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Managed Futures for Institutional Investors: Analysis and Portfolio Construction


Praise for Managed Futures for Institutional Investors

"Brian and Galen echo their wealth of experience and their access to a data set of unrivalled breadth to produce a useful and comprehensive guide to the managed futures industry. Topics are tackled responsibly and with great perspective. A useful guide for all managed futures investors." —Leda Braga, PhD, President, BlueCrest Capital Management LLP

"As one of the only books to analytically address the effect of estimation error on inferences and decision making, this book is a must-read for any serious hedge fund investor. Building on their own long history of thoughtful research, Galen and Brian deliver an exceptionally clear exposition of the managed futures industry. Their expert knowledge of the markets in which CTAs invest, the key participants involved, and the nuances of the data enable Galen and Brian to offer both a state-of-the-art understanding of every component of CTA investing as well as expansive insights about how investors should evaluate and combine managers using the historical data available." —Mark Carhart, PhD, CEO, Kepos Capital LP

"Burghardt and Walls' unique backgrounds of academic research combined with practical market experience make this book a required read for any institutional investor consideringa managed futures investment." —Tony Gannon, CEO, Abbey Capital Limited

"Galen Burghardt and Brian Walls have produced a superb book on managed futures. It is an accessible yet thoughtful and rigorous analysis of a much misunderstood asset class by two of the very best experts in the field. The clarity of their explanations and the quality of their research are exceptional. Every institutional investor should own a copy." —Ewan Kirk, PhD, CEO and founder, Cantab Capital Partners

"This book is a fantastic introduction to managed futures. The research is of the highest quality, the topics are both broad and thoroughly researched, and the writing is clear and interesting. Galen and Brian have produced an indispensable resource for any serious investor." —Rishi K Narang, founding principal, Telesis Capital LLC, and author of Inside the Black Box: The Simple Truth About Quantitative Trading

Galen Burghardt is Director of Research for Newedge USA, LLC, a joint venture between Calyon and Société Générale. He is the lead author of The Treasury Bond Basis and The Eurodollar Futures and Options Handbook, which are standard texts for users of financial futures. He was an adjunct professor offinance in the University of Chicago's Graduate Schoolof Business (now the Booth School). He was the headof financial research for the Chicago Mercantile Exchange, and gained access to the world of futures through his work in the Capital Markets Section of the Federal Reserve Board. His PhD in economics is from the University of Washington in Seattle.

Brian Walls is the Global Head of Research at Newedge Prime Brokerage, the foremost provider of brokerage services to the managed futures industry. ¿He has worked in the financial services industry for thirty years in the various capacities of trading, operations, management, and research. ¿He was a pioneer of capital introduction services and is a sought after and trusted advisor to many Commodity Trading Advisors, global macro managers, fund of funds and institutional investors. He is the chairman of the Newedge Index Committee.


Introduction: Why Invest in CTAs?

What Kind of Hedge Fund is a CTA?

Why Do CTAs Make Money?

How Much Should You Invest?

What About the Risks?

They're a Good Fit for Institutional Investors.

How the Book is Structured.

Part I: A Practical Guide to the Industry.

Chapter 1 Understanding Returns.

Risk and Cash Management.

Trading, Funding, and Notional Levels.

The Stability of Return Volatilities.

Basic Futures Mechanics.

A Typical Futures Portfolio.

Chapter 2 Where Are the Data?

The CTA Universe and Your Range of Choices.

The Fluid Composition of a Database.

How Backfilled Data Can Mislead.

Trading Programs and Lengths of Track Records.

Returns Net of Fees and Share Classes.

Sources of Data for Indexes of CTA Performance.

Chapter 3 Structuring Your Investment: Frequently Asked Questions.

How Many Managers Should You Choose?

What are CTA Funds?

What are Multi-CTA Funds?

What are Managed Accounts?

What are Platforms?

How Do You Compare and Contrast These Offerings?

Who Regulates CTAs?

How are Structured Notes and Total Return Swaps Used by CTA Investors?

What Are the Account Opening Procedures for a Managed Account?

What is the Minimum Investment in a CTA?

What Does It Mean When a Manager is Closed?

What Are the Subscription Procedures for a Fund?


Part II: Building Blocks.

Chapter 4 How Trend Following Works.

The Two Basic Strategies.

Making the Systems Work in Practice.

Transactions Costs.

Other Considerations.

Case Study: Two Models from 1994–2003.

Rates of Return and Leverage.

Commodities and Capacity Constraints.

Market Environment and Give Backs.

Chapter 5 Two Benchmarks for Momentum Trading.

Data and the Trend Following Sub-Index.

Trend Following Models.

Laying the Groundwork for Analyzing Returns to Trend Following.

Constructing a Portfolio.

Simplifying Assumptions.

How Did the Models Do?

The Newedge Trend Indicator.

Next Steps.

Chapter 6 The Value of Daily Return Data.

How Good Are Daily Data?

Estimating Return Volatility.

Distributions of Estimated Volatility.

Beware a False Sense of Confidence.

What if Underlying Returns are Highly Skewed?

Effect on Drawdown Distributions.

Chapter 7 Every Drought Ends in a Rainstorm: Mean Reversion, Momentum, or Serial Independence?

The Costs of Being Wrong about Timing Investments Can Be Substantial.

The Data.

The Test Tally.

Test for Serial Dependence: Autocorrelation.

Test for Serial Dependence: Runs.

Conditional Return Distributions.


Chapter 8 Understanding Drawdowns.

Drawdown Defined.

What Should They Look Like?

What Forces Shape the Distributions?

The Distribution of all Drawdowns.

The Distribution of Maximum Drawdowns.

The Core Drawdown Function.

Empirical Drawdown Distributions.

Reconciling Theoretical and Empirical Distributions.

Putting a Manager’s Experience in Perspective.

What about Future Drawdowns?

Further Questions.

Chapter 9 How Stock Price Volatility Affects Returns.

A Look at Historical Returns.

Stock Price Volatility and Returns on the S&P 500.

S&P 500 Volatility Dominates Market Volatility.

CTA Returns, Correlations, and Volatility.


Chapter 10 The Costs of Active Management.

Forgone Loss Carry Forward.

Liquidation and Reinvestment.

Other Costs.


Chapter 11 Measuring Market Impact and Liquidity.

A Very Fat Data Set.

A Representative Market Maker.

Fitting the Curve to the Data.

Hidden Liquidity.

Estimating the Risk Aversion Parameter.

Volume, Volatility, and Market Impact Profiles.

Where Do We Go from Here?


Part III: Portfolio Construction.

Chapter 12 Superstars versus Teamwork.

The Contribution of Low Correlation to Portfolio Performance.

How Reliable Are Correlation Estimates?

The Contest.

Dropping and Adding Managers.

The Value of Incremental Knowledge about Return Distributions.

The Costs of Dropping and Adding Managers.

Chapter 13 A New Look at Constructing Teamwork Portfolios.

Why Look Back?

A Fresh Look at the Original Research.

Two New Approaches.

Comparing the Four Approaches.

Reviewing the Results.

Chapter 14 Correlations and Holding Periods:  The Research Basis for the Newedge AlternativeEdge® Short-Term Traders Index.

Review of Previous Research.

Index Methodology and Construction

How Low are the Correlations?

Why Are the Correlations Low?

Holding Period and Return Correlation

Why Are There Not More Short-term Traders?

Replicating the Index.

Cautions and Managing the index.



Chapter 15 “There Are Known Unknowns”:  The Drag of Imperfect Estimates.

Improving Risk Adjusted Returns.

Throwing Out the Losers.

Due Diligence and Evaluation.


About the Authors.