The diversification benefits of commodity trading adviser hedge funds have been proven over two decades. In recent years, however, many investors have questioned whether the typical hedge fund fee structure consumes too much alpha. In one example, a U.K. hedge fund manager appears to have made $2 billion to $3 billion in fees over five years on one fund alone, while investors actually lost money.
This raises the question for investors: Is there a lower cost, higher alpha way to access CTA performance?
One approach promulgated over the past five or six years has been to build simple "trend" models — the notion that investors can capture excess returns by buying securities that have been rising, and shorting those that have declined. Banks create indexes and offer over-the-counter swaps that track their performance; some asset managers, including CTAs, offer static trend-following models in managed accounts or other vehicles. The thesis is that "trend," broadly defined, is a key driver of CTA performance; hence, if you can access this key driver cheaply, you'll get most of the value of CTAs — analogous to the passive vs. active debate. More optimistic investors might hope that lower fees will translate into better performance, just as index-based exchange-traded funds tend to outperform more costly active mutual funds.
The question for investors, then, is whether this approach works. The short and unsatisfying answer is, not really. Why is this? There are three reasons:
1. One trend product might look nothing like the next one, which undermines the notion that "trend" is an identifiable and predictable beta that can be captured easily.
2. Trend products have relatively low correlation to actual CTAs, suggesting that static trend models fail to explain a significant portion of CTA performance, particularly before fees.
3. Trend products on average fail to improve returns over high-cost hedge funds, so investors might benefit from daily liquidity but fail to see better performance over time.
Now let's turn to the data.
Most large investment banks offer derivatives linked to risk premium indexes. (Risk premiums are defined as trading strategies like currency carry or merger arbitrage that can be broken down into relatively simple rules.) We reached out to sophisticated allocators for recommendations on which products we should include in this study. The list we compiled held eight indexes.