Although commodity trading advisors have had a banner year, investors don’t have a big enough allocation to get the protection they need, according to Universa Investments’ Ron Lagnado.
Lagnado, the tail-risk hedging firm’s research director, recently analyzed several CTA indexes dating back to the 1980s, measuring performance, risk, and volatility. He found that for investments in managed futures funds to meaningfully add to performance, asset owners would have to allocate at least 10 percent of their portfolios to the strategy.
A move like that may add other complications. “Are such large allocations desirable or even feasible at a large pension fund?” he asked in a paper exploring the strategy. “Is it opening the door to some other yet-to-be seen risk?”
The analysis comes as CTA strategies are outperforming most other investments in the public markets. In 2022 so far, the Barclay CTA Index has posted an 8.24 percent return in an environment where most stocks have posted losses. Meanwhile, the SG CTA Index has posted a 19 percent return year-to-date.
Allocators have taken notice. Both the New York State and Local Retirement System and the San Diego City Employees’ Retirement System have lauded the managed futures strategy’s role in shoring up annual performance.
Lagnado analyzed the Barclays CTA Index’s month returns back to 1980, the SocGen CTA Index’s returns back to 2000, and the AQR Managed Futures Strategy Fund’s returns back to 2010 to determine how the strategy behaved in past cycles.
The analysis showed that during the 1980s, the Barclays CTA index had an annualized return of 20.3 percent. In the following decades, that declined. In the 1990s, annualized returns sat at 7.1 percent, in the 2000s, they were 5.9 percent, and in the 2010s, they were 0.8 percent. The other indexes followed a similar pattern. The SocGen CTA index returned an annualized 1.6 percent from 2010 to 2019.
“CTAs have had a great year,” Lagnado said, adding: “But if it doesn’t work well in all environments, you have to decide how to allocate.”
In Lagnado’s view, then, the significantly positive returns of CTAs in 2022 are likely an anomaly, the result of interest rate hikes that haven’t been seen in decades. “If we get a slow grind upward in rates, they’re not going to do as well,” Lagnado said.
Lagnado argues he doesn’t take issue with CTA strategies themselves. Instead, it’s how they’ve been positioned. Some proponents highlight CTAs as the end-all, be-all risk mitigation strategy. Lagnado, whose firm does run tail-risk hedging strategies, believes CTAs and tail-risk hedging strategies can complement one another.
It makes sense: While CTAs have been outperforming in a period of a slow market decline, tail-risk hedges perform well during major shocks.
“When you get a fast crash, this may not be able to activate fast enough,” Lagnado said. “When you get a long, slow grind down in the market, this is a good thing.”
Paired together, they can likely mitigate more risk than deployed alone. But asset owners have to determine the size of their allocations — and how much they can pay for the strategies.
