
for the efficient use of cash made possible by the low margin passive long-only commodity indices, such as the Goldman Sachs
requirements of futures contracts. Rather than allowing cash not Commodity Index (GSCI), DJ AIG Commodity Index (DJ AIG),
being used for margin to collect interest at the investor’s futures and Rogers International Commodity Index (RICI) as performance
commission merchant (FCM), the investor can deploy it to gain a benchmarks. These indices are not appropriate because they
higher notional exposure when investing using a managed account. include only a small fraction of the futures markets most CTAs
Consequently, the investor is not paying interest, since they did trade (excluding the many financial products), and do not account
not need to borrow money to get the extra exposure. The following for active management or the ability to take short as well as long
example helps to highlight this important point. positions, all of which should result in lack of correlation over time.
Example: A pension plan sponsor has $50 million (USD), and Active management and the ability to take long and short positions
wishes to get $50 million exposure in a managed futures strategy are key features that differentiate managed futures strategies
that allows for a funding factor of two. The investor then only needs not only from passive long-only commodity indices, but from
to invest $25 million to the managed futures strategy and may put traditional investments as well. Although most CTAs trade equity
the other $25 million in Treasury bills to receive interest. index, fixed income, and foreign exchange futures, their returns
should be uncorrelated and unrelated to the returns of these asset
Another critical difference between futures and equities is that classes because most managers are not simply taking on systematic
there are no barriers to short selling in futures. Since two parties exposure to an asset class, or beta, but are attempting to add alpha
agree to enter into a contract, there is no need to borrow shares or through active management and the freedom to enter short or
incur other costs associated with entering into equity short sales. spread positions, which can result in totally different return profiles
Thus, in that sense, it is easier to invoke a long-short strategy via than the long-only passive indices.
futures than it is using equities.

Not all CTAs are trend followers. Many of the earliest and most The existence of these risk premia is consistent with futures prices’
successful futures traders employed trend following strategies, as role as biased predictors of expected spot prices. The futures price
do some of the largest CTAs today, which might help to explain the equals the discounted present value of the expected spot price
prevalence of this overly casual generalization. Trend following may plus a risk premium, which can be positive or negative depending
be the most common managed futures strategy, but it certainly is on the skewness or bias of distribution of expected spot prices.
not the only one. The myriad other approaches to futures trading If all financial assets, including futures contracts, have a zero net
offer institutional investors access to a variety of sources of return, present value (NPV), then:
including trend following, which are uncorrelated to traditional and
alternative investments, and oftentimes, to one another. E(ST) = Fe(μ -r)T
s
These include discretionary fundamental or global macro managers

who express their views using futures, short-term traders whose where T represents the delivery date, E(ST) the expected spot
strategies vary tremendously, chartists who scan the markets for price, F the futures price, and (μs-r) the risk premium, the sign of
patterns, and contrarian traders. The wide availability of clean data which depends on whether or not the risk premium is positive or
has also converted academics, researchers, and scientists to trading. negative. Equity index futures, for example, tend to be downward-
These individuals apply advanced quantitative techniques to the biased predictors of expected spot prices since the natural risk
markets that go beyond basic rules-based systems to forecast the in equities markets is to the downside. CTAs offer liquidity to
direction in price or changes in volatility. Managed futures programs hedgers in order to capture positive risk premia (CISDM 2006, 4).
that rely on strategies other than trend following are becoming a It is also important to account for transactions, storage, and other
larger and more important part of the space. costs which may affect futures prices.
Another common misconception about managed futures strategies

is that they are a zero sum game. This would be the case if CTAs
were trading exclusively against other CTAs, but academics and
practitioners have demonstrated that some futures markets
participants are willing to hedge positions, or buy or sell forward
even if they expect spot prices to rise or fall in their favor (CISDM
2006, 4).

cmegroup.com
GROWTH OF FUTURES MARKETS AND

MANAGED FUTURES
The growth in open interest in futures markets has led to a substantial growth in managed futures assets under management.
Electronic exchanges and technology have also contributed to the scalability and capacity of managed futures.
EXHIBIT 1: Managed Futures Growth in Assets Under Management 1980-2014
Managed Futures Growth in Assets Under Management 1980 - 2014
$350
Assets Under Management ($Billions)
$300
$250
$200
$150
$100
$50
$0
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: BarclayHedge Alternative Investment Database
The substantial influx of assets into the futures markets in the It has also augmented the capacity of the more niche strategies and
form of passive long-only money in commodity markets as well as large diversified trend followers alike. The proliferation of passive
the explosion of assets under management for active traders has long-only indices has created new opportunities and risks for CTAs
had numerous important implications for CTAs. The tremendous as exchange traded funds and notes attempt to roll massive numbers
increase in open interest has resulted in increased depth and of contracts each month. Fundamental discretionary traders, for
liquidity in many markets, allowing managers to add previously instance, must incorporate the augmented interest from the long
inaccessible markets to their domain of traded instruments. side when making trading decisions.

MANAGER STYLE AND SELECTION
As previously mentioned, most observers closely associate Although certain voices in the investment management
managed futures with trend following strategies. The liquidity community have heralded the death of trend following many times
of futures contracts and copious amounts of available data, over the years, there is a high probability of generating strong
however, facilitate the application of numerous other variations returns over sufficiently long rolling time periods, 36 months or
of quantitative systematic trading strategies to these instruments more, for instance. The “long gamma” profile associated with most
and the time series associated with them. The influence of CTAs and trend followers in particular often means that returns
fundamental economic variables on commodities and futures are lumpy and a given manager’s performance will usually depend
markets provides opportunities for niche sector and market on a few large positive months. As such, it may take some time
specialists to trade programs which generate returns that are often to draw from this right tail of the distribution of returns, and the
uncorrelated to most trend following programs. likely interim outcome is flat lining or entering a drawdown as the
program searches for opportunities in the markets it trades. Those
A useful analogy for the different managed futures trading
who do not hold these investments over sufficiently long time
programs and styles, as well as for alternative investments
horizons will typically experience frustration and disappointment
in general, consists of thinking of the various trading styles or
since the events that drive performance, typically massive flights
programs as radio receivers, each of which tunes into a different
of capital to or from quality, only take place occasionally.
market frequency. Simply put, some strategies or styles tend to
The market environment for most CTAs post-2008 financial crisis
perform better or “tune in” to different market environments.
has been challenging. Market interventions are widely regarded as
Trend Following the cause of a reduced number of trends and higher correlations,
Trend following has demonstrated performance persistence over significantly shrinking the opportunity set for most CTAs.
the more than 30 years since the first “turtle” strategies began
Exhibit 2, on the following page, illustrates the maximum,
trading, and roughly 70 percent of CTA strategies belong to this
minimum and mean rolling return of the Barclays Capital BTOP
managed futures strategy sub-style. Trend following is dominated
50 Index over different holding periods since January 1987.
by momentum and/or breakout strategies, both of which attempt
Each blue bar represents the range of all rolling returns for that
to capture large directional moves across diversified portfolios
number of months over the life of the index. For example, the bar
of markets. It also tends to be diversified across time frames,
furthest to the left represents all 3-month rolling returns since
although some trend followers may be exclusively long-term
the inception of the BTOP 50 Index. The minimum, depicted
(multiple months) or very short-term (days, hours, or minutes).
by the green dot, shows the worst 3-month rolling return in the
Subtle differences in risk budgeting across markets, time horizons,
distribution. The orange square indicates the mean, and the blue
and parameter selection may result in trend following programs
triangle shows the best 3-month rolling return in the distribution
which yield vastly different performance statistics and/or exhibit
for this particular example.
non-correlation to one another. Even within the trend-following
space, there can be large differences between managers; these
differences range from multi-billion dollar institutional quality firms
employing an array of sophisticated and diversified techniques, to
small shops trading with discretion.

cmegroup.com
EXHIBIT 2: Maximum, Minimum, and Mean Rolling Return of Barclays Capital BTOP 50 Index Over
Different Holding Periods
Maximum, Minimum, and Mean Rolling Return of BTOP 50 Index Over Different
Holding Periods, January 1987 - March 2014
160% max mean min

Rolling Rate of Return for Period
140%
120%
100%
80%
60%
40%
20%
0%
-20%
3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48 51 54 57 60
Months
Source: Bloomberg
The conclusion readers should draw from the graph is that the Managers generally do not make material changes to their strategies
possibility of making money increases dramatically if the investor or models for this same reason, especially during drawdowns, since
maintains the allocation to managed futures three to five years. this would be tantamount to redeeming in the same way as in the
example. Initial research and testing are critical, however, to ensure
During periods of flat or underperformance, the trend follower
robustness and performance persistence, as are ongoing efforts to
stops out of or exits stale positions and begins to put on new ones
refine the program and ensure it evolves with markets over time.
for which the profit expectation is greatest. This often results in a
Evolution and research have always been essential to successful
mean-reversion or “rubber band” effect which manifests itself as
trend followers, and any perceived “shifts” typically involve
a sudden burst of positive performance after an extended drought
incremental improvements or innovations designed to enhance
of opportunities during which the program’s money management
the program rather than depart from it materially (Fischer and
system strived to preserve capital. Experienced investors often
Bunge 2007, 2).
choose to add to trend followers in a drawdown in anticipation
of this effect. Likewise, inexperienced or impatient investors all
too often redeem at the bottom of a manager’s drawdown, only to
witness the surge in performance shortly thereafter.

Other Managed Futures Strategies Managed Futures Equal Black Box Trading?
Although the majority of quantitative CTAs employ some variation The quantitative nature of many managed futures strategies
of trend following strategies, other managed futures quantitative makes it easy for casual observers to mistakenly categorize them
strategies abound, many of which exhibit no statistical relationship as black box trading systems. In actual fact, many CTAs offer a
whatsoever with trend following programs. Counter-trend strategies high degree of transparency into the strategy behind their models
attempt to capitalize on the often rapid and dramatic reversals that and on an ongoing basis will provide daily position transparency.
take place at the end of trends. Some quantitative traders employ With managed accounts, this is standard. It is true, however, that
econometric analysis of fundamental factors to develop trading managers will (understandably) not offer model transparency at the
systems. Others use advanced quantitative techniques such as level of algorithms or source codes. Investors, in fact, should not
signal processing, neural networks, genetic algorithms, and other expect them to.
methods borrowed and applied from the sciences. Recent advances
Hermes BBK Partners, in their paper “CTAs: Shedding Light on the
in computing power and technology as well as the increased
Black Box”, point out that “Going back to the 1970’s and 1980’s,
availability of data have resulted in the proliferation of short-term
CTAs as a strategy have been very willing to run managed accounts
trading strategies. These employ statistical pattern recognition,
for clients.” The authors, Tommasso Sanzin and Larry Kissko, say
market psychology, and other techniques designed to exploit
that “with these vehicles clients have full position level transparency
persistent biases in high frequency data. Toward the end of 2008,
on a daily basis. Every trade made by a program can be seen by a
short-term strategies were in high demand among fund of funds
client so as an allocator, it is difficult to achieve a more granular
and institutional investors searching for sources of return which
level of transparency. In addition, many CTAs are willing to disclose
appeared to be statistically independent from the factors driving
their portfolio positioning together with P&L attribution to non-
performance across both the traditional and alternative investments
managed account investors, making them possibly one of the most
universes.
transparent strategies according to hedge fund standards.”
The very short holding periods of short-term traders allow them
The Hermes BBK paper goes on to distinguish between “good
to rapidly adapt to prevailing market conditions, making it easy
and bad transparency: we we would argue that knowing when a
for them to generate returns during periods which are difficult
CTA is risk on or risk off is both critical and entirely achievable.
for traditional and alternative investments. The countless
A straightforward risk-return attribution by sector should not be
combinations and permutations of portfolio holdings that these
difficult to access. Compare this to managers in the equity or credit
trading managers may hold over a limited period of time also tend
space who may give you their exposures but don’t always reveal the
to result in returns that are not correlated to any other investment,
attribution.”
including other short-term traders.

cmegroup.com
Furthermore, any systematic or algorithmic trading system has Manager Selection

a large human element. Namely, in the coding of this system, Peer analysis is often complicated by the blending of managed
several decisions were made concerning the techniques invoked. futures sub-styles or other subtle differences that frustrate
What limits should be used? Should there be a component of the creation of peer groups of managers. The exception tends
optimization? There are countless questions and decisions that to be the rule. It might be difficult to categorize an eclectic
go into the codification of a systematic trading program that manager who combines a price-based model with fundamental
are qualitative in nature – after all, the coding and creation was analysis to discretionarily arrive at trading decisions, or a grain
done by humans! Those who are not quantitatively minded often trader whose returns are 0.9 correlated with a number of trend
completely overlook this fact. There are both pros and cons followers. It is possible to overcome these hurdles, however, by
in systematic trading, as well as in discretionary trading, thus taking a quantitative approach to peer analysis. Managers whose
discriminating purely on the basis of systematic or discretionary returns are correlated likely have similar risk factors or exposures
is not warranted; indeed many managed futures programs are a embedded in their programs or trading styles. Creating peer
hybrid of both. groups of highly correlated managers simplifies the basis for
comparison across metrics of interest, and facilitates the analysis
Discretionary Trading
of programs which have historically tended to perform similarly in
Not all CTAs employ quantitative or systematic trading
different market environments. The implications of quantitative
approaches. In fact, some of the most unique alternative
peer group analysis of this sort for manager selection are obvious.
investment programs consist of discretionary CTAs and niche
sector or market specialists. Like their systematic counterparts, The importance of manager selection varies somewhat depending
discretionary CTAs may use fundamental and technical inputs upon the objectives of the managed futures investor.
to make trading decisions and may trade one or many markets
across a continuous domain of time horizons. Some discretionary
CTAs do analyze chart patterns or other technical indicators, but
many discretionary CTAs employ fundamental analysis of supply
and demand as the basis for their programs. The most successful
discretionary traders tend to have clearly defined, well-articulated
risk management coupled with unique experience and background
relevant to the market or markets they trade. The fact that most
discretionary managers have the flexibility to trade in a completely
opportunistic fashion often results in returns which tend to be
uncorrelated to trend following, managed futures and other hedge
fund styles, as well as passive long-only commodity indices.

MANAGED FUTURES RISK, RETURN, AND THE

POTENTIAL FOR ENHANCED DIVERSIFICATION
The exploitation of trends or other price behaviors that tend to Since then, the importance of alternative investments to
accompany large macro dislocations or events by CTAs produces institutional investors as sources of absolute return and portfolio
both a positive return expectation and uncorrelated variance, diversification has grown tremendously, especially over the
making them additive to most portfolios. Although CTAs tend past 15 years. Managed futures strategies should continue to
to have high volatility and lower Sharpe ratios relative to other play a prominent role in the increasingly important alternative
alternative investments, the addition of an uncorrelated element portion of institutional portfolios, due not only to their role in
which often contributes positive gamma, enhances the return and dampening portfolio variance, but also their ability to improve
decreases the variance of most portfolios. (It is important to recall other important performance statistics, including semideviation,
that this volatility comes from large, infrequent positive returns drawdown, skewness, kurtosis and the Omega performance
and that the Sharpe ratio is flawed as a measure of risk-adjusted measure, which incorporates all of the information embedded in
performance, as we will soon demonstrate.) The fact that an the distribution of returns of an investment, as well as an investor-
investment is volatile on a stand-alone basis does not necessarily determined threshold of loss.
mean that it will increase the volatility of the entire portfolio.
Lintner performed his analysis on mean-variance portfolios of
Modern Portfolio Theory suggests that adding uncorrelated
traditional and managed futures investments using stock and
variance actually decreases overall portfolio variance. The addition
bond indices, and two sets of managed futures account and fund
of uncorrelated variance may also help investors reduce other
investment returns, likely due to the paucity of managed futures
important measures of risk, including drawdown, semideviation,
performance data. This study employs index data exclusively, due
and kurtosis in the left tail.
to its wide availability, as well as to minimize selection bias. It
Lintner’s paper found that the low and occasionally negative also attempts to maximize robustness and statistical validity by
correlations between futures portfolios and traditional equity calculating all statistics using as many observations as possible,
and fixed income portfolios enable the creation of portfolios with resulting in comparisons across heterogeneous time horizons
substantially less variance at every possible level of expected when historical index data is not available. As such, the number of
return relative to traditional portfolios consisting solely of observations used for calculations varies.
stocks or mixtures of stocks and bonds (Lintner 1996, 105-106).
He alludes to the growing interest of institutional investors
in alternative investments as means to tap additional sources
of uncorrelated return, pointing to real estate, venture capital
investments and “diversified holdings of oil-well exploration pools”
as examples before turning to managed futures (Lintner 1996,
102).

cmegroup.com
RISK AND RETURN: OMEGA – A BETTER APPROACH
Popular culture and the media often portray futures trading as one Moreover, from a practical point of view, there is an obvious
of the riskiest and most speculative forms of investment. Several difference between upside volatility and downside volatility.
intrinsic characteristics of futures contracts make them substantially
The Omega function and performance measure, first presented by
less risky, however, than investments in other instruments
Con Keating and William Shadwick, overcome the shortcomings
which have not been branded with many of the same negative
of the mean-variance framework and allow investors to refer to the
characteristics. Most casual observers and even many experienced
risk-reward characteristics of portfolios with respect to a reference
practitioners attribute this volatility to the underlying instruments
point or threshold other than the mean. Omega fully incorporates
traded, but such a conclusion would be fallacious.
the impact of all of the higher moments of the distribution
Futures garnered their reputation as risky largely due to the volatility of returns into an intuitive performance measure that allows
of individual commodity markets, which many observers closely practitioners to assess risk and return in the context of their own
associate with the futures markets. The volatility of the passive long- loss threshold without burdensome utility functions (Keating and
only commodity indices, such as the Goldman Sachs Commodity Shadwick 2002, 2). Investors specify what they constitute as their
Index (GSCI), also explains in part the perception of high risk. own loss threshold or minimum acceptable return, which serves as
The nearly 20 percent annualized volatility of the GSCI, combined the benchmark return. The Omega function makes a probability-
with its maximum historical drawdown of more than 60 percent weighted comparison of “profits” and “losses”, however defined,
certainly justifies this perception. However, it is important to make relative to this investor-determined threshold. The Omega function
a number of critical distinctions here. First, there are fundamental is defined as:
and substantial differences between passive long-only indices like
the GSCI and actively managed trading strategies like those which b
this paper highlighted earlier. “Commodities,” loosely defined, are ∫ [1-F(x)]dx

Ω(r):=
r
also different than futures contracts, which are nothing more than r
∫ F(x)dx
exchange traded instruments linked to the prices of a diversified a
variety of global markets.
Those assessing risk must also carefully define it. Modern Portfolio
where F(x) is the cumulative distribution function for the returns,
Theory equates risk with variance (or volatility as measured by
bounded by the endpoints a and b, with a threshold of r (Keating
standard deviation), which measures the dispersion of outcomes
and Shadwick 2002, 12). Exhibit 3 illustrates the cumulative
from the mean. Using volatility to measure risk, however, penalizes
distribution function for an investment, along with depictions of the
those outcomes which are greater than the expected, or upside
threshold and profit and loss integrals.
volatility. Outcomes which exceed expectations (most rational
investors would not select investments for which the return Omega provides practitioners with an extremely useful tool since
expectation is negative), or exceed a necessary or desired threshold, it accounts for the non-normal distributions of returns which are
cannot truly be said to be risky in the sense that they do not imply commonplace in finance, particularly for alternative investments.
loss or failure to meet an objective. In other words, volatility ignores Despite the apparent intuitiveness of the Sharpe ratio, the fact that it
the skewness and kurtosis of a manager’s distribution of returns. ignores skewness and kurtosis and penalizes upside volatility essentially
renders it useless for investment performance analysis.
Managed futures may be more volatile than long/short equity or
equity market neutral hedge funds, but not necessarily more risky.
Measuring risk by volatility is dangerous to do in the alternatives
space since the distributions are typically non-Gaussian.

EXHIBIT 3: Cumulative Distribution and Omega Functions
y (F(X))
numerator of Ω
y=1
y=0 x (returns)
denominator of Ω
x=r
Source: Bhaduri and Kaneshige, 2005
The Omega function is a powerful tool in the risk toolbox The BTOP 50 Index, HFRI Fund Weighted Composite Index,
[Bhaduri and Kaneshige, 2005]. Furthermore, the selection of a and HFRI Equity Hedge Index all exhibit excess kurtosis, or “fat
threshold as the focus dovetails well with the needs of pensions. tails” in their distributions of returns as well (3.02, 2.55, and 1.90,
Pensions typically view investments through an asset-liability lens. respectively), consistent with the vast majority of hedge fund
Consequently, the return they seek is a function of the liabilities strategies.
they face. The Omega function lends itself well to this framework
The fact that a given investment or strategy displays fat tails is
since a natural threshold for a pension to select is a return which
not as important as the location of the extreme deviations which
will at least cover its liabilities.
cause them. Skewness describes the relative length of the tails or
Exhibit 4, “Statistics: Traditional and Alternative Investment the degree of asymmetry of a distribution of outcomes. Positive
Benchmarks,” illustrates the shortcomings of evaluating skewness suggests that a number of relatively large positive
investment performance solely through the lens of mean and deviations inflate the mean of the distribution, resulting in a fat
variance, particularly for managed futures. The Barclays Capital right tail. Conversely, negative skewness occurs when a number of
BTOP 50 returns display more variance than those of the Hedge relatively large negative deviations pull the mean down, resulting in
Fund Research, Inc. (HFRI) Fund Weighted Composite Index, or a fat left tail.
the HFRI Equity Hedge (Total) Index, as measured by standard
The BTOP 50 displays large positive skewness (1.07) relative to the
deviation (10.13 percent compared to 6.87 percent and 9.06
HFRI Fund Weighted Index (-0.68) and HFRI Equity Hedge Index
percent). The variance of all negative observations of the BTOP
(-0.25). The positive skewness exhibited by most CTAs explains
50 and HFRI hedge fund indices in question, however, were
the majority of the differences in variance between the BTOP 50
comparable (semideviation of 4.62 percent versus 5.14 percent
and HFRI hedge fund indices. This paper explores the reasons for
and 6.13 percent), as were worst drawdowns (-13.31 percent
excess kurtosis in hedge fund returns, and , in a later section, for
versus -21.42 percent and -30.59 percent).
differences in skewness for different hedge fund strategies.

cmegroup.com
EXHIBIT 4: Statistics: Traditional and Alternative Investment Benchmarks
HFRI Fund Weighted Index

DJ UBS Commodity Index
HFRI Equity Hedge Index

Composite Global Index
Barclay BTOP 50 Index
MSCI World Daily Total
Barclays Capital Bond
Newedge Short-Term
S&P/Citigroup World
Composite US Index
Return Net (USD)
LPX Buyout Index

S&P 500 Total
REIT TR Index
Traders Index
Return Index
GSCI TR
Annualized ROR 8.15% 11.74% 9.88% 5.81% 8.52% 5.95% 4.63% 10.86% 12.62% 8.39% 9.12% 0.26%
Annualized Standard Deviation 10.13% 15.31% 15.21% 3.40% 6.17% 19.26% 14.78% 6.87% 9.06% 25.98% 16.42% 4.03%
Annualized Semideviation 4.62% 11.39% 11.40% 2.21% 3.60% 13.52% 11.02% 5.14% 6.13% 19.60% 14.56% 2.27%
Worst Drawdown -13.31% -50.95% -54.03% -3.67% -12.43% -67.65% -54.26% -21.42% -30.59% -80.95% -67.56% -14.03%
Sharpe Ratio (Risk Free Rate = 0%) 0.80 0.77 0.65 1.71 1.38 0.31 0.31 1.58 1.39 0.32 0.56 0.06
Sortino Ratio (Risk Free Rate = 0%) 1.76 1.03 0.87 2.62 2.37 0.44 0.42 2.11 2.06 0.43 0.63 0.11
Skewness 1.07 -0.66 -0.67 -0.37 1.06 -0.22 -0.56 -0.68 -0.25 0.21 -1.25 0.27
Excess Kurtosis 3.02 2.20 1.63 1.46 7.15 2.54 2.72 2.55 1.90 5.16 8.27 -0.25
Omega (3% Threshold) 1.53 1.59 1.46 1.79 2.07 1.21 1.15 2.28 2.18 1.32 1.44 0.63
Months 327 411 411 197 409 411 278 291 291 195 291 75
Positive Months 184 264 255 139 277 232 164 207 202 123 179 32
Negative Months 143 147 156 58 131 179 114 84 89 71 112 43
Percent Winning Months 56.27% 64.23% 62.04% 70.56% 67.73% 56.45% 58.99% 71.13% 69.42% 63.08% 61.51% 42.67%
Average Month 0.70% 1.03% 0.89% 0.48% 0.70% 0.64% 0.47% 0.88% 1.03% 0.95% 0.85% 0.03%
Average Positive Month 2.54% 3.53% 3.51% 0.96% 1.52% 4.24% 3.10% 1.83% 2.32% 4.90% 3.46% 1.10%
Average Negative Month -1.67% -3.46% -3.40% -0.68% -1.03% -4.02% -3.31% -1.46% -1.90% -5.87% -3.32% -0.77%
Modern Portfolio Theory

Correlation to S&P 500 Total -0.04 1.00 0.88 -0.11 0.18 0.18 0.31 0.74 0.73 0.75 0.61 -0.41
Return
R Squared 0.00 1.00 0.77 0.01 0.03 0.03 0.09 0.54 0.53 0.56 0.37 0.17
Beta -0.02 1.00 0.87 -0.03 0.07 0.22 0.31 0.34 0.45 1.22 0.68 -0.09
Alpha 0.72% 0.00% -0.01% 0.50% 0.62% 0.41% 0.20% 0.59% 0.65% 0.22% 0.28% 0.09%
Sources: Bloomberg, LPX GmbH. All statistics calculated to maximize number of observations; as such, number of observations used for calculations varies (Starting Dates: BTOP 50 -
Jan 1987, S&P 500 Total Return Index - Jan 1980, MSCI World - Jan 1980, Barclays Capital Bond Composite US Index - Sep 1997, Barclays Capital Bond Composite Global Index - Feb 1980,
GSCI TR - Jan 1980, DJ UBS Commodity Index - Feb 1991, HFRI Fund Weighted Index - 1990, HFRI Equity Hedge Index - Jan 1990, LPX Buyout Index - Jan 1998, S&P/Citigroup World REIT
TR Index - Jan 1990, Newedge Short-Term Traders Index - Jan 2008). All statistics calculated through Mar 2014 with the exception of the Barclays Capital Bond indices, which did not
report returns for Sep 2008 or Oct 2008.

HIDDEN RISK: THE IMPORTANCE OF LIQUIDITY,

TRANSPARENCY AND CUSTODY
Model risk always exists, as no model is perfect by definition. The lack of transparency and difficulty involved in pricing illiquid
What is less appreciated by many in the investment community instruments magnifies model risk. Infrequent pricing of instruments
is that model risk and liquidity risk are entangled. There are no obfuscates the relationships among market price and the different
valuation issues with exchange-traded instruments, and model risk factors or variables used in pricing or trading models, complicating
is magnified when dealing with illiquid instruments. In general, the their testing and design. Lack of transparency and illiquidity
less liquid the instruments traded, the more hidden risk, and the substantially reduce the margin of error during the research and
more dangerous model risk becomes. The historic 2008 financial development of trading or risk models. The losses that will ensue
meltdown is a vivid example of this statement [Bhaduri and Art, in the event that models fail to account for a critical piece of
2008]. information will be of an order of magnitude many times larger for
illiquid instruments due to the relative thinness of these markets.
Most managed futures programs by definition trade exclusively
The seller will likely have to accept a deep discount in price to
exchange-listed futures or options on futures. Settlements on
exit an illiquid position, particularly during a “fire sale” or crisis
all futures contracts are determined by the various exchanges
event. The credit debacle of 2007-2008, for example, exposed many
at the end of each trading day, compelling managers to mark
hedge funds and other sophisticated investors who had invested in
their books to market. Some CTAs also trade the inter-bank FX
structured debt products whose models failed to incorporate many
forward market, where the process of price discovery takes place
of the hidden risks. The investors and portfolio managers holding
24 hours a day. It is also one of the deepest and most liquid in the
these instruments suffered deep losses as they struggled to find
world. These qualities enable hedge fund investors to mitigate or
liquidity in thin markets, or watched other positions go to zero due
completely eliminate some of the more deleterious risks associated
to poor assumptions made by the rating agencies.
with investing in alternatives. The liquidity of the underlying
instruments traded as well as the high level of transparency Conversely, risk managers can monitor and control risk with relative
available through managed account investments with CTAs ease due to the transparency and liquidity of futures contracts.
facilitates tactical asset allocation. Investors and CTAs alike can Instead of relying on complex models with numerous assumptions,
easily exit unprofitable positions, or positions that they expect to risk managers are free to focus on monitoring margin to equity,
become unprofitable in the near future, with minimal slippage, counting contracts and testing for disaster scenarios, such as
usually in a matter of minutes. correlation convergence with a multiple standard deviation shock.
Transparency and constant price discovery facilitates simple, no
Ironically, the liquid, transparent, marked-to-market nature of the
nonsense testing and monitoring. Investing via separately managed
instruments traded by liquid hedge funds may make their returns
accounts, a common practice among managed futures investors,
appear more volatile or risky than those of many hedge funds
facilitates risk management tremendously by providing the investor
trading esoteric or illiquid instruments, which trade infrequently
with full transparency and in extreme cases, the ability to intervene
and are therefore marked to a stale price or a model. As a result,
against the trading manager by liquidating or neutralizing positions.
these hedge funds often intentionally or unintentionally smooth
their returns, artificially dampening their volatility and depth of
their drawdowns.

cmegroup.com
Hidden sources of risk that many hedge fund investors do not fully Returning to the ever-important topic of liquidity, it is worth
appreciate are the structural and operational risks associated with pointing out that from a behavioral finance point of view, it is easy
investing directly into a fund vehicle. Fund investments require the for investors to underestimate the value of liquidity [Bhaduri and
investor to transfer money to the trading manager with an implicit Whelan, 2007]. If a hedge fund is trading illiquid instruments and
guarantee that it will be returned at some future date. Wiring has a long lock-up, then simply comparing its return statistics to a
money to the manager exposes the investor to the risk of fraud or CTA that is trading exchange-traded instruments and does not have
theft of the investment. Managed account investments mitigate a lock-up is incorrect, since it does not assign a value to liquidity
this risk by giving the manager limited power of attorney to trade [Bhaduri and Art, 2008]. Lock-ups by private equity funds and
on behalf of the investor, who maintains legal custody of the cash hedge funds trading illiquid instruments cost the investor in terms
and instruments at his FCM. Wiring money to a manager also of reduced flexibility, and they should be rewarded with higher
exposes the investor to operational risks, and requires expensive and returns to compensate for this. There are not yet many measures
time-consuming due diligence on the manager’s middle and back or instruments to deal with this problem [Bhaduri, Meissner, and
office processes, as well as its service providers. Fund investments, Youn, 2007].
including those in liquid instruments, often attempt to impose
lockups, gates, or onerous redemption terms on investors. Most
fund documents also give the general partner the right to suspend
redemptions, in effect providing the manager with a call option
on the liquidity it had previously offered investors. There is no real
value added by having the money housed with the manager who
is being paid to try and provide an attractive risk-adjusted return
over time with proper risk controls. Managers who refuse to grant
managed accounts are in essence refusing to give transparency and
are subjecting their clients to additional risks.

THE LACK OF CORRELATION AND POTENTIAL

FOR PORTFOLIO DIVERSIFICATION
After highlighting the attractive risk and return properties of Exhibit 7 on page 20, “Correlation Matrix: Traditional and
managed futures, Lintner turns to a discussion of the lack of Alternative Investment Benchmarks,” illustrates the low and
correlation of managed futures strategies with other investments. occasionally negative correlations between managed futures and
He then concludes his paper by presenting evidence of the other investments. The highest of these were 0.52 with the Newedge
substantial improvements in risk and return that managed futures Short-Term Traders Index and 0.22 with each of the bond indices,
strategies contribute as part of a diversified portfolio of equities and the lowest was -0.20 with the Listed Private Equity (LPX) Buyout
and fixed income (Lintner 1996, 105). The absence of correlation Index, suggesting that significant benefits would accrue to investors
between managed futures, traditional investments, and other who added managed futures strategies to portfolios including some
alternative investments creates a prominent role for this liquid, or all of these investments. These correlations will be explored in
transparent hedge fund strategy in institutional portfolios. more detail later in this section.
The long-term correlations among equities, fixed income and Exhibit 5 demonstrates that managed futures improve the efficient
managed futures remain low more than 30 after Lintner’s study, frontier from a mean-variance framework. This is congruent with
suggesting a continuing relevance to investors interested in the earlier findings of Lintner.
attaining the “free” benefits of diversification.
Exhibit 5: Efficient Frontier: BTOP 50 Index and Traditional Portfolio of Equities and Fixed Income
January 1987 – December 2014
Efficient Frontier: BTOP 50 Index and Traditional Portfolio of

Equities and Fixed Income, January 1987 - March 2014
S&P 500 Index with Barclays Capital Bond Composite Global Index
BTOP 50 Index with 60/40 Blend of S&P 500 Index and Barclays Capital Bond Composite Global Index
12
60% S&P 500 Index/40% Barclays Capital

11 Bond Composite Global Index
100% S&P 500 Index
Annualized Return (%)
10
9
100% Barclays Capital
Bond Composite
8 Global Index
100% BTOP 50 Index

7
6
0 2 4 6 8 10 12 14 16 18
Annualized Standard Deviation (%)
Source: Bloomberg. Barclays Capital Bond Composite Global Index did not report returns for Sep or Oct 2008

cmegroup.com
Recall that when the Omega score drops below one, the quality The Omega graph in Exhibit 6 indicates that for low thresholds,
of the investment with respect to achieving the threshold is poor. the combination of managed futures strategies and a traditional
(For a review of Omega graphical analysis, please refer to Ranjan portfolio is optimal, and for higher thresholds, the more
Bhaduri and Bryon Kaneshige, “Risk Management – Taming the concentrated portfolios dominate. This is, likely because their
Tail,” Benefits and Pensions Monitor, December 2005.) Studying the higher volatilities allow for a greater likelihood of exceeding the
potential role of managed futures strategies in traditional portfolios annualized return threshold Investors may be able to maintain the
of stocks with the Omega lens for risk-adjusted performance is higher Omega scores available at lower return thresholds at higher
taking a enhanced and modern approach to the Lintner study. As return thresholds, however, through the thoughtful and prudent use
stated earlier, Lintner did not have the benefit of the Omega tool of leverage.
during the time he conducted his work, and the Omega function
These Omega results yield a very compelling argument for the
encodes all the higher statistical moments and distinguishes
inclusion of managed futures in an institutional portfolio.
between upside and downside volatility.
EXHIBIT 6: Omega Graph: BTOP 50 Index and Traditional Portfolio of Equities and Fixed Income
January 1987 – December 2014
Omega Graph: BTOP 50 Index and Traditional Portfolio of

Equities and Fixed Income, January 1987 - March 2014
3
BTOP 50 Index
Traditional Portfolio (60% S&P 500 Index/40% Barclays Capital Bond Composite
2.5
Omega Performance Measure
Global Index)
50% BTOP 50 Index/50% Traditional Portfolio (60% S&P 500 Index/40% Barclays
Capital Bond Composite Global Index)
2
1.5
0.5
0
0 5 10 15 20 25 30
Annualized Return Threshold (%)
Source: Bloomberg. The Barclays Capital Bond Composite Global Index did not report Sep or Oct 2008

Correlations Between Managed Futures and Other Lintner analyzed the portfolio benefits of combining managed
Investments account investments in fifteen different futures programs using
The variety of trading sub-styles within managed futures and the different weighting schemes. For our purposes, the weighting
lack of correlation among them, as well as to other traditional and schemes are not important since these may vary according to the
alternative investments, makes it possible to enhance the return portfolio manager’s objectives. Instead, this section will focus on
or diminish the risk of portfolios through the addition of managed the correlations among managers since these provide the most
futures “alpha” strategies. These include sub-styles such as short- information about potential benefits to be had from diversification.
term trading, niche discretionary strategies, relative-value, etc. For simplicity, it also will distill correlations among managers into
These qualities make it possible to construct diversified, liquid, average pair-wise correlation.
transparent fund of funds and portfolios by combining uncorrelated
This section also draws upon the performance of the constituents
programs. Lintner’s pioneering research demonstrated that there
of the Newedge Short-Term Traders Index, a theoretical index of
are substantial benefits which accrue from “selective diversification”
10 trading programs whose holding period is less than ten days on
across a number of different futures managers and funds due to the
average, trade two or more market sectors, and which are open for
“rather moderate” correlations among them (Lintner 1996, 105).
investment (Burghardt et.al. June 9, 2008, 4). There is some risk of
The astronomically high number of combinations and permutations
survivorship bias since all of the constituent programs remain open
of portfolio holdings and investment horizons of short-term traders,
for investment. Selection bias appears to be less of a concern since
and accordingly, the unique and uncorrelated returns which result,
this index contains managers of all trading styles, track records of
make them a fascinating case for revisiting Lintner’s analysis of
various lengths, and various levels of assets under management.
diversification among futures managers.
Regardless, while the constituents of the index do not provide
an exhaustive sample, it is likely that they provide one which is
representative of short-term trading and its correlation properties.

cmegroup.com
EXHIBIT 7: Correlation Matrix of Traditional Alternative Investment Benchmarks

S&P 500 Total Return Index


Newedge Short-Term
S&P/Citigroup World
Composite US Index
MSCI World Index
LPX Buyout Index

Barclays Capital
Traders Index
REIT Index
GSCI TR
Barclay BTOP 50 Index 1.00
S&P 500 Total Return Index -0.04 1.00
MSCI World Index -0.02 0.88 1.00
Barclays Capital Composite 0.22 -0.11 -0.09 1.00

US Index
Barclays Capital Bond 0.22 0.18 0.23 0.90 1.00

GSCI TR 0.12 0.18 0.25 -0.03 0.00 1.00
DJ UBS Commodity Index 0.16 0.31 0.41 0.03 0.12 0.89 1.00
HFRI Fund Weighted Index 0.00 0.74 0.75 -0.07 0.07 0.32 0.44 1.00
HFRI Equity Hedge Index -0.02 0.73 0.73 -0.07 0.06 0.36 0.44 0.95 1.00
LPX Buyout Index -0.20 0.75 0.76 -0.09 -0.13 0.29 0.31 0.77 0.77 1.00
S&P/Citigroup World -0.01 0.61 0.64 0.21 0.28 0.22 0.36 0.51 0.49 0.60 1.00
REIT Index
Newedge Short-Term 0.52 -0.41 -0.40 0.07 0.05 -0.17 -0.11 -0.27 -0.34 -0.37 -0.33 1.00
Traders Index
Sources: Bloomberg, LPX GmbH. All statistics calculated to maximize number of observations; as such, number of observations used for calculations varies (Starting Dates: BTOP 50
- Jan 1987, S&P 500 Total Return Index - Jan 1980, MSCI World - Jan 1980, Barclays Capital Bond Composite US Index - Sep 1997, Barclays Capital Bond Composite Global Index - Feb
1980, GSCI TR - Jan 1980, DJ UBS Commodity Index - Feb 1991, HFRI Fund Weighted Index - 1990, HFRI Equity Hedge Index - Jan 1990, LPX Buyout Index - Jan 1998, S&P/Citigroup
World REIT TR Index - Jan 1990, Newedge Short-Term Traders Index - Jan 2008). All statistics calculated through Dec 2011 with the exception of the Barclays Capital Bond indices,
which did not report returns for Sep 2008 or Oct 2008.
Lintner found that the “average correlation between the monthly The average pair-wise correlation among the constituents of the
returns of each manager with those of every other manager,” or Newedge Short-Term Traders Index was 0.107, another very low
average pair-wise correlation, among the fifteen managers in his value which supports the conclusion that short-term traders, like
sample was 0.285, with a minimum of 0.064 and a maximum of those managed futures programs in Lintner’s sample, generally
0.421 (Lintner 1996, 110). This extremely low average pair-wise exhibit low correlations to one another (Burghardt et.al. June 9,
correlation, and the sample maximum of 0.421 suggests that 2008, 4).
the trading programs Lintner analyzed would generally have
contributed to a portfolio in which any of them were part of the
whole.

The minimum pair-wise correlation within the sample was -0.166 of diversified, liquid, transparent “alpha” strategies. If managed
and the maximum was 0.562, comparable to the results from futures consisted solely of trend following strategies, this would
Lintner’s sample albeit with slightly wider dispersion. Pair-wise be a more difficult exercise, given the tendency toward high
correlations are displayed in Exhibit 8. correlation among trend followers. The diverse and uncorrelated
investments offered by CTAs, however, allow institutional
The lack of correlation among managed futures strategies, as well
investors access to an entire universe of liquid, transparent hedge
as with traditional and other alternative investments, allows them
fund strategies.
to contribute constructively to most portfolios. The analysis of
pair-wise correlation also provides an illuminating example of how
futures trading programs can be combined to create a portfolio
EXHIBIT 8: Distribution of Pair-Wise Correlations Newedge Short-Term Traders Index
Distribution of Pair-Wise Correlations Among Constituents in the Newedge STTI,

Longest Common Performance Histories (Sep 1993 - Mar 2014)
14
12
10
8
Frequency
0
-0.10 -0.9 -0.8 -0.7 -0.6 -0.5 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
Pair-wise Correlations
Source: Newedge Alternative Investment Solutions

cmegroup.com
MANAGED FUTURES AND PERFORMANCE DURING

FINANCIAL MARKET DISLOCATIONS
The volatility and market dislocation that accompanied the dependent, and the response of the program to prevailing price
subprime mortgage crisis, credit crunch, and explosion and collapse action during a crisis determines performance, at least in the
of commodities prices during the second half of 2007 and 2008, short- term.It is important to distinguish between exogenous and
was briefly alluded to earlier in this paper. The diversified mix of endogenous market shocks. When there is a major exogenous shock,
investments many institutional investors had relied upon failed to i.e., one caused by factors external to the market, CTAs may be
generate returns. The major U.S. and Global equities market indices, positioned favorably or unfavorably in a variety of asset classes. The
the S&P 500 and MSCI World, performed dismally, returning -35.87 same is true of managers in most strategies. The notion that CTAs
percent and -39.44 percent, respectively, from August 2007 when provide a tail risk ‘hedge’ is overly specific, but over time these
the credit crisis began, through December 2008. strategies can provide diversification benefits that reduce the impact
of tail risk events. The difference between tail risk management via
Most alternative investments, which had promised absolute returns,
diversification and hedging is the main idea here.
disappointed investors as well. The HFRI Fund Weighted Composite
Index, an equally weighted index designed to represent the returns Certain generalizations about CTA returns and the market
of hedge funds across all strategies, returned -17.19 percent from conditions that generate them do tend to result in bouts of strong,
August 2007 through December 2008. The HFRI Equity Hedge positive performance during certain kinds of market dislocations.
(Total) Index, which includes hedge funds whose core holdings The majority of CTAs employ strategies that many describe as “long
consist of equities and therefore does not benefit as much from volatility” , which tend to produce a positively skewed distribution
diversification as the HFRI Fund Weighted Composite Index, of monthly returns. This is a figurative description, as in most cases
returned -25.11 percent. Private Equity and Real Estate Investment there is no direct use of options products; the positions are taken in
Trusts, represented by the LPX Buyout Index and the S&P/Citigroup futures contracts. The long option/positive gamma return profile
World REIT Index, returned an atrocious -70.42 percent and -47.23 originates from the tight control of downside risk relative to less
percent, respectively, from August 2007 through December 2008. frequent outsized returns, suggesting that these managers generate
CTAs, however, capitalized on the market dislocations of 2007 and the majority of their returns during lower frequency, high impact
2008, providing managed futures investors with returns of 17.69 events. In contrast, most hedge fund strategies have fat left tails in
percent over the same period, as measured by the BTOP 50 index. their distributions of returns since they perform well under normal
conditions but suffer infrequent, large losses under highly volatile
Managed futures strategies tend to capture massive flows of capital
conditions and should therefore be considered short volatility
as markets reestablish equilibrium in the wake of new information
strategies.
or in the transition from one economic cycle to another. It cannot
be emphasized enough that managed futures are not and should not A historically accurate picture of CTAs’ collective long-term
be treated as a portfolio hedge, but rather as an additional source of performance when crises strike financial markets is stated well in
non-correlated returns, as this paper has demonstrated. a paper from Commonfund (James Meisner, Kristofer Kwait, John
Delano): “CTA returns have demonstrated substantial long-term
Although managed futures returns tend to be uncorrelated to other
diversification properties in the context of a broad, multi-asset class
investments over the long run, correlations are non-stationary over
policy portfolio. They also represent one of the few investment
shorter time horizons and may temporarily converge during crisis
strategies that have the potential for outsized positive returns during
conditions. Not all market dislocations are the same, making CTAs
extended periods of market stress.”
vulnerable to rapid reversals or the sudden onset of volatility. The
reaction of managed futures strategies to price action is path-

Exhibit 9, “Performance of BTOP 50 During Worst 15 Quarters of “Black Monday” in 1987, the events leading up to the Persian Gulf
S&P 500 Index,” illustrates that CTAs have historically capitalized War in 1990, Long Term Capital Management and the Russian
on the various forms of volatility which accompany market Crisis in 1998, the burst of the tech bubble and ensuing recession in
dislocations, be they sustained trends consistent with a flight to or 2000-2002, the credit crunch and commodity run-up of 2007-2008,
from quality, shorter-term choppy price action, or sudden reversals and the European Sovereign Debt Crisis, all serve as examples of
associated with rapid swings in sentiment explained by market market dislocations during which the performance of equities
psychology and behavioral finance. Exhibit 9 provides a compelling suffered and managed futures strategies performed well.
reason to include managed futures in a diversified portfolio.
EXHIBIT 9: Performance of the BTOP 50 Index During 15 Worst Quarters of S&P 500 (Total Return) Index
Period Event S&P 500 Total Return Index Barclay BTOP 50 Index Difference
Fourth Quarter 1987 Black Monday - Global Stock Markets Crash -22.53% 16.88% 39.41%
Fourth Quarter 2008 Bear Market in U.S. Equities led by Financials -21.95% 9.14% 31.08%
Third Quarter 2002 WorldCom Scandal -17.28% 9.41% 26.69%
Third Quarter 2001 Terrorist Attacks on World Trade Center and -14.68% 4.12% 18.79%
Pentagon
Third Quarter 1990 Iraq Invades Kuwait -13.75% 11.22% 24.97%
Second Quarter 2002 Continuing Aftermath of Technology Bubble -13.39% 8.52% 21.92%
Bursting
First Quarter 2001 Bear Market in U.S. Equities led by Technology -11.86% 5.97% 17.83%
Second Quarter 2010 European Sovereign Debt Crisis, "Flash Crash" -11.42% -1.94% 9.48%
First Quarter 2009 Credit Crisis Continues -11.01% -1.75% 9.26%
Third Quarter 1998 Russia Defaults on Debt, LTCM Crisis -9.94% 10.54% 20.48%
First Quarter 2008 Credit Crisis, Commodity Prices Rally -9.45% 6.43% 15.88%
Third Quarter 2011 European Sovereign Debt Crisis -8.90% 0.44% 9.34%
Third Quarter 2008 Credit Crisis, Government-Sponsored Bailout -8.37% -4.11% 4.26%
of Banks
Fourth Quarter 2000 DotCom Bubble Bursts -7.82% 19.78% 27.60%
Third Quarter 1999 Anxiety during Run Up to Y2K -6.24% -0.67% 5.57%
Source: Bloomberg
Performance of the BTOP 50 Index During 15 Worst Quarters of S&P 500 (Total Return) Index
cmegroup.com
Exhibit 10, “BTOP 50 vs. S&P 500 During S&P 500’s Worst Five The quarter-by-quarter analysis provides a high level of granularity,
Drawdowns Since 1987,” illustrates the tendency of CTAs to and also provides further evidence that managed futures strategies
perform well during periods which are difficult for equity markets, tend to perform well during extended dislocations, but do not
albeit through a different lens. It illustrates the performance of always do so. It is also worth noting that the historic quarters
the BTOP 50 Index from peak to valley during the five worst referred to in Exhibit 9 all are referencing periods after the Lintner
drawdowns of the S&P 500, each associated with a different study, and thus further corroborate his important findings.
financial market dislocation.
EXHIBIT 10: BTOP 50 vs. S&P 500 Total Return Index’s Worst Five Drawdowns since 1987
S&P 500 Total Return Index

60%
50% 9/00 - 9/02
40%
14.48%
9/87 - 11/87 11/07 - 2/09
30%
7/98 - 9/98
20% 8.46% 5/11 - 9/11*
14.48%
10% 5.80%
0.10%
0%
-10%
-20%
-15.37% -16.26%
-30%
-40% -29.58% -44.73%

-50% -50.95%
-60%
Source: Bloomberg
* S&P 500 Total Return Index had not completely recoved from its drawdown beginning in 11/07, due in part to its depth and severity; the drawdown
beginning 5/11 is included because it would have qualified as one of the worst had the index recovered to its previous highs

Similarly, Exhibit 11, “Performance of the BTOP 50 in Worst 10 CTA performance tend to coincide with the left tail events of
Quarters of HFRI Fund Weighted Composite Index,” suggests that hedge funds, suggesting that managed futures should complement
managed futures have historically tended to perform well when most alternative investment portfolios.
the performance of many other hedge fund strategies suffers.
This lends credence to the idea that the tail events which drive
EXHIBIT 11: Performance of the BTOP 50 Index During Worst 10 Quarters of HFRI Fund Weighted Index
Period Event HFRI Fund BTOP 50 Index Difference

Weighted Index
Third Quarter 2008 Credit Crisis, Government-Sponsored Bailout of -9.60% -4.11% 5.49%
Banks
Fourth Quarter 2008 Bear Market in U.S. Equities led by Financials -9.19% 9.14% 18.33%
Third Quarter 1998 Russia Defaults on Debt, LTCM Crisis -8.80% 10.54% 19.34%
Third Quarter 2011 European Sovereign Debt Crisis -4.14% 0.44% 4.58%
Third Quarter 2001 September 11th Terrorist Attacks -4.03% 4.12% 8.15%
Third Quarter 1990 Saddam Hussein invades Kuwait, Oil Price Shock -3.92% 11.22% 15.15%
Third Quarter 2002 WorldCom Scandal -3.85% 9.41% 13.27%
First Quarter 2008 Credit Crisis, Collapse of Bear Stearns -3.44% 6.43% 9.88%
Second Quarter 2012 European Sovereign Debt Crisis Continues -3.28% 0.42% 3.70%
Fourth Quarter 2000 DotCom Bubble Bursts -3.26% 19.78% 23.03%
Source: Bloomberg

cmegroup.com
Exhibit 12, “BTOP 50 vs. HFRI Fund Weighted Composite Index’s Short-term traders are usually engineered to perform better during
Worst Five Drawdowns Since 1990,” provides an additional a higher volatility regime, although of a different type than that
perspective as before. Once again it seems that the performance of which is conducive to trend following. Volatility describes only the
managed futures complements other actively managed strategies dispersion of changes in price around the mean, not the manner in
during periods of market dislocation or duress. which they unfold. Proper, rigorous due diligence always necessary,
but there are many excellent CTAs of various strategies that should
While managed futures strategies have proven to be great
do well on a risk-adjusted basis over the long-run.
diversifier during equity drawdowns, it is incorrect to assume
that they are necessarily a pure hedge for equities. It is true that It is also essential to highlight the fact that certain dislocations
good trend-followers are supposed to catch trends, so during a or events may produce market environments which are difficult
prolonged bear market, a good trend-following program should be for most hedge fund strategies, including certain managed
able to generate returns. However, that does not mean that if there futures strategies. The diversity within and the lack of correlation
is a quick and sudden drop in the equity market, that a trend- among alternative investments, and within and among managed
following CTA will necessarily be positive. As stated earlier, the futures in particular, suggests that it is highly likely that at least
universe of managed futures is diverse, with many different types a few alternative strategies will outperform during any given
of trading strategies – not just trend followers. environment. Again, it may be helpful to think of different
alternative investments and market environments in terms of the
radio signal and receiver analogy.
EXHIBIT 12: BTOP 50 vs. HFRI Fund Weighted Index’s Worst Five Drawdowns since 1990

40%
30% 6/02 - 9/02

11/07 - 2/09
20% 5/98 - 8/98 17.39%

14.48% 5/11 - 12/11
9/00 - 11/00
7.57%
10%
5.97% -0.03%
0%
-10% -6.39% -5.72%

-8.11%
-11.42%
-20%
-21.42%
-30%
Source: AlphaMetrix Alternative Investment Advisors, Bloomberg

Managed futures present very real risks for investors just like execution and order flow, and compliance and operational policies
any other hedge fund style. Investors can potentially experience and procedures. The investor should also take care to understand
volatility and substantial drawdowns, especially if the trading any disclosure documents, prospectuses, and offering memoranda
manager has set a higher return objective and is taking more risk prior to investing in a manager’s fund in order to understand
to try to obtain it. Investors should always conduct thorough due additional risks and relevant disclosures. It is also important to
diligence to properly understand the potential risks and weaknesses make sure that proper governance and separation of duties exists
of trading programs before investing. This is especially important within the trading manager as well as among the trading manager,
because the trading methodologies employed by CTAs, the level of its fund, and service providers. Only by conducting proper due
risk and return that is targeted, and the quality of the operational diligence and vetting of the trading methodology and manager’s
infrastructure of trading managers may vary tremendously across credentials can the investor determine the suitability and potential
the space. As such, it is critical that the investor takes the time risks of the investment.
to properly understand the nuances of the trading manager’s
Managed futures strategies can provide an additional source
investment strategy, risk management, as well as the domain of
of uncorrelated absolute return that complements other
instruments traded and potential concentration risks. The investor
alternative investment strategies by demonstrating a proclivity for
should also be acutely aware of operational risks and should make
outperformance during periods which tend to be difficult for many
every effort to understand the relationship between the trading
other actively managed investments.
manager, associated entities, patterns in personnel turnover, trade

cmegroup.com
An analysis of the semicorrelations provides further insight into the The lack of strong negative semicorrelation with cyclical investments
performance of managed futures during financial market dislocations. provides further evidence that a managed futures strategy is not a
Semicorrelation provides a clear picture of the relationship between portfolio hedge. The weak negative semicorrelation, however, may
the returns of two investments when one of them experiences losses. suggest that managed futures do offer an uncorrelated investment style
Exhibit 13 shows the semicorrelations among the BTOP 50 Index that tends to perform well during financial market dislocations; rolling
and various other traditional and alternative benchmarks. Like the analysis may provide deeper insight into this question.
correlations in Exhibit 7, all of the coefficients of semicorrelation
Paradoxically, the tremendous diversity of trading styles and
are less than 0.43, and many of them are negative. The fact that
methodologies within managed futures and the lack of correlation
all semicorrelations are bounded between -0.32 and 0.43 does not
among many of them does not appear to preclude them from sharing
provide evidence of any strong relationships among the BTOP
a penchant for most kinds of volatility or apparent resistance to it.
50 Index and the other indices on the downside. The signs of
Trend following conjures up the archetypal image of the long gamma
the coefficients, however, are congruent with intuition and the
strategy that thrives during financial market dislocations, but trading
hypothesis that managed futures perform well during financial market
managers across the entire space tend to generate strong performance
dislocations. The semicorrelation coefficient between the BTOP 50
in difficult environments for other investments. The tendency toward
Index and each of the investments that tend to be cyclical in nature,
high correlation among trend followers suggests that investors can
namely equities, hedge funds, and private equity, is weak negative.
typically maximize the benefits to their portfolios with a relatively
Conversely, the semicorrelation coefficient between the BTOP 50
small number of them. Other managed futures strategies, however,
Index and each of those investments which tend to be counter-
successfully exploit the sustained massive flows of capital that create
cyclical, such as fixed income and commodities, is weak positive.
trends in different ways, resulting in distinct and uncorrelated returns
Others still are so close to zero that it appears there is no relationship.
profiles. Still others exploit altogether distinct phenomena that tend to
accompany financial market dislocations or are independent of them.
EXHIBIT 13: Semicorrelations of BTOP 50 Index and Various Traditional and Alternative
Investment Benchmarks
January 1980 - March 2014

Newedge Short-Term
S&P/Citigroup World
Composite US Index
HFRI Fund Weighted

Return Net (USD)
LPX Buyout Index

Barclays Capital
S&P 500 Total
Traders Index
Return Index
REIT Index
GSCI TR
Indexx
Barclay BTOP 50 Index -0.24 -0.24 0.15 0.13 0.09 -0.03 -0.32 -0.21 -0.32 -0.09 0.43
Sources: Bloomberg, LPX GmbH. All statistics calculated to maximize number of observations; as such, number of observations used for calculations varies (Starting Dates: BTOP 50 -
Jan 1987, S&P 500 Total Return Index - Jan 1980, MSCI World - Jan 1980, Barclays Capital Bond Composite US Index - Sep 1997, Barclays Capital Bond Composite Global Index - Feb 1980,
GSCI TR - Jan 1980, DJ UBS Commodity Index - Feb 1991, HFRI Fund Weighted Index - 1990, HFRI Equity Hedge Index - Jan 1990, LPX Buyout Index - Jan 1998, S&P/Citigroup World REIT
TR Index - Jan 1990, Newedge Short-Term Traders Index - Jan 2008). All statistics calculated through Dec 2011 with the exception of the Barclays Capital Bond indices, which did not
report returns for Sep 2008 or Oct 2008.

Discretionary macro traders who utilize the liquid, transparent volatility is high. Other short-term traders appear to generate returns
futures markets to express their views tend to capture many of independent of volatility or the prevailing volatility regime. The
the same sustained capital flows as trend followers. Unlike trend highly flexible nature of short-term traders enables them to quickly
followers, however, these trading managers retain the flexibility reposition themselves within rapidly changing market environments.
to quickly reduce risk or reverse their positions, often resulting in As such, they often perform very well during market dislocations
completely unique and uncorrelated returns for their investors. Other since they adapt quickly to take advantage of the opportunities these
discretionary CTAs focus on relative value relationships or on a niche shock events present.
market or sector which may not be sensitive to global systematic
Exhibit 14 illustrates the semicorrelations between the Newedge
events. As such, these trading managers often generate strong returns
Short-Term Traders Index (Proforma) and different traditional and
during shocks or dislocations to the system and display non-correlated
alternative benchmarks over the life of the index.
properties to trend followers and other investments.
The short track record of this theoretical index may result in some
Short-term traders thrive on many kinds of volatility, including the
spurious correlations, but in the tradition of Professor Lintner, we
sustained variety that generates trends, but also on choppy, range-
attempt to make due with the data available.
bound activity and rapidly shifting volatility regimes where volatility of
EXHIBIT 14: Semicorrelations of Newedge Short-term Traders Index and Various Traditional and Alternative
Investment Benchmarks
January 1980 - March 2014

S&P/Citigroup World
Composite US Index
Return Net (USD)
LPX Buyout Index

Barclays Capital
S&P 500 Total
Return Index
REIT Index
GSCI TR
Newedge Short-Term 0.22 -0.46 -0.55 0.19 0.15 -0.36 -0.42 -0.48 -0.54 -0.34 -0.32
Traders Index
Sources: Bloomberg, LPX GmbH, Newedge. All statistics calculated to maximize number of observations; as such, number of observations used for calculations varies (Starting Dates:
BTOP 50 - Jan 1987, S&P 500 Total Return Index - Jan 1980, MSCI World - Jan 1980, Barclays Capital Bond Composite US Index - Sep 1997, Barclays Capital Bond Composite Global Index
- Feb 1980, GSCI TR - Jan 1980, DJ UBS Commodity Index - Feb 1991, HFRI Fund Weighted Index - 1990, HFRI Equity Hedge Index - Jan 1990, LPX Buyout Index - Jan 1998, S&P/Citigroup
World REIT TR Index - Jan 1990, Newedge Short-Term Traders Index - Jan 2008). All statistics calculated through Dec 2011 with the exception of the Barclays Capital Bond indices, which
did not report returns for Sep 2008 or Oct 2008.

cmegroup.com
BENEFITS TO INSTITUTIONAL INVESTORS
Managed futures strategies can provide institutional investors Rather than allowing cash to sit idle, many futures investors prefer
with a variety of liquid, transparent investment programs that do to deploy part of this cash to increase their trading level and
not exhibit correlation to traditional or alternative investments, notional exposure. For instance, if an investor buys a theoretical
and often, one another. Though not a hedge, they often provide futures contract with a notional value of $100,000 and a margin
robust performance in unfavorable environments for equities requirement of $10,000, $10,000 will be deployed as margin and
and most alternative investments. The exchange-listed nature of $90,000 will remain in cash. If the investor chooses to do so, he
the underlying instruments traded facilitates risk management could double his notional exposure from $100,000 to $200,000
and mitigates many of the dangers associated with model risk. by posting an additional $10,000 as margin on the purchase of
Additionally, institutional investors who access the space via a second futures contract. The investor now holds a notional
separately managed accounts substantially minimize operational position of $200,000 on his $100,000 cash. This position will be
risks and the possibility of fraud, maintain custody of assets, and able to withstand losses of 40 percent before all of the investor’s
have access to full transparency of positions. This section attempts cash is consumed, triggering a margin call (a 40 percent loss on
to shed insight into other intrinsic features of managed futures two $100,000 contracts equals $80,000. Any losses surpassing this
which enable institutional investors to capitalize on these desirable level would dip below the margin requirement on this position of
characteristics. $20,000).
One of the unique advantages managed futures offer institutional

investors is the ability to notionally fund investments, allowing
investors to efficiently deploy cash to gain increased exposure or
for allocation elsewhere in the portfolio. Due to the low margin
requirements for most futures contracts, only a small fraction of
the cash deposited at the manager’s futures commission merchant
is deployed as margin for trading. The remainder sits in cash
equivalent instruments, earning interest and serving as a reserve
in the event of trading losses.

EXHIBIT 15: Managed Futures Alpha Overlay – How It Works
• Begin with initial capital outlay (100%).
• Invest 10% of the cash in managed futures. Since futures Initial Capital
require only a small cash deposit, it is easy and prudent to use 100%
notional funding to increase exposure to the managed futures
component to 20%.
Managed Futures
• Invest remaining 90% of cash in fund investments. 10% Cash
• Result is enhanced portfolio diversification for small cash outlay.

Managed Futures Managed Futures
10% Cash 10% Notional 2X
(held at FCM/Prime Broker) (posted as margin)
Fund Investments
90% Cash
Managed Futures
Alpha Overlay Portfolio
110% Notional Exposure
The liquidity and transparency of these instruments tremendously Many institutional investors also appreciate the fact that managed
facilitates risk management since the notional exposure, margin futures offer favorable 60 percent long-term, 40 percent short-term
usage, and prices of the instruments are all known. The risk capital gains tax treatment, despite the fact that the holding period
manager can therefore easily determine and monitor portfolio risk. for the underlying instruments is typically less than what would
qualify as “long-term” under U.S. tax laws.
The low margin requirements of futures contracts in effect allow for
free leverage. Whereas leverage typically involves borrowing funds The question of asset-liability mismatch is an important
or instruments at LIBOR plus a spread, the only cost associated with consideration for many institutional investors, particularly those
leverage via notional funding is the opportunity cost of interest income who manage pension funds, endowments, or who otherwise meet
foregone on the idle cash. Aside from utilizing idle cash to increase recurring obligations by making periodic payments. The liquidity
notional exposure, many investors choose to reallocate it to other of managed futures and other highly liquid hedge fund strategies
parts of their portfolio, effectively allowing them to create an alpha alleviates asset-liability mismatch, allowing institutional investors
overlay for a relatively small fraction of the total investment capital, for whom it is an issue to mitigate the effects of illiquid investments
as explained in Exhibit 15. Strategies like this allow for substantial elsewhere in their portfolio. In the event that the investor needs
increases in portfolio diversification for a relatively small cash outlay. to suddenly liquidate assets to meet an unanticipated obligation, it
could easily do so from this part of its book without foregoing the
opportunity to attain absolute returns.

cmegroup.com
CONCLUSION
Managed futures strategies have evolved tremendously since the While recent years have certainly been difficult, with an unusually
first iterations of long-term trend following in the late 1940s. small number of trading opportunities, the industry has seen
Advances in technology, computing power, and telecommunications difficult periods before. Throughout the history of the industry,
have opened up heretofore inconceivable and inaccessible CTAs of all persuasions have offered institutional investors
possibilities in futures trading, not only for quantitative or significant potential sources of uncorrelated returns to enhance the
systematic managers, but also for niche and discretionary experts diversification of portfolios. The fact that managed futures strategies
whose access to critical information has been facilitated by these as a whole have historically performed well in environments that
developments. tend to be difficult for most other investments provides additional
benefits to portfolios.
Quantitative scientists and researchers have been able to apply
highly technical and sophisticated methods to the markets for the While it is important to remember that managed futures are not
first time since the clean, high quality data which they require a portfolio hedge, the mechanics of trend following, short-term
has only recently become available at accessible prices. Short- trading, discretionary macro, and statistical pattern recognition
term traders are scouring tick databases which took years to explain their respective intrinsic proclivities for different kinds of
build for persistent statistical aberrations whose exploitation has volatile markets. The prolonged dislocation in the global financial
been made possible by the meteoric ascent of electronic markets markets of 2007 and 2008 serves as only the latest example in a
and decreased transactions costs. Short-term traders are at the canon of many.
frontiers of interfacing trading with technology. Trend following has
While the growth of managed futures has been impressive, it has
emerged from its naive, primarily rules-based beginnings to a highly
paled in comparison with that of other alternative investments
sophisticated group of strategies whose ability to generate robust
(hedge funds that are non-managed futures, private equity, and real
returns has been enhanced, while more closely controlling risk and
estate). There are hedge funds on the entire liquidity continuum
drawdown. Some trend followers employ armies of scientists and
between mutual funds and private equity funds, and managed
mathematicians, and have formed alliances with top universities.
futures should be regarded as liquid alpha, as opposed to the more
If these developments are any indication, the future of managed
limited characterization of simple trend follower. The space of
futures strategies is bright. Incredible opportunities lay ahead for
managed futures is rich and fertile, with a very broad range of
the next generation of traders and investors alike.
strategies and styles.

The liquidity and transparency of the underlying instruments The predisposition of managed futures toward positively skewed
substantially mitigate the hidden risks which often accompany distributions of returns also suggests that few trading programs are
investing in hedge funds and alternative investments. Price susceptible to the risk of infrequent, potentially catastrophic losses.
discovery takes place constantly in futures markets, and settlements The mean-variance framework and Sharpe ratio rarely capture these
on all futures contracts are determined by the various exchanges effects, suggesting that deep analysis of the higher statistical moments
at the end of each trading day, facilitating the pricing of portfolios or the application of the Omega function present superior approaches
and the measurement and management of risk. Investors often to the assessment of investment performance, risk, and return.
underestimate the value of liquidity. History shows that the
As plan sponsors, endowments and foundations reacquaint
performance of hedge funds that trade illiquid instruments have
themselves with managed futures – or as the case may well be,
under-performed hedge funds that have better liquidity terms
truly discovers them for the first time – they should consider it an
[Bhaduri and Art, 2008].
eclectic amalgamation of liquid alpha strategies. Managed futures
Indeed one might argue that the space of managed futures has offers institutional investors actively managed exposure to a truly
become so diverse with so many different types of risk-adjusted global and diversified array of liquid, transparent instruments. The
return possibilities to legitimately target, that it is perhaps returns of many of these do not display correlation and do not appear
questionable why anyone would invest in alternatives that have to be easily explained by traditional or alternative investments, and
onerous lock-ups and trade illiquid or non-exchange traded oftentimes, one another. Institutional investors should view managed
instruments. A portfolio manager who is performing his or her futures not only as means to enhance portfolio diversification, but
fiduciary duty must justify that the investments that they are making also as absolute return vehicles with intuitive risk management.
are getting a proper liquidity premium. This in turn means that
if they make an investment in an illiquid vehicle, then they are in
essence stating that they could not have achieved that risk-adjusted
return through more liquid investments in managed funds. The
excellent breadth and liquidity of CTAs, or portfolios of CTAs, lends
itself well as the engine of structured products. It is important to
realize that due diligence is needed in selecting good CTAs. Like
anything else, there are both good and bad CTAs, and only rigorous
and proper due diligence will help to differentiate them. In addition,
in recent years, 40 Act Funds have been introduced that mimic
managed futures strategies. These funds have attracted a good
amount of attention and a significant amount of assets.
For more information on Managed Futures, visit www.cmegroup.com.

cmegroup.com
CONCLUSION IN CONTEXT OF LINTNER
It is not without some trepidation that the objective of this paper the board of any institution, along with the portfolio manager,
was set—namely, a modern day Lintner paper. John Lintner’s work should be forced to articulate in writing their justification in not
concerning the role of managed futures in a portfolio is considered having an allocation to the liquid alpha space of managed futures.
a classic.
It is also fitting that during the silver anniversary of John Lintner’s
The famous quote by Sir Isaac Newton, “If I have seen further it fine work, it survived the ultimate litmus test through the historic
is only by standing on the shoulders of giants,” is in some sense an financial meltdown of 2008. In the depths of the crisis, managed
understatement for our particular case as Lintner laid out the futures strategies, collectively,were one of the very few bright
entire road map. spots for investments (both alternative and traditional). While
the post-crisis environment has been especially challenging, the
It is remarkable just how solid Lintner’s long-term argument has
instrinsic properties of these strategies could again play a vital role
remained through the test of time even when the performance of
in protecting portfolios in future crises and beyond, as they have
the recent challenging years is included in the analysis, as it has
done during each sustained crisis over the last several decades.
been here, through 2013.The inclusion of managed futures in an
institutional portfolio leads to better risk-adjusted performance One might argue that Lintner saved his very best work for last.
(either through the mean-variance framework, or through the
more modern Omega analysis). The results are so compelling that
Acknowledgements
The authors would like to thank Mohammad Shakourifar, Ph.D. and Dennis Zarr.
To contact the authors:

Ryan Abrams Ranjan Bhaduri Elizabeth Flores
[email protected] [email protected] [email protected]
For more information on Managed Futures or CME Group contact:

David Lerman Neil Somma Randy Warsager
Senior Director, CD&S, Director, CD&S, Hedge Funds Senior Director, CD&S, Hedge Funds
Asset Managers [email protected] [email protected]
[email protected] 212 299 2348 212-299-2352
312-648-3721

REFERENCES
1. Bhaduri, Ranjan and Bryon Kaneshige. “Risk Management – Taming the Tail.”
Benefits and Pensions Monitor, December 2005.
2. Bhaduri, Ranjan and Christopher Art. “Liquidity Buckets, Liquidity Indices, Liquidity Duration, and their Applications to Hedge
Funds.” Alternative Investment Quarterly, Second Quarter, 2008.
3. Bhaduri, Ranjan, Gunter Meissner and James Youn. “Hedging Liquidity Risk.”
Journal of Alternative Investments, Winter 2007.
4. Bhaduri, Ranjan and Niall Whelan. “The Value of Liquidity” Wilmott Magazine, January 2008.
5. Burghardt, Galen et.al. “Correlations and Holding Periods: The research basis for the AlternativeEdge Short-Term Traders Index”.
AlternativeEdge Research Note. Newedge Group, June 9, 2008.
6. Center for International Securities and Derivatives Markets (CISDM). “The Benefits of Managed Futures: 2006 Update.” Isenberg
School of Management, University of Massachusetts, 2006.
7. Fischer, Michael S. and Jacob Bunge. “The Trouble with Trend Following.”
Hedgeworld’s InsideEdge. November 20, 2007.
8. Keating, Con and William F. Shadwick. “A Universal Performance Measure.”

The Finance Development Centre, 2002.
9. Lintner, John. “The Potential Role of Managed Commodity-Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and
Bonds.” The Handbook of Managed Futures: Performance, Evaluation & Analysis. Ed. Peters, Carl C. and Ben Warwick. McGraw-
Hill Professional, 1996. 99-137.
10. Kissko, Larry and Tommaso Sanzin. “,CTAs: Shedding Light on the Black Box” Hermes BPK Partners (2012)
11. Meisner, James, Kristofer Kwait and John Delano. “Understanding the Managed Futures Stratey and its Role in the Institutional
Portfolio. Commonfund Hedge Fund Strategies Group, 2012
*All charts, graphs, statistics, and calculations were generated using data from Bloomberg, the Barclays Capital Alternative Investment
Database, LPX GmbH, and Manager Reported Returns.

Data sources: CME Group unless otherwise noted
IMPORTANT DISCLAIMER
This document and the information contained herein is purely for discussion purposes only and intended for educational use. The information may be subject to verification or amendment; no
representation or warranty is made, whether expressed or implied, as to the accuracy or completeness of the information provided. It is strongly recommended that an investment in Pooled Vehicles
or Separately Managed Accounts be made only after consultation with a prospective investor’s financial, legal and tax advisors. This document does not constitute legal, tax, investment or any other
advice, and should not be construed as such. Depending on the applicable jurisdiction, investing in Pooled Vehicles or Separately Managed Accounts may be restricted to persons meeting applicable
suitability requirements or designations, such as Accredited Investor, Qualified Eligible Person, or Qualified Purchaser.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. An investor in a Pooled Vehicle may lose all or substantially all of its investment. An investor in a Separately Managed
Account may lose all, substantially all, or more than all of its investment.
This information is neither an offer to sell nor a solicitation of any offer to buy any interest in a financial instrument or participate in any trading strategy. Any such offer, if made, would be made only
by way of the Confidential Offering Memorandum and associated disclosure documents, and only in jurisdictions in which such an offer would be lawful. Any decision to invest should be made only
on the basis of consideration of all of the Confidential Offering Memorandums and associated disclosure documents. Such Confidential Offering Memorandum and associated disclosure documents
contain important information concerning risk factors and other material aspects of such financial instrument or trading strategy and must be read carefully before a decision to invest is made. This
information must be accompanied by or preceded by the Confidential Offering Memorandum and associated disclosure documents.
Any person making an investment in a Pooled Vehicle or Separately Managed Account must meet the applicable suitability requirements and must be able to bear the risks involved. A Pooled Vehicle
or Separately Managed Account may not be suitable for certain investors and an investment in a Pooled Vehicle or Separately Managed Accounts will not constitute a complete investment program.
No assurance can be given that a Pooled Vehicle’s or Separately Managed Account’s investment objective will be achieved. Among the risks of Pooled Vehicles and Separately Managed Accounts are
the following:
• Pooled Vehicles and Separately Managed Accounts are speculative and involve a substantial risk of loss.
• Performance of Pooled Vehicles and Separately Managed Accounts may be volatile.
• Redemptions from Pooled Vehicles may be made only infrequently and only if an investor provides prior written notice of its desire to redeem well in advance of the intended redemption date. The
assets held in a Separately Managed Account are subject to suspension and other events associated with the exchange(s) on which they are traded. As a result, an investor in a Separately Managed
Account may be unable to redeem some or all of its investment in the event of a suspension.
• Pooled Vehicles and Separately Managed Accounts may be highly illiquid.
• There is no secondary market for the units in a Pooled Vehicle or Separately Managed Account and none is expected to develop.
• There are restrictions on transferring units in Pooled Vehicles.
• A Pooled Vehicle’s fees and expenses and Separately Managed Account’s fees and expenses are significant. Trading profits must be greater than such fees and expenses to avoid loss of capital.
• An investor in a Pooled Vehicle or Separately Managed Account may not be entitled to periodic pricing or valuation information with respect to their individual investments.
• There may involve complex tax structures and delays in distributing important tax information.
• Pooled Vehicles and Separately Managed Accounts are not subject to the same regulatory requirements as U.S. mutual funds.
• Trades executed for Pooled Vehicle or Separately Managed Account will take place on non-U.S. and/or U.S markets.
• Pooled Vehicles and Separately Managed Accounts may be subject to conflicts of interest.
An investment in a Pooled Vehicle or Separately Managed Account involves risk, including the risk of losing all or substantially all of your investment in Pooled Vehicle or Separately Managed Account, or
more than all of your investment in a Separately Managed Account. The information set forth in this document has not been independently verified for accuracy or completeness. These materials and the
presentations of which they may be a part of, and the summaries contained herein, do not purport to be complete, and are qualified in their entirety by reference to the more detailed discussion contained
in Confidential Offering Memorandums and associated disclosure documents.
CME Group is a trademark of CME Group Inc. The Globe logo, CME, Chicago Mercantile Exchange and Globex are trademarks of Chicago Mercantile Exchange Inc. CBOT and Chicago Board of Trade are
trademarks of the Board of Trade of the City of Chicago. NYMEX, New York Mercantile Exchange and ClearPort are trademarks of New York Mercantile Exchange Inc. COMEX is a trademark of Commodity
Exchange Inc. All other trademarks are the property of their respective owners. Further information about CME Group can be found at www.cmegroup.com.
Copyright © 2012 CME Group. All rights reserved.

CME GROUP HEADQUARTERS CME GROUP GLOBAL OFFICES
20 South Wacker Drive Chicago New York London

Chicago, Illinois 60606 +1 312 930 1000 +1 212 299 2000 +44 20 3379 3700
cmegroup.com Singapore Calgary Hong Kong
+65 6593 5555 +1 403 444 6876 +852 3180 9387
Houston São Paulo Seoul
+1 713 658 9292 +55 11 2565 5999 +82 2 6336 6722
Tokyo Washington D.C.
+81 3242 6232 +1 202 638 3838
© 2014 CME Group Inc. All rights reserved. HF151.2/6M/0714

A Quantitative Analysis of Managed Futures Strategies: Lintner Revisited

Uploaded by

Copyright:

Available Formats

A Quantitative Analysis of Managed Futures Strategies: Lintner Revisited

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

A Quantitative Analysis of Managed Futures Strategies: Lintner Revisited

Uploaded by

Copyright:

Available Formats

LINTNER REVISITED

Dedicated to the late John Lintner

4 Managed Futures – Some Basic Properties

6 Growth of Futures Markets and Managed Futures

7 Manager Style and Selection

12 Risk and Return: Omega – A Better Approach

15 Hidden Risk: The Importance of Liquidity, Transparency and Custody

17 The Lack of Correlation and Potential for Portfolio Diversification

22 Managed Futures and Performance during Financial Market Dislocations

30 Benefits to Institutional Investors

34 Conclusion in the Context of Lintner

2 Past performance is not necessarily indicative of future results.

Past performance is not necessarily indicative of future results. 3

MANAGED FUTURES – SOME BASIC PROPERTIES

4 Past performance is not necessarily indicative of future results.

These include discretionary fundamental or global macro managers

Another common misconception about managed futures strategies

Past performance is not necessarily indicative of future results. 5

GROWTH OF FUTURES MARKETS AND

EXHIBIT 1: Managed Futures Growth in Assets Under Management 1980-2014

Managed Futures Growth in Assets Under Management 1980 - 2014

Source: BarclayHedge Alternative Investment Database

6 Past performance is not necessarily indicative of future results.

MANAGER STYLE AND SELECTION

Past performance is not necessarily indicative of future results. 7

160% max mean min

8 Past performance is not necessarily indicative of future results.

Past performance is not necessarily indicative of future results. 9

Furthermore, any systematic or algorithmic trading system has Manager Selection

10 Past performance is not necessarily indicative of future results.

MANAGED FUTURES RISK, RETURN, AND THE

Past performance is not necessarily indicative of future results. 11

RISK AND RETURN: OMEGA – A BETTER APPROACH

this paper highlighted earlier. “Commodities,” loosely defined, are ∫ [1-F(x)]dx

variety of global markets.

12 Past performance is not necessarily indicative of future results.

EXHIBIT 3: Cumulative Distribution and Omega Functions

Source: Bhaduri and Kaneshige, 2005

Past performance is not necessarily indicative of future results. 13

EXHIBIT 4: Statistics: Traditional and Alternative Investment Benchmarks

HFRI Fund Weighted Index

HFRI Equity Hedge Index

MSCI World Daily Total

Barclays Capital Bond

Barclays Capital Bond

LPX Buyout Index

Negative Months 143 147 156 58 131 179 114 84 89 71 112 43

Modern Portfolio Theory

14 Past performance is not necessarily indicative of future results.

HIDDEN RISK: THE IMPORTANCE OF LIQUIDITY,

Past performance is not necessarily indicative of future results. 15

16 Past performance is not necessarily indicative of future results.

THE LACK OF CORRELATION AND POTENTIAL

Efficient Frontier: BTOP 50 Index and Traditional Portfolio of

60% S&P 500 Index/40% Barclays Capital

100% BTOP 50 Index

Annualized Standard Deviation (%)

Past performance is not necessarily indicative of future results. 17

Omega Graph: BTOP 50 Index and Traditional Portfolio of