Creating a CTA from Scratch

How sophisticated are managed futures strategies?

November 2022. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • CTAs have become popular again given their positive returns in 2022
  • However, they are typically difficult to grasp given their ever-changing portfolios
  • Building a CTA from scratch is not complicated and reduces the opaqueness 

INTRODUCTION

2022 has been a long year of disappointments for investors. Growth stocks do not go up forever. TIPS do not protect against high inflation. And cryptocurrencies like Bitcoin do not preserve their value.

However, some parts of the capital markets are zero-sum games, i.e. for every loser, there must be a winner. The U.S. Dollar is a clear one, and so are commodities like natural gas that benefit from the war in Ukraine. Some global macro funds have made outsized returns, e.g. Crispin Odey’s main hedge fund is up more than 190%, albeit after years of suffering double-digit losses.  

Managed futures strategies, also known as commodity trading advisors (CTAs) or trend following funds, have also generated strong returns. These strategies have become available via ETFs, where the assets under management increased from $200 million to more than $1 billion over the last 12 months (read: Managed Futures: The Empire Strikes Back).

CTAs have a long track record and have been well-researched. However, given their nature of going long or short any market, makes them difficult to understand as their portfolios are ever-changing. We could run a factor exposure analysis to reveal their risk exposures (try Finominal’s Portfolio Diagnostics for portfolio analysis) and replicate their returns historically, but instead, we will attempt to create a CTA from scratch.

BUILDING A CTA

The basic investment strategy of a CTA is to follow and exploit trends, regardless of their direction, which is called time-series momentum in academic research. Futures are used in portfolio construction and trends are measured in as many markets as possible. A portfolio might be long the USD / JPY, short the S&P 500, long lean hogs, short gold, etc. Essentially, it’s a highly dy