US - Institutional investors are increasingly turning to commodity trading advisers following a historical reluctance to do so, Agecroft Partners believes.
The alternatives marketing firm said the number of pension funds allocating to hedge funds has steadily increased over the past 10 years, along with the percent of their average portfolio allocation. But while many of the major hedge fund strategies, such as Equity Long/Short, have been widely accepted by institutional investors for many years, CTAs have only recently been accepted as a core hedge fund allocation as pension funds scramble to enhance their returns and reduce the volatility of their portfolios after the market correction of 2008, the firm added.
CTAs typically use a quantitative trading programme to generate momentum or trend-based returns by going long or short futures contracts in areas such as commodities, foreign currencies, equity indexes, fixed income and interest rates.
Before 2009, very few pension funds allocated to CTA despite the fact the strategy represents approximately 15% of the hedge fund industry and is one of the oldest and most regulated of all hedge fund strategies. In addition, CTAs have been one of the only strategies to generate returns that have been negatively correlated to equity benchmarks. Agecroft said.
The firm believes the reason institutional investors avoided CTAs was because they could not understand how the systematic models worked and were unable to evaluate which firm's model was superior.
However, after the 4th quarter of 2008, pension funds realised their portfolios were not as diversified as they previously believed and over the next year, many institutional investors along with their consultants began to take a closer look at CTAs.
"They discovered that not only did they do well in 2008, but the average CTA was also up in 2000, 2001 and 2002, which in addition to 2008 were the last four years the S&P had posted negative returns," Agecroft managing member Donald Steinbrugge.
"Some CTAs also exhibited a historical dynamic correlation to the equity markets where they were positively correlated in up equity markets and negatively correlated in down markets, which was driven by their systematic models that are designed to make money based on both bull and bear trends in markets. This means that correlations under explain the diversification benefits of these trend following CTAs. A better statistic to look out is their correlation in down markets minus their correlation in up markets."
CTAs were also able to offer full liquidity to investors at a time when many hedge fund managers raised gates on withdrawals or suspended redemptions due to a mismatch in fund liquidity provisions terms and the underlining investments. Some CTAs have even begun to offer weekly or daily liquidity Steinbrugge added.
These attributes have seen a growing number of pension funds allocate to CTAs, with recent investments coming from schemes including the Texas Teachers Retirement System, New Jersey Public Employees' Retirement System and Eastman Kodak Co. O
"CTAs have come a long way over the past two years in gaining credibility with institutional investors. These investors have been drawn to their uncorrelated historical return stream with long only benchmarks, the institutional structure of the leading firms in the strategy, the high level of liquidity in the underlining investments and fund term, ease of creating a separate account and most importantly strong historical performance," said Steinbrugge.
"Agecroft Partners believes that we are in the initial stages of seeing significant assets flows from institutional investors into this strategy."
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