What Investors Want: Section Name

SECTION NAME
ISSUE 9 June 2, 2009
In This Issue
Founding Father Q&A
Patrick Welton of Welton Investment Corp. listened to investors talk about managed futures in the early 2000s and in response to their concerns built a diversified program that contains global macro components. Dr. Welton discusses his approach ........... 2
What Investors Want

The crisis changed things. Investors talk about different worries than they did two years ago. Regulators have become much more aggressive. Thinking about the changes, I was startled when Pat Welton said that proper portfolio design should ask timeless questions. Then I thought about it and understoodyou can read the interview in Founding Father Q&A. Dr. Welton started from the question of how to tailor investments so as to meet clients needs. That same question underlies a report from Celent analysts Ranjit Behera and Sreekrishna Sankar, summarized in Futures Lab. Comparing commodity trading advisors with commodity hedge funds, they find that CTAs are better prepared to meet current investor expectations. Investors may want Y but get X. Ferenc Sanderson looks at this issue in Practitioner Viewpoint. Ferenc and I used to be colleagues and it was obvious back then that he is one of the most astute observers of hedge funds, as this article demonstrates. Investors, managers, traders all seek new ways of making money. We asked several industry veterans what they see happening in derivatives markets. See Insider Talk for their perspectives. This year is the 150th anniversary of the publication of Charles Darwins book, On the Origin of Species, and the 200th anniversary of his birth. Markets evolve in their own way and investors priorities change over time. Adapting to change is crucial, but some ideas are timeless. Like paying attention to your customers. Chidem Kurdas Editor kurdas@opalesque.com
Futures Lab
Read about investors new priorities in the post-crisis commodity markets. Commodity trading advisors stand to become the preferred way to invest but need better tools for risk control, argue the authors of a report from Celent ............................................. 5
Insider Talk
A line-up of industry people with derivatives experience talk about trends in options and futures markets ....................................... 8
Practitioner Viewpoint
Cranwood Capitals Ferenc Sanderson questions the conventional pigeonholing of investment strategies .............................. 12
Regulators & Courts
The futures regulator is likely to expand, as are futures exchanges ............................14
Top Ten
Stock index traders with the highest returns ........................................16
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OPALESQUE FUTURES
FOUNDING FATHER Q&A
The Portfolio Doctor

In the financial industry, the title doctor usually refers to a graduate degree in finance, math or occasionally physics. Patrick Welton, by contrast, is a medical doctor who taught at Stanford medical school and did cancer and genetic sequencing research. On the side, though, he traded futures and designed trading algorithms. Over the past 21 years he and his wife, Annette, built Welton Investment Corp. In a way, Dr. Welton applies a physicians mission to money managementhe diagnoses the problem and figures out a solution. Here he discusses investors concerns regarding managed futures and how to address those issues by constructing a truly diversified futures portfolio. His prescription: a blend of approaches that does not rely exclusively on any one style or market pattern.
Opalesque Futures Intelligence: How did you get into futures? Patrick Welton: My interest in quantitative methods dates back to the days when I was captain of the high school math team. I studied math and physics in college, before switching to molecular biology and other subjects. Annette and I traded with our own money in the early 1980s. First we traded US equities, then we focused on how to trade futures. We found them to be a very attractive way to take positions because it requires less capital and the market is liquid. We developed our own investment strategy through the years. Eventually we moved to trading for a professional firm, Commodities Corp. In 1989 we started Welton Investment Corporation. OFI: Would you describe the strategy? PW: From 1992 into the early 2000s, we offered a trend-following managed futures program. Over this decade, the firm grew to include research, trading and middle office staff to meet the needs of our investor base. In 2003, based on the input of some of our most sophisticated investors, the firm decided to pursue a different concept and started to develop a diverse set of trading strategies. Today, this diverse collection of strategies forms the basis for our flagship Global Directional Portfolio (GDP) program which is now in its sixth year of trading and manages approximately $500 million. OFI: What was the investors feedback? PW: Investor interest in managed futures has waxed and waned since the 1990s. Investors generally want the well-proven benefitsthe non-correlation with markets and the big gains at times when other investments make large losses, as happened in 2008. Many would like to increase their allocation to managed futures. That being said, investors or their agents have had concerns that get in the way of making a well-supported asset allocation decision. OFI: What are the concerns? PW: One is that managed futures, when largely consisting of traditional trend following, goes through extended periods of disappointing performance. A corollary is that investors
Patrick Welton
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OPALESQUE FUTURES
FOUNDING FATHER Q&A

were not happy about the occasional sharp drawdowns that they would have to incur to stay in a traditional trend-following strategy. These concerns have been significantly recalibrated now that more traditional investments and hedge funds have shown their ability to produce even larger and swifter drawdowns of capital, not to mention the risk management failure of over-concentrated exposures.
Good portfolio design has to ask timeless questions. For managed futures and global macro, the timeless question is the source of return.
OFI: But how can losses be eliminated? All strategies lose money some time. PW: Sophisticated clients know that the downside cannot be eliminated, but as a manager we can try to limit the undesirable characteristics. What are needed are ways to ameliorate some of the negatives, like big givebacks in performance or sharp run ups and sharp run downs, which are a result not just of investment technique but also portfolio construction. Our approach is to employ disciplined diversification in portfolio construction to try and create more robust and timeless investment results. OFI: What do you mean by timeless? PW: Human beings dont have a technology that predicts the future well even for short periods, let alone for months or years. Good portfolio design has to ask timeless questions. For managed futures and global macro, the timeless question is the source of return. Asset price fluctuations are the source of returns. There are many dimensions. The fluctuations can be fast and jagged, slow and smooth, within or between markets. A core question is whether you can design ways of reliably capturing the different types of asset price movements. The more types of fluctuations you can catch, the more timeless the entire portfolio allocation design will be.
OFI: How do you catch diverse kinds of fluctuation? PW: Many managers have diversified across asset classes. Thats not a difficult diversification step but is nonetheless valuable. If one looks under the hood at the attributed sources of return, one too often finds less diversification than expected, often with large amounts of returns coming from a concentrated set of markets. Some managers have diversified across time frames, doing both long- and short-term trading. This has been happening in the past few years. Meaningful stylistic diversification is harder. It used to be that investors had to go to several firms to put together a stylistically diversified futures portfolio. OFI: Which approaches have a diversifying effect within managed futures? PW: Long-term trend following can generate wonderful returns, but there may be long periods of no opportunity for this strategy. Choppy, range-bound markets are difficult to trade if youre looking for a trend. Oftentimes during those periods other strategies like mean reversal and fundamentals-based approaches perform normally, so including them can help diversify return source and ultimately smooth returns at the portfolio level. Relative value strategies, for instance, give the manager tremendous flexibility in accentuating profit opportunities that dont exist in a single market. If you go below the surface of different strategic styles, there is yet another level of diversification in how the style is applied. OFI: How many levels of diversification do you consider? PW: There are six primary levels of diversification to consider: strategies vary by markets, timing, style basis, directionality, input foundations, and the way those styles are implemented. OFI: What does this mean for investors? PW: The wide dispersion of performance across managers is another issue that has discouraged investors from wider adoption of managed futures. In any given year managers returns from top to bottom quartile can be 10 or 20 percentage points apart, which complicates the investment decision. But once
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OPALESQUE FUTURES
FOUNDING FATHER Q&A

you look at returns in terms of the diversity of what managers do, you have an explanation of the extreme dispersion of returns. Tracking the diversity, you have a reliable framework for investing. OFI: How did you diversify? PW: In response to the feedback from investors, in 2004 we created the GDP program which does not rely solely on trend following. GDPs portfolio architecture is the biggest design advance. Each individual component, whether it makes trade decisions based on fundamental data or statistical data, has a function in the architecture. Further diversification within this architecture is often the most robust basis to advance the portfolio quality. For example, if in commodities we have both a trend-following strategy across time frames and a fundamentals-based strategy, but no mean reversion or price discovery-based models, then it is highly probable that our clients will gain the most significant benefit if we direct our research toward purposefully filling these holes in the architecture. OFI: How do you allocate between programs? PW: By design we want GDP to have near-zero correlation to major markets and to other hedge fund strategies. We want to diversify broadly and to be a reliable diversification source for our investors. The systems indicate where the trades will be at a certain time but from a top-down view we prefer to maintain a reasonable balance of where the return comes from. Over the years, the portfolio is designed to make money across markets, time frames and styles, with returns balanced across the momentum, mean reversion and fundamentals groups. As we continue to fill out the different styles, momentum based returns, while still significant and valuable, will account for a smaller relative proportion of GDPs returns. Exactly where we get the highest return rotates among asset classes, strategy types and time frames year by year. OFI: Do investors see you as a CTA or a global macro manager? PW: Price fluctuations across asset classes is the domain for both managed futures and global macro. These strategies are close cousins. Systematic quantitative strategies are associated with managed futures, but so are global macro funds with a broad approach. The profits generally come from the same sources. We are generally classified as diversified managed futures. Because some of our programs are fundamentally based, we at times also get classified as global macro. We explain what we do and how we do it, so investors can properly classify us according to their definition. OFI: Whats going on this year? PW: At any given time we can talk about what happened in the past 90 days, but while a colorful conversation, it isnt that meaningful from a strategic sense. Most quarters present a mix of random noise and normal market behavior. Theres been a lot of noise in recent months after the dramatic 2008 trends ended. Very recently, there have been a number of positive performance contributors. This is more of a human interest cycle than an insightful way of considering portfolio construction. OFI: Whats the right way to look at strategy? Look instead at 30 years of managed futures performance a period with real data through all kinds of environments and you see that managed futures have out-performed nearly all asset classes, providing strong evidence that the strategy deserves serious consideration as a perpetual holding in any welldiversified portfolio.
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FUTURES LAB
Commodity Investing
We present edited excerpts from a report on commodity markets from Celent, the consulting firm. This report makes an intriguing point. Managed futures stands to become the preferred way to invest in commodities because of concerns raised by the financial crisis, argue authors Ranjit Behera and Sreekrishna Sankar, analysts at Celent Bangalore. The commodity trading advisor model has always existed as a choice for investors but it was overshadowed by the hedge fund model, Sreekrishna Sankar told us. However, he says now that investors have realized certain critical issues in the hedge fund model, it will be easier for CTAs to raise money and managed futures assets will grow faster than before. As the summary below makes clear, this is a qualified predictionCTAs will need better tools to manage risk and tailor portfolios to investor needs. And the assets will flow to well-established managers with track records, so it wont be easy for small and new firms to raise capital. Even so, this analysis points to a larger managed futures industry with greater opportunity for all.
The 2000s saw rising demand for commodities from emerging economies, capital infusion from players who invest in commodities for returns (rather than for hedging) and phenomenal growth in trading on exchanges. A rally began in 2002, accelerated and continued until mid-2008. Commodities attracted investment from all segments of the financial world. The major players were pension funds, mutual funds, insurance companies, hedge funds, commodity trading advisors and the proprietary desks of various investment banks. They brought financial and technological sophistication to the market. By 2008, the global commodities market stood at $15.3 billion, with 85% of the transactions happening in the over-the-counter market (see chart). Commodities were heavily affected by the financial crisis. Investors unlevered their positions because of the credit contraction. Even as the credit crisis eased via monetary intervention, the problem transformed into an economic crisis. This led to a drop in demand and a slowdown in world trade, suppressing commodity prices. Commodity indices and the prices for crude oil, agriculture-based commodities and metals fell rapidly. For most financial players involved in commodity markets, huge losses seem to have been the norm. This is especially true for hedge funds, which were hit due to their high leverage. Some were forced to shut down. However, broker-dealers made decent money from the trade volume surge as many players tried to profit from the volatile markets.
Post-Crisis Model for
Commodity Market Snapshot in 2008

Global Commodity Market $15.25 T
Exchanges $2.25 T
OTC Market $13 T
Index Invts $200 B
Non-Index Invts $2050 B

Source: Celent
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FUTURES LAB
One asset class that performed extremely well during this phase was managed futures. To put the relative performance into perspective, in 2008 commodities as an asset class lost about 24% and hedge funds as a whole lost around 20%. Meanwhile, CTAs gained more than 18%. A major profit-reaping mechanism for hedge funds was leveraging in the OTC markets. That approach to profiting from commodities might well become history as governments look at the risks taken by funds and move to correct the lack of transparency. A new regulatory regime has appeared on the horizon. We will discuss how the commodity market game will pan out in the crisis aftermath and which investment vehicles are better equipped for handling the changes.
6 CTAs as Model for the Future

Investors routing money into commodity markets via hedge funds are asking for more transparency and real time investment data. Demands for independent third-party valuation of the portfolio and analysis of risk are also on the rise. CTAs fit the bill perfectly for providing better information on investments as well as greater liquidity for withdrawals. Hence CTAs could be seen as a preferred means to get exposure to the commodity market.
Investment Flows
Investing a portion of a portfolio in commodities provides an opportunity for diversification. Investors will continue to seek this mode of diversification, and investments by financial players like insurance companies, pensions and others could reach over $2 trillion. Table 1 shows the impact of commodity investing via managed futures on a stock portfolio. The data indicates the smoothing effect of commodity investments on the overall portfolio, with decreases in both volatility and downside deviation. TABLE 1
Though established CTAs will attract the bulk of the new capital, new CTAs can make a mark in growing sectors like emissions and freight trading.
Moreover, CTAs have long been regulated. We believe that CTAs transparency and adherence to regulatory norms helped them weather the crisis and will make them a model for commodity investing in the post-crisis era. But their 2008 favorable performance on its own will not be enough to significantly lure investors. CTAs will have to adapt to the newer compliance regimes and upgrade risk management systems. They will have to work more closely with their clients to understand the risks that are important for each client. There is already a trend in this direction. CTA offerings have been evolving to address investors demands for products tailored to reduce risk. Many CTAs try to uncover investment opportunities to best suit the clients concerns. This trend intensified after the slump in the commodity market. CTAs will need better tools to assess the risks and better ways to mitigate them. They have to rapidly upgrade their technology to accommodate greater trading traffic. Viable technologies need to be developed to accommodate alternative trading systems. The managed futures industry is fragmented. There are more than a thousand CTAs operating, with $160 billion managed in commodityrelated futures. The increased flow of money should give enough breathing space for all to survive, though players with proven track records will attract the bulk of new investment. New CTAs wishing to enter the market will have to struggle, since most investors prefer managers with established records. Though
World Stocks With and Without Managed Futures

January 1994 through November 2008 World Stocks
Return Volatility Downside deviation 2.99% 14.34 11.27
80%WS/20%MF Change
4.11% 11.39 8.74 1.12 -2.95 -2.53
Source: Celent
In terms of assets under management, pension funds are the largest segment of commodity investors with total assets of around $30 trillion under their control followed by mutual funds. Big pension funds like CalPERS and BT Hermes have been active investors in the commodity market. Banks treasury departments have also made forays into commodity investments. For most players commodities are a recent addition to their portfolio and hence form a small portion of total assets. The industry consensus is that a 3% to 5% portfolio exposure to commodities will be ideal for diversification. On a conservative estimate, a 3% asset exposure of major buy-side players may result in $2.4 trillion of investments into commodities over time.
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FUTURES LAB
established CTAs will attract most of the new capital, new CTAs can make a mark in growing sectors like emissions and freight trading. commodity exchanges can be done via index funds or directly via derivatives. Index investments give investors exposure to multiple commodities at the same time.
Investors have already started to move towards exchanges in search of more transparency and to minimize counterparty risk.
Move to Exchanges
Around 85% of commodity transactions occur on the OTC market because big commodity hedgers and investors preferred customized contacts. Owing to this high tilt towards OTC, some commodity transactions are not completely transparent and price discovery has become a major issue. The 2008 plunge in commodity prices created doubts regarding the kind of deals happening OTC and the motive behind them. A big issue now is counterparty risk minimization. It is very likely that there will be a migration of buy side players towards avenues with lower counterparty risk, and thus volumes on exchanges will increase once the market recovers from the crisis. Though the OTC market is comparatively large, transactions on exchanges have grown rapidly in recent years. Investments in
The rise in index investing has resulted in higher trading volumes on exchanges globally. Both developed and developing countries actively participate in commodity trading. Over 40% of commodity trading on exchanges was carried out on US exchanges, followed by 26% in China, 17% in the UK and 7% in India. Trading on exchanges in China and India has gained importance in recent years due to the emergence of these countries as significant commodities consumers and producers. Most exchanges concentrate on a couple of sectors. For example, the bulk of the trading on NYMEX is in energy and metals, whereas Zhengzhou Commodity Exchange of China is predominately agro based. While exchanges barely form 15% of the commodity market, their role as price indicators has been crucial. Post crisis, exchanges and clearinghouses are expected to take a greater role. Investors have already started to move towards exchanges in search of more transparency and to minimize counterparty risk. Since CTAs have always traded listed contracts, they face little counterparty risk and are well positioned to meet investors demand that exchange-listed instruments be used. By contrast, it will be a change for many commodity hedge funds to rely on exchanges and major clearinghouses. Hence managed futures is the right model on this score as well. Table 2 summarizes the points weve made.
TABLE 2
Future of Commodity Investing

Attribute
Preferred type of Transaction Preffered Market Preffered Model Preffered Strategy Risk management and compliance
Before the Crisis

Opaque OTC Hedge fund / index investing Passive / Active Moderate focus
Future
Higher Transparency Exchanges / OTC with Clearinghouse CTA, newer models Active Prime focus
Source: Celent
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OPALESQUE FUTURES
INSIDER TALK
Derivatives Trends
As much as futures markets developed over the years, the pace of change has not slackened. Government actions in response to the credit crisis and climate change will probably result in new types of listed derivatives that some traders will doubtless take advantage of. Hedge funds and commodity trading advisors look for opportunities in local markets and new instruments. While there can be no certainty as to what will emerge, we asked several market veterans for insight as to recent developments. Our lineup starts with Jay Kim, global head of futures brokerage and head of the prime service group at Woori Investment & Securities. Woori is the top index futures and options brokerage in the Korean institutional market. Many macro funds and CTAs trade in Asian markets. As of November 2008, the US Commodity Futures Trading Commission allowed US residents to trade Kospi 200 futures contracts. The Kospi is an index that covers all common shares on the Korean Stock Exchanges, while the Kospi 200 consists of the largest 200 companies that together account for over 70% of the Kospi market value.
Opalesque Futures Intelligence: How active is the Korean futures market? Jay Kim: Kospi 200 options and futures are very liquid. The market contracted in the past 12 months but now it is growing fast again. There are many global market makers and foreigners are a growing presence. From April 2008 to April 2009, foreign participation in Kospi 200 futures has been quite stable at 25%. However, during that period there has been a great deal of increased activity in options by foreign investors, from 23.7% to 33.5% in terms of the number of contracts and from 36% to 46.4% in terms of the value of trading volume. OFI: Who trades in this market? JK: One reason there is liquidity is that there are different kinds of investors. Some use computerdriven systems, others are manual traders. Some traders bet on countries, for instance selling futures in Korea and buying futures in Japan. Traders compete with each other, so the speed of execution is very important, especially in options. Also, Korean retail investors remain a large part of the futures market, accounting for 37% of the trading. We think that is why Kospi options attract big global traders. OFI: What is it that attracts big traders like hedge funds? JK: Korean retail investors are sophisticated, but still they bet on direction and dont worry about fair value. So there is more mispricing than you see in markets dominated by professionals and market makers have a good chance to make money. That said, weve known individuals who traded futures with their own automated system and made high returns year after year. Other retail investors hear about that and decide to trade futures themselves.
Jay Kim
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INSIDER TALK
A big change is happening in over-the-counter derivatives. Regulators want centralized clearing and standardization. The IntercontinentalExchange Inc. began clearing credit default swap index contracts in March and the Chicago Mercantile Exchange teamed up with hedge fund firm Citadel to launch CDS clearing. The next step is to move standardized OTF derivatives to exchanges. That would continue a trend of increasing diversity in listed derivatives instruments. Stock index, currency and interest rate futures, now commonplace, were once novelties. Over the years, managers in sectors such as discretionary macro, trendfollowing and quantitative trading developed programs to take advantage of the wider range of instruments. Extrapolating from that experience, we can expect new traded derivatives to lead to new strategies. Tim Youssef and Nimit Savani, managing directors and co- heads of derivatives at Lighthouse Financial, and Rob Weinstein, senior managing director at the firm, tell us what they see happening. Lighthouse Financial covers all areas of derivatives.
Opalesque Futures Intelligence: Will credit default swaps become traded like futures contracts? Tim Youssef: We dont yet know what CDS trading on an exchange will look like, but it is a foregone conclusion that credit derivatives will become centrally traded and more transparent. As these markets become more transparent, well see debt and equity derivatives come together. Therell be a lot of spillover between equity derivatives and credit derivatives in the coming years. Instruments that have been separate will increasingly be intertwined. OFI: What products are in demand? Rob Weinstein: As the market changes, the need for derivatives changes too. For instance, trades that used to be done with single stocks are now being executed through exchange-traded funds. As single-stock trading dried up, ETF trading ramped up. Many large hedge funds use ETFs as the vehicle of choice to take directional views. Nimit Savani: Many single securities are highly correlated with an index, so an ETF can be used to make the trade instead of the single name. For example, an individual security in an emerging market like China may not have much liquidity; the ETF is more liquid. As a wide variety of ETFs came to be traded, options on these became available. OFI: How common are these derivatives? NS: You see market makers writing options on ETFs for Asia, Latin America and other emerging markets. Listed options are more liquid than you would think, because there is interest in making markets. That creates more trading opportunity, which in turn encourages market making. OFI: Are the options actively traded? NS: There has been an explosion in ETF derivative trading in the past couple of years, from plain vanilla listed options to total return swaps. People use them to take positions in some of the less liquid international ETFs. Long/short traders use ETFs to make country and sector bets. Increasingly those trades are moving into derivatives, using options on ETFs.
Tim Youssef
Nimit Savani
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OPALESQUE FUTURES
INSIDER TALK
10
For an alternative view, we turned to Hans Hufschmid, chief executive officer of GlobeOp, a provider of services to hedge funds and other financial players. The company processes complex over-the-counter derivatives, among other services. It administered $91 billion in assets as of May. Mr. Hufschmid is a true hedge fund veteran. He was a principal at Long-Term Capital Management and co-head of that firms London office for five years, where he supervised traders, researchers and other personnel. LTCM nearly collapsed in 1998 and was liquidated by a consortium of banks. In 2000, Mr. Hufschmid became one of GlobeOps founding partners. He takes a long term perspective on OTC derivatives while discussing the current state of markets and prospects for global macro strategy.
Opalesque Futures Intelligence: Will credit default swaps become traded like futures contracts? Hans Hufschmid: Theres been talk for some 15 years about moving over-the-counter derivatives to exchanges, so Im not sure whether it will happen this time either. If it does, it would make our life a little easier. Standardized contracts are always easier to process, though it doesnt take away the need for valuation, pricing and collateral management work. OFI: How active are derivatives markets? HH: What weve seen in the past 12 to 18 months is a clear contraction in OTC market volumes, both open contracts and average daily volumes. Although markets have somewhat recovered from the shock of 2008, you do still see liquidity problems. OFI: Which markets look promising? HH: Theres a lot of interest in all kinds of debt trading. Also, there are great opportunities for global macro, whether in indexes, currencies or other assets. To make money, this strategy needs dislocations in markets and shifts in economic fundamentals. Thats whats happening now.
Hans Hufschmid
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OPALESQUE FUTURES
PRACTITIONER VIEWPOINT
12
Beware of Labels
This viewpoint is from Ferenc Sanderson, chief operating officer of Cranwood Capital Management LLC. He points out the problems that can be caused by the conventional pigeonholing of investment styles. Cranwood is an interesting example of a fund that straddles categories. Increasingly, fund managers are using futures to implement strategies that are not classified as managed futures. Conversely, many commodity trading advisors overlap with global macro. Welton Investment Corp., featured in this issue, is a case in point, spanning managed futures and global macro. Before he joined Cranwood, Mr. Sanderson was senior hedge fund analyst at Lipper and a research fellow attached to Columbia Universitys Program on Alternative Investments. Earlier in his career he was director of research at Daiwa Securities America.
Hedge fund strategy labels can be deceptive, as became clear last year. What were supposed to be distinct strategies turned out to be quite similar. The experience suggests that investors should pay closer attention to what a manager is actually doing and not take the strategy description at face value. In 2008 this was exposed in a dramatic way, in widespread style-drift. The indices for all hedge fund categories correlated at record high levels (often over 0.8) with the price of oil and other commodities as well as with the MSCI World Index. Even multi-strategy single-manager returns demonstrated similarly high correlations to oil and stocks. That means that one way or another everyone was following the same trade, namely going short the financials and long oil. That was the trade du jour. But in the summer of 2008, the trade blew up. So almost everyone suffered losses, regardless of the size of the firm, whether it had a well developed infrastructure or how deep its talent pool was. Such crowded trades plus style drift explain what happened as everyone played the same beta movements. There were $10 billion managers going down alongside $10 million managers. The point is that investors portfolios turned out to be a lot less diversified than you would expect from the standard strategy descriptions. Only now do institutional investors and other allocators realize the mistakes that were made.
Ferenc Sanderson
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OPALESQUE FUTURES
PRACTITIONER VIEWPOINT
13
The bucket you are put into has an important bearing on how investors perceive you.
My own experience is another example of how misleading labels can be. Cranwood pursues a fixed income arbitrage strategy, focusing on mean-reversion along the US interest rate curve. But we execute this strategy exclusively with futures contracts using butterfly spreads. So in a sense we fall into the CTA and managed futures allocation bucket. Some investors pigeonhole us under the broader fixed income arbitrage label, mixing what we do with mortgage-backed securities, corporate or junk bond instruments. But our instruments are liquid, exchange-listed and devoid of heavy leverage or counter-party risk issues. Since we trade only futures, you could consider us a managed futures fund. But then, our risk/ return profile may be more consistent and substantially less volatile other managed futures funds which tend to be more directional and trend following. Moreover, we stay in our niche in interest rates and do not blend financial, commodity or currency futures.
Good News
The bucket you are put into has an important bearing on how investors perceive you. They may be looking for certain characteristics that they associate with certain strategies. For instance, today the majority of investors want trading oriented strategies that have liquidity, focus on exchange-traded instruments, do not employ a lot of leverage and are not susceptible to counterparty risk. So it is important for a manager to clearly explain what hes doing and just as important for the investor to understand the characteristics of the fund. Investors can probably understand more clearly a managers underlying strategy, instruments and risk factors when honing in on specialist alpha generators. In many cases, the risk factors of these niche/specialist managers can be defined, whereas managers that pursue a broader mandate might be subject to the same kinds of style drift and crowded trades many suffered from in 2008. The reality is that people tend to go with what they know, or have been accustomed to doing, so it is no wonder that a blind reliance on traditional labels continues to dominate manager search and initial screening. The good news is that academic researchers are increasingly moving away from self-defined strategy labels to more objective descriptors of fund performance and returns. It is only a matter of time before the whole lexicon of investment categories changes.
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OPALESQUE FUTURES
REGULATORS & COURTS
14
Growth Likely Under New CFTC Chief

Last week Gary Gensler, a former Goldman Sachs partner and Treasury official, was sworn in as chairman of the Commodity Futures Trading Commission. As he starts the job, the most ambitious agenda for financial regulation since the Great Depression is being parsed and negotiated. The CFTC is in the thick of this effort in large part because it looks to be the regulator of credit default swaps, the derivatives blamed for causing the near-collapse of insurance giant AIG. Treasury Secretary Timothy Geithner recently proposed requiring central clearing of over-thecounter derivatives trading. But there are a number of other, futures-related, regulatory issues Mr. Gensler promised to tackle. He made formal commitments on these matters to Senator Bernie Sanders of Vermont. Mr. Sanders had previously blocked Genslers approval on the ground that during the Clinton administration the nominee worked to deregulate the financial industry and to exempt credit default swaps from regulation. A theme that runs through the list of Mr. Genslers promised regulatory initiatives is the need for greater authority for the CFTC to undertake these actions (Table). The Obama budget has already allocated a 10% increase in financing to the agency and the mood in Congress supports expansion in terms of both staff and authority. While a larger and more powerful futures regulator is highly likely, its exact domain is uncertain because the Securities and Exchange Commission will probably get to administer some of the new requirements. Mr. Gensler does not favor the merger of the CFTC with the SEC, one possibility that has been put forth as a way of creating an over-arching regulator. There is some uncertainty about the treatment of credit default swaps. Messrs. Geithner and Gensler want central clearing but leave it open how much of CDS will move to exchanges. Standardized contracts are expected to be listed on exchanges but that may be only a small portion of CDS contracts. By contrast, a bill introduced by Senate Agriculture Committee Chairman Tom Harkin of Iowa goes beyond registering derivatives trades with clearinghouses and requires that all derivatives be on CFTC-regulated futures exchanges. He said the Administrations proposal for OTC derivatives is a step in the right direction but there is still more that needs to be addressed and he plans to move forward with the legislation Banks such as Mr. Genslers former employer Goldman, which would lose profits from the transfer of OTC trades to exchanges, favor clearinghouses rather than exchanges. Still, prospects look reasonably bright for the expansion of futures exchanges as well as the futures regulator.
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OPALESQUE FUTURES
REGULATORS & COURTS
15
Other regulatory focal points are margin requirements, trading through foreign futures exchanges and registration exemptions given to commodity pool operators. Changes in these may have an immediate impact on some futures traders, but it is not clear whether and how current practices will change. Mr. Gensler promised to review these matters and left it at that. He may wish to retain as wide discretion as possible for future action, but he will be under pressure from Congress. If Iowa farmers complain about the effects of agricultural futures trading, for instance, Mr. Harkin might push for new position limits.
Genslers Response to Senator Sanders

Selected quotes from the CFTC Chairmans statement before his approval by the Senate: We must urgently move to enact a broad regulatory regime that covers the entire over-the-counter derivatives marketplace. This regime should consist of two main components. One component is the regulation of the derivatives dealers themselves. The other component is the regulation of the marketplace. I will work with the Congress to provide the CFTC with the additional authority it needs to improve the transparency of the OTC derivatives market. We should subject all derivatives dealers to: - conservative capital requirements. - business conduct standards. - record keeping requirements (including an audit trail). - reporting requirements. - conservative margin requirements. Position limits should be applied consistently across all markets, all trading platforms, and exemptions to them must be limited and well-defined. I will ask CFTC staff to undertake a review of all outstanding hedge exemptions I will work closely with Congress to pass legislation that will mandate registration of hedge fund advisers as part of a comprehensive package of regulatory reform. In addition, if confirmed, I will work with the agency staff to review all previously granted exemptions from registration as commodity pool operators. I support actions to close the London Loophole and ensure that foreign futures exchanges with permanent trading terminals in the US comply with the position limitations and reporting and transparency requirements that are applied to trades made on US exchanges. I look forward to working with Congress to give the CFTC unambiguous authority to promulgate rules and standards to achieve these goals. Such rules and standards governing treatment of foreign boards of trade should replace the issuance of noaction letters in this in this regard.
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OPALESQUE FUTURES
TOP TEN We feature top managers from a different database every issue.
16
We present a stock index sector ranking from Managed Account Research Inc. These stock index traders have the highest compounded annual returns for the three-year period that started April 2006. In terms of assets under management, the managers are very diverse, ranging from about $157 million managed by Paskewitz to less than $1 million managed by several others. The Managed Account Research database provides information on various alternative investments, including but not limited to managed futures programs.
Top Stock Index Traders for the Past Three Years

CTA and program Three-Year Compounded Annual Return 49.35% 36.40% 33.02% 32.93% 29.64% 20.42% 15.82% 12-Month Return Year-to-Date
Pere Trading Group Pere Trading Program Desoto Capital Mgmt. E-Mini Program White Indian Trading Co Ltd. STAIRS Paskewitz Asset Mgmt. Contrarian 3X S&P Program Parrot Trading Parrot Trading Partners Golden West CTA LLC Options Eickelberg & Assoc. Inc. Stock Index Option Program The Roy Funds Systematic Equity Indices Large-Cap GrowthPoint Investments Index Condor
56.20% 43.99% 33.94% 31.10% -6.29% -3.81% 11.34%
-25.60% 4.15% 5.71% -0.26% -5.78% 2.89% 1.13%
13.80%
27.21%
2.39%
13.57%
23.38%
3.22%
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Alternative Market Briefing is a daily newsletter on the global hedge fund industry, highly praised for its completeness and timely delivery of the most important daily news for professionals dealing with hedge funds. A SQUARE is the first web publication, globally, that is dedicated exclusively to alternative investments with "research that reveals" approach, fast facts and investment oriented analysis. Technical Research Briefing delivers a global perspective / overview on all major markets, including equity indices, fixed Income, currencies, and commodities. Sovereign Wealth Funds Briefing offers a quick and complete overview on the actions and issues relating to Sovereign Wealth Funds, who rank now amongst the most important and observed participants in the international capital markets. Commodities Briefing is a free, daily publication covering the global commodity-related news and research in 26 detailed categories. The daily Real Estate Briefings offer a quick and complete oversight on real estate, important news related to that sector as well as commentaries and research in 28 detailed categories. The Opalesque Roundtable Series unites some of the leading hedge fund managers and their investors from specific global hedge fund centers, sharing unique insights on the specific idiosyncrasies and developments as well as issues and advantages of their jurisdiction.
Opalesque Islamic Finance Briefing delivers a quick and complete overview on growth, opportunities, products and approaches to Islamic Finance. Opalesque Futures Intelligence, a new bi-weekly research publication, covers the managed futures community, including commodity trading advisers, fund managers, brokerages and investors in managed futures pools, meeting needs which currently are not served by other publications.
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PUBLISHER Matthias Knab - knab@opalesque.com EDITOR Chidem Kurdas - kurdas@opalesque.com ADVERTISING DIRECTOR Denice Galicia - dgalicia@opalesque.com EDITORIAL ADVISOR Tim Merryman - tmerryman@opalesque.com CONTRIBUTORS Bucky Isaacson, Frank Pusateri, Pavel Topol, Ty Andros, Walt Gallwas. FOR REPRINTS OF ARTICLES, PLEASE CONTACT: Denice Galicia dgalicia@opalesque.com
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ISSUE 9 June 2, 2009