Download the full study here: Prospects for CTAs in a Rising Interest Rate Environment
Campbell & Company, a specialist in systematic trading strategies, touched on a hot button issue recently when it released its white paper “Prospects for CTAs in a Rising Rate Environment.”
Among institutional investors one of the managed futures investing concerns has been the relative impact of interest rates on CTA performance. Although never widely discussed, the owner of the managed futures segregated account can benefit from interest income derived off the margin deposit. Due to this funding structure, CTAs have multiple returns streams. The primary performance driver is their trading strategy, but under certain circumstances CTAs also generated returns from the collateralized margin deposit that could be invested in interest bearing products such as short term US Treasuries. This additional returns driver, available only on investments that utilize a margin deposit, was always whispered to be part of the “secret sauce” of why managed futures performance has been traditionally strong. Thus, a managed futures investment was always viewed in part as a play on interest rates. In regards to returns from investments in Treasury Products, when rates were high and moving lower, the CTA might have benefited from two returns sources: the interest income from the treasury products and the price appreciation from the bonds moving lower in price.
Problem is CTAs who benefited from interest income and falling bond prices might encounter difficulty in a rising rate environment, is thinking among some. However, this myth might not be entirely accurate.
What is not being considered is the CTA can actually benefit from rising rates in the form higher interest income. While the value of a short term bond may decline in price, these bonds are typically held to maturity by a cash management firm, thus negative price swings in performance bonds are negligible on the CTA’s performance.
Enter the study by Campbell & Company, which takes a statistical look at CTA performance during periods of rising interest rates. With interest rates at all time lows and much analysis focusing on the potential for a rising rate environment, the question becomes salient to investors.
Statistical Study of Managed Futures during Rising Rate Environments
The study considered the Barclay CTA index, where performance data of the reasonably diversified index back to 1980 and study bias issues with the index are reasonably close to issues with equity indexes. The Campbell study showed that in fact managed futures outperformed uring periods of rising rate environments.
Is All Interest Income Calculated in Reported Returns?
What the study did not address is that depending on the account type and investor sophistication, the investor might not be credited with interest earned off collateralized margin deposits. For instance, much of the general Barclay CTA index is comprised of CTAs who might have operated in a distribution channel where the brokerage firm, not the CTA, accrued the interest income from the margin deposit. This thus such interest earned (“float”) may not be included in the CTA’s performance calculation. In a direct segregated account opened in the name of the investor, and not the CTA, the institution might typically accrue 60% or 80% of the interest income, depending on the negotiation and services being provided by the brokerage firm. In a retail account such interest is typically accrued to the brokerage firm. The point is, under many circumstances, the CTA might not even be capturing interest income. The Barclay CTA index is generally considered to include a significant number of CTAs using in retail distribution channels through FCMs, and thus the CTA likely did not accrue interest income and could not report this as a component of their performance capsule. .
Performance reported by a CTA to major CTA databases is typically reviewed by the National Futures Association (NFA) during their audit of the CTA. In a direct segregated account the goal to ensure that reported performance is an accurate reflection of the actual investor experience, inclusive of all fees, expenses. Further, performance reporting between databases is typically monitored by the brokerage industry and reviewed by investors.
Download the full study here: Prospects for CTAs in a Rising Interest Rate Environment
DISCLOSURE: These are the opinions of the author and may not have considered all risk factors. Nothing on this web site should be construed as an individual recommendation, talk to your independent advisor. The author and Opalesque may have relationships with those people they cover in the publication. Mr. Melin provides a full disclosure of his business relationships to regulators and certain eligible participants who engage him in consulting projects. Managed futures investing involves risk and there are no guarantees of safety or future performance being implied. Managed futures can be a risky investment. This web site and its content is subject to the terms of the web site. Risk Disclosure and terms of web site are available here: http://www.uncorrelatedinvestments.com/templates/Disclaimer.html Performance information received on this site is provided by third parties and deemed reliable but there is no guarantee relative to same. Performance reporting sources and quality assurance techniques may include, but are not limited to: disclosure document, CTA self reporting, brokerage firm reporting, consultant reporting, spot checking other reporting databases; nonetheless no guarantee of accuracy or implication performance verification or auditing is being made by the publishers. The CTA Database is a project separately managed from www.uncorrelatedinvestments.com.