Metals could fuel growth with interest rates at inflexion point

Technical analysts see positive signs in metal commodities

The fringes of many CTA funds could be the drivers of their portfolio growth if a real inflationary cycle recurs, according to some systematic trading managers.

Julius Staniewicz, senior strategist for John W Henry & Company’s Strategic Allocation Program (SAP), says any re-emergence of inflation could see metal commodities — traditionally a smaller component of CTA portfolios due to the markets’ relative illiquidity — “fly, and it will not matter if we only have 5% exposure, it will still be extremely profitable.”

However inflation could also effect the more liquid markets of currencies and interest rates, as Staniewicz notes: “Real inflation will probably also have a major deleterious effect on interest rates, so we will be positioned to take advantage of that,” he says.

Staniewicz says August and September were characterised for CTAs predominantly by “sharp reversals in the currencies and interest rate markets.” The G7’s announcement they would tolerate a weakening dollar was interpreted by many market participants as a strengthening yen against the weakening greenback. Both effects could prove to be “major drivers in potential profitability in bigger moves in currency markets,” according to Staniewicz. The yen’s positive response made money for many CTAs, rising quickly through what had been an 18-month high for the currency.

Interest rates also possibly stand at a useful inflexion point, he adds. From a decline of almost 22 points between 13 June to late July in bond futures, there has been a retracement of half the fall to the end of September.

“It is fairly difficult to discern any trend out of having, in the relatively compact period, a fairly wide swing. But a lot of technical analysis will say you are at an inflexion point if you have retraced half of the move, and the question is where it will go from here.”

The key to playing the high volatility that traders have seen recently, Staniewicz says, is risk control. SAP trades in 65 markets with about 70% of its assets allocated to the most liquid markets of currencies and interest rates, around 12.5% in each of energy and commodities, and 5% in normally non-US equity indices.

While some fund of fund managers remain wary of venturing too far into CTAs as underlying strategies, not all are black box systems seen by some as impenetrable to the outside gaze.

Julius Baer, for example, is launching a fund with 50% of its risk in currency markets. The fund will not invest in equities nor in commodities. (For more on this fund, see the front page). Timothy Haywood, the firm’s director of fixed income alternative investments, says the fund will be “fundamentally driven” while paying regard to models as well.

However, Craig Reeves, managing director of Platinum Capital Management — and its Equity Plus fund of funds — says the opaqueness of the processes and strategies some CTA managers use can make them difficult to feel comfortable with. The high leverage some CTA funds use, both by borrowing and through embedded leverage in contracts they use, can also be of concern, he adds.

Over the coming months Reeves says he would “probably not be inclined to do anything currency-based.” Although he has researched many CTA and currency funds, he had found few currency funds with a very long track record.

Barry Colvin, chief investment officer at Tremont, which manages the Matrix Bastion and Conservative Approach Strategy (CAS) funds, also shuns CTAs, as he feels their managers face an information mis-match against other traders, particularly in commodities. However Colvin adds China’s growing demand for copper, and gold and platinum being safe harbours amid uncertainty could see these metals benefit. “If you are in the soya bean market as a CTA manager, for example, you are up against players like Kellogs, and so you’re at quite a disadvantage there,” he says.

Key Points
Re-emergence of inflation could see metal commodities become the main drivers of CTA funds’ growth

Julius Baer is to launch a currency and global macro, multi-strategy fund with half its risk exposure to currencies.

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