Replicating a CTA via Factor Exposures
Possible?
November 2022. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Strategies can be copied by recreating them from scratch or using factor exposures
- CTAs can be replicated via factor exposure analysis by utilizing only 4 asset classes
- Not a perfect replication, but surprisingly good given the limited input
INTRODUCTION
Our two most recent research articles focused on creating a CTA, also known as managed futures or trend following strategies, from scratch (read Creating a CTA from Scratch – I & Creating a CTA from Scratch – II). Essentially, we applied a simple 12-month lookback for determining up and down trends in 59 markets from four asset classes. The result was a diversified portfolio of long and short positions that had a correlation of 0.6 to the SG CTA Index, which is the benchmark index for the managed futures industry, in the period from 2000 to 2022.
This approach is called a bottom-up replication as it copies the investment and portfolio construction process of CTAs. However, we can also replicate indices top-down via factor exposure analysis (read Replicating Famous Hedge Funds), which we explore in this research article.
We will only use four indices representing U.S. equities, U.S. Treasuries, commodities, and the U.S. Dollar, which are all available via ETFs. Given that CTAs trade up to 200 markets, we are likely to fail to achieve a close replication, but we shall see.
FACTOR EXPOSURE ANALYSIS
First, we conduct a simple regression analysis using the four asset class indices for deriving the factor betas for the SG CTA Index. We observe that the betas changed their signs multiple times in the period from 2001 to 2022. Furthermore, the betas to bonds and the U.S. Dollar were more extreme, but that is simply a function of bonds and currencies being less volatile than equities and commodities.
The current exposure of the SG CTA Index, which is comprised of 20 large and well-known managed futures funds, is long the U.S. Dollar,
