James A., who wishes to remain anonymous, was an emerging Commodity Trading Advisor (CTA) with a bright future. A quant and trading application developer, he established his public investment CTA product in 2008 with a partner, according to regulatory records. The firm traded an algorithmic model that had shown promise during the market environment of price persistence. Assets under management were growing as the firm received its first institutional allocation, a significant point in an emerging manager’s development.
Then MF Global hit.
James said the large institutional investor was stunned that no explanation could be made as to where his investment capital had gone. The institutional investor had made a substantial allocation to a pool of dozens of CTA with the help of a consultant who knew the CTA space. After the experience, the investor appears scared from the experience.
“He’s been burned. This is still an issue. It’s not a one off event,” James said, noting the reputational damage done to the managed futures industry has been significant.”
In the wake of MF Global fallout, he refocused his energy into a consulting firm which provides data capture services and conducts algorithmic strategy development, modeling and rendering services for hedge funds, quantitative traders operating in a custom API environment. His partner operates the CTA, but finds it difficult to operate without significant institutional allocations. James, however, is optimistic regarding quantitative mathematical investing techniques, but not so certain about the outcome of MF Global.
When assessing MF Global’s widespread impact, concerns expressed by many industry participants center on the difficulty to trade after the bankruptcy. This point is raised in The Aftermath of MF Global and Peregrine Financial Group Meltdowns: A Crisis of Trust. One of the study’s conclusions is that in order to re-instill confidence is creating a system where positions and margin are more seamlessly managed during a bankruptcy.
The impact study, funded by Horizon Cash Management, raises serious questions regarding regulatory audit processes as well, a sore subject along with the practical trade operation concerns. According to Diane Mix Birnberg, Horizon’s Founder and Chairman, the most significant issues identified in the study were positions not transferring and audit procedures.
“CTAs are stunned that their audits (by the NFA) are all encompassing, a brutal experience,” Ms Birnberg said. “The NFA comes in for a week and takes over. This typically brings the CTA’s world to a halt. CTAs and CPOs are subjected to very tough and often disruptive audits yet in the case of PFG in particular their audit process were lacking in basic good audit practices and procedures for several audit cycles.”
NFA CTA / CPO audits famously “rigorous.” The audit process includes examination of the CTA’s business operations, checking for a workable disaster recovery model — all in addition to an account by account audit of performance and examination of reporting that performance to CTA databases and in related disclosure materials. In other words, it’s a known as a tough audit, one in which most participants in the managed futures industry, including brokerage firms, feared.
Even those industry participants who didn’t hold assets at MF Global are feeling the reverberations. But protective measures to safeguard client assets are a growth industry, and one such measure was employed by Horizon before MF Global imploded.
Not All Impacted By MF Global the Same
According to Ms. Birnberg, Horizon’s customers were not impacted by MF Global because they sweep excess cash out of FCM accounts to a custodial account maintained on behalf of clients by Horizon. Horizon’s customer base consists of CTAs and CPOs, but also includes hedge funds and institutional investors.
Stunting Industry Growth?
The managed futures industry was growing at the fastest clip of any major alternative asset category, but much of that growth has been concentrated at the top. For the emerging tier of CTA, MF Global and PFG clearly stunted this growth.
Ms Birnberg notes most CTAs who participated in the survey (51%) were 5 years or younger. “These CTAs were just keeping their head above water,” she said. “They don’t have the time or resources to engage in a fight for justice. They need to make payroll, they can’t worry about behind the scenes issues, the investigation or regulatory politics.”
The survey found that CTAs have been generally dismissive of regulatory measures to fix the issue. “There have been knee jerk reactions that no matter what the fix is it’s ‘not enough.’ There is a severe loss of trust, a loss of confidence.” Many CTAs might point to the lack of criminal charges in the MF Global fiasco, while some might point to an audit issue with the NFA in failure to identify the PFG fraud. “There is incredible anger and frustration. Things need to change. Top to bottom entire industry needs to address key issues.”
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.