Ofi16jun2009

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SECTION NAME ISSUE 10 • June 16, 2009 In This Issue Founding Father Q&A Investor perspective: Ernest Jaffarian of Efficient Capital compares CTAs and hedge funds ....................................................... 2 Mainstreaming “In my 20 years in the business, this is a significant change,” says Ernest Jaffarian, Founding Father of Efficient Capital. “People are finally starting to take notice of futures!” He was speaking mainly of large investors, but there is a related trend best summarized as the mainstreaming of futures and other alternatives. You hear about it from industry people like Gabriel Burstein, who stands at the cross-roads of hedge funds and mutual funds as head of research at Lipper. Managed futures are no longer only for alternatives investors, he says. Advisers to the mass affluent are recommending the strategy. Another part of the story: institutions want regulated and liquid investments. So managers on both sides of the Atlantic are launching mutual funds and exchange-traded funds — see Futures Lab. Insider Talk follows up the subject with a conversation about a global macro mutual fund, in the pipeline from Millennium. Clients asked for UCITS, says manager Arne Hassel. In Practitioner Viewpoint specialists from Kinetic Partners discuss UCITS III, the European mutual fund framework that is a good fit for futures-trading strategies. Top Ten, an amazing list from a long-term allocator, demonstrates why investors big and small should have such strategies in their portfolio. Admittedly, elite managers like Tewksbury do not sound like mainstreaming candidates. But some very successful funds are becoming available in the wider market. We expect to report more on this trend. Meanwhile, have a pleasant summer. I hope you will make time for OFI despite the call of the beach! Our next two issues are scheduled for July 14th and August 11th. In September we go back to our once-every-two-weeks publishing schedule. There is much going on and we will do our best to bring it to you. Chidem Kurdas Editor [email protected] Futures Lab Innovative mainstream products: ETFs and mutual funds may open market to futures ..4 Insider Talk Arne Hassel of Millennium Global says the UCITS mutual fund format fits a macro strategy ................................................... 8 Practitioner Viewpoint Why UCITS III, the European “passport” fund framework, favors managed futures and macro ............................................. 10 Regulators & Courts Contract question, climate futures, fraud .....................................................14 Top Ten An extraordinary lineup put together by a large investor ......................................... 16 Copyright 2009 © Opalesque Ltd. All Rights Reserved. OPALESQUE FUTURES ISSUE 10 • June 16, 2009 FOUNDING FATHER Q&A 2 CTA vs. Hedge Fund Investing Ernest Jaffarian, founder and chief executive of Efficient Capital Management LLC, is a longtime investor who has allocated billions of dollars. He continues to make allocation decisions to commodity trading advisors for a distinguished group of clients. Here he compares managed futures with hedge fund strategies and tells us what investors like and don’t like. He argues that a portfolio of commodity trading advisors is the better way to invest in a turbulent world and explains why he has confidence in futures. Mr. Jaffarian has been in the trading and investment business for well over 20 years. He joined Chicago Research & Trading Inc. as a member of the proprietary trading group on the floor of the Chicago Board Options Exchange in 1986. Later he worked for Hull Trading Company, a leading electronic trading business specialized in derivatives. He was responsible for allocating Hull’s own capital to commodity trading advisors. In a management buy-out, the Hull managed futures unit became Efficient Capital. Subsequently Goldman Sachs acquired Hull Trading. Opalesque Futures Intelligence: How many managers are you currently invested with? Ernest Jaffarian: We have more than 40 managers in the portfolio. Last year alone we visited more than 200 commodity trading advisors. OFI: What’s the advantage of a portfolio of CTAs compared to a diversified fund of hedge funds? EJ: CTAs have an entirely different risk/return profile than hedge funds, as academic research has shown. The crucial difference is rooted in the fact that CTAs do not try to make money by taking credit risk or liquidity risk. And they don’t take volatility risk in the sense of being short volatility. Those are primary sources of income for many hedge fund strategies. OFI: What is the source of profit in managed futures? EJ: The asset class on the whole seeks to make money by pure trader skill while being agnostic about market direction. Because of that, CTAs have no correlation to major asset classes or, even better, are negatively correlated on the downside but positively correlated on the upside to stocks. 2008 presented proof of the concept. Hedge fund strategies heavy on market direction beta or alternative beta – like credit exposure – all got crushed. By contrast, CTAs saw opportunities as result of market dislocation and had one of the best years in their history. OFI: Do you invest in new CTAs? EJ: We do not seed CTAs. How long they need to be around for us to consider investing depends on the trading style and the experience of the manager. Trading experience is one characteristic that’s pretty important in this space. For us, 20 years of trading and two years in the CTA business is a more valuable combination than someone who’s been a CTA for four years and has no other experience. OFI: Besides experience, what do you look for in a CTA? EJ: To begin with, we think the person’s character is extremely important. We want Ernest Jaffarian Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 FOUNDING FATHER Q&A a world class operation in every respect, whether in trade execution or infrastructure, and an ongoing research effort to improve what they do. Also, we seek managers with trading styles that have some unique feature. It does not do us any good if a CTA has a 90% correlation to other CTAs. That adds no value to our portfolio. futures belong in the same asset bucket? EJ: If you line up global macro managers that trade exclusively in futures versus global macro managers that trade other instruments as well, you find that they are not very correlated. Global macro as expressed in the CTA world has significant differences from global macro as expressed in hedge funds. For instance, 3 There are managers who make fabulous returns by taking inappropriate risks. Frankly, that describes a significant part of the hedge fund world. You’ll see hedge funds that make money for 48 months running and then collapse because they took too much credit risk. Our mandate is to avoid those risks and try to generate returns in a different way. OFI: What do investors want now? EJ: Investor interest in CTAs waxed and waned in the past. I think 2009 will bring a paradigm change, for two reasons. One, the diversification benefit of CTAs, a point made repeatedly in academic studies, showed up in full force last year and is now being accepted by people who used to resist the idea. Two, people are starting to distinguish CTAs from hedge funds and allocate separately. CTAs have always been lumped together with hedge funds. Investors are now starting to say they want so much exposure to the hedge fund space and so much exposure to the CTA space. In my 20 years in the business, this is a significant change. People are finally starting to take notice of futures! OFI: What keeps you up at night? EJ: I sleep pretty soundly these days. In 2008 the volatility of our composite portfolio was the lowest in our history. Frankly, I’m more concerned about events in places like Pakistan or North Korea than I am about our portfolio. Can you imagine the impact of a nuclear explosion in Saudi Arabia? There are any number of possible events that would rock markets, including futures markets. Even with those geopolitical risks, I would much rather have a broadly diversified futures portfolio than own stocks and bonds or be locked into one currency. Futures markets as a system are more stable than stock markets, as we saw on Black Monday 1987 and in the recent crisis. Now the US government is trying to move more instruments to futures exchanges. I have confidence in the integrity of the futures market. “People are starting to distinguish CTAs from hedge funds and allocate separately. CTAs have always been lumped together with hedge funds.” OFI: That must be difficult with trend followers. Don’t they mostly follow the same trends? EJ: We do not rely on trend followers alone. We include as much diversity as we can find. There is a lot of diversity among CTAs. Some traders hold positions for no more than a few minutes, others hold for weeks. You have traders that focus on a single market, you have those that trade every market around the world. There are traders that rely on patterns in the markets and traders that rely on mathematical analysis of economic turning points. OFI: How come all these different approaches are practiced in futures markets? EJ: Futures markets are the canvas upon which the traders apply their skills. They use futures because these have desirable characteristics. Futures markets are nondirectional, extremely efficient and very liquid. If you have a sense of how to pull return out of markets, you will gravitate to futures because the instruments allows you to express that skill. OFI: Do global macro and managed in the hedge fund version people usually pick two to four macro themes that they put into play using an array of instruments and hold for a long time. By contrast, CTAs with a global macro style tend to have a larger range of themes and hold positions with a much looser hand—they run very dynamic trade books compared to macro hedge funds. OFI: Is asset growth the enemy of return? EJ: It is not necessarily the case that smaller funds do better. It depends on the trading style. Yes, someone who trades in a very short time frame can’t manage as much as someone with a longer time frame. That said, two of the largest futures managers, Transtrend and Winton, continue to perform well. It has more to do with the style and infrastructure of the manager than the assets under management. We have no hard rules about the size of the assets a CTA manages. OFI: What do you try to avoid? EJ: We don’t want managers that take a lot of risk relative to their return, take volatility risk or don’t show discipline. Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 FUTURES LAB 4 Global Mainstreaming of Liquid Alternatives A new market may be opening for the services of commodity trading advisors, global macro managers and quantitative traders. This year a number of alternative investment products have been launched in mass markets worldwide. More are in the pipeline. Many of these use, at least in part, futures-and-options trading strategies. This development is potentially so important that we decided to devote Futures Lab to it. Below you will find descriptions of intriguing new products and commentaries from industry watchers as to what’s happening. Both the European and US public markets have attracted novel products, although in different formats reflecting regulatory variations. The investment programs are shaped not only by managers’ strategies and market demand but by the regulatory framework, in particular the UCITS system in Europe and mutual fund requirements in the United States. Here we review both markets. For more on UCITS, see Insider Talk and Practitioner Viewpoint. Investors emphatically do not want to repeat the experience they had in the 2008-2009 crisis. This is the case for both large and small investors, both institutions and individuals. Those who had hedge fund investments and suffered from the liquidity squeeze want more stringent rules about redemption. People who were surprised about losses want to have more information about the funds. At the same time, retail investors whose conventional stock and bond portfolios went down steeply in the crisis now seek new options. Alternative investment products introduced under US mutual fund or European UCITS regulations meet these various demands from different parts of the market. Investors want liquidity and transparency, says Maarten Nederlof, founder of Safari Advisors LLC and former co-head of Deutsche Bank’s hedge fund capital group. After the redemption freezes many hedge funds instituted in the crisis, being able to redeem has become a priority for alternatives investors. Exchange-traded funds, US mutual funds and UCITS vehicles meet investors’ desire for greater liquidity. But not all strategies are suitable for these formats. Managed accounts and managed futures are very liquid, while hedge funds are not, Mr. Nederlof said, speaking at a press briefing. “Expect a surge of interest in exchange-traded funds and managed accounts.” He expects a regime Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 FUTURES LAB change in investment management that will favor liquid strategies and greater oversight and risk management. The packaging or format of an investment program – such as private limited partnership versus regulated public fund – is becoming more important. “There are strategies that can be packaged in a 1940 Act structure,” Mr. Nederlof said, referring to the US law governing mutual funds. Managed futures is prominent among those strategies. It is notable that the new products do not necessarily or primarily target retail investors. Institutions are often a big part of the market. For that reason, we prefer to use the term mainstream alternatives rather than retail products. For instance, one offering – an exchange-traded hedge fund index from Deutsche Bank – explicitly warns that it is not for everybody but only for sophisticated investors. Still, these products are available in the mass market, whether in the form of an open-ended US mutual fund, an exchange-traded fund or a UCITS III vehicle, and are open to a much broader customer base than has been the norm for alternative investments. 5 questions about asset allocation, how products like alternatives fit into their business,” Mr. Goldman said. Rydex/SGI executives have been crisscrossing the United States talking with financial advisers. Sanjay Yodh of SGI says family offices and high-net-worth investors are now moving to mutual funds for added transparency and liquidity. Daily liquidity, required for open-end US mutual funds, does come at a cost—the returns will likely be lower than can be achieved in a limited partnership hedge fund with the same strategy. Nevertheless, many institutions do not want to be trapped in illiquid investments. Mr. Yodh and others see a convergence between the retail and institutional realms. Rydex/SGI is planning new products for the convergent market. TABLE 1 Standard & Poor’s Diversified Trends Indicator Returns, Best Five Months Month Oct 2008 Sep. 1990 Sep. 2004 Feb. 2008 Aug. 1990 DTI 10.4% 8% 5.6% 5.3% 5.2% S&P 500 -16.8% - 4.9% 1.1% -3.2% -9% Institutional/Retail Convergence While some products invest in outside hedge funds and commodity trading advisors, others use models to replicate the returns of hedge fund or CTA indices. One pioneering product, the Rydex/SGI Managed Futures Strategy Fund launched in March 2007, uses a quantitative methodology to track Standard & Poor’s Diversified Trends Indicator. Richard Goldman, chief executive of Security Global Investors (SGI), says there is tremendous demand today for alternatives as investors seek to diversify their portfolios after traditional stock and bond portfolios performed spectacularly badly. “We believe investors are looking for new solutions, new products,” he said, at a press briefing. The Rydex/SGI alternative funds – which cover other strategies in addition to managed futures – are distributed through financial advisers. Preliminary results from a survey of financial advisers in the US shows that close to onethird want to increase their clients’ allocation to alternatives. “Intermediaries have lots of Rydex/SGI Managed Futures Strategy Fund offers investors a feature that proved to be very elusive in the crisis—real diversity. This shows clearly when you look at the best months of the DTI index the fund replicates (table1). DTI had its top performance mostly during months when the S&P500 had a steep decline, like October 2008. This pattern has generated interest among registered investment advisers who are the gatekeepers of the mass affluent market. The fund had close to $1.7 billion in assets as of April. Across all strategies Rydex manages about $20 billion; separately SGI has $17 billion. Manages futures and global macro strategies have an inherent advantage in extremely turbulent markets, points out Dr. Gabriel Burstein, global Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 FUTURES LAB head of mutual and hedge fund research at Lipper and an ex-global macro trading and investment strategist at Goldman Sachs and HSBC. “In periods of market turmoil and difficult markets in general, bottom company fundamentals become invisible, unpredictable and unreliable,” he says. “The only visible predictable elements are at the top: the macro view. When fundamentals disappear, technical patterns dominate and systematic investment averages through the excessive noise.” Macro and managed futures out-performed other strategies in 1994, 1998, 2001 and 2008 by exploiting technical patterns, according to Dr. Burstein. Managed futures are not only for alternatives investors any more, he says, pointing out that UCITS mutual funds in Europe and Asia have started to offer these strategies. TABLE 2 6 Constituents of dbX Systematic Macro Index Systematic macro is part of Deutsche Bank’s Hedge Fund Index, the basis of an exchangetraded fund launched this year. Commodity Fund: Millburn Commodity CTA: Aspect Diversified CTA: BlueTrend CTA: IKOS Financial CTA: Millburn Multi-Markets CTA: NuWave CTA: Winton Currency Fund: FX Concepts GCP Global Macro Fund: Polar sophisticated investors who understand its strategy, characteristics and risks.” In the US, this month WisdomTree Investments filed with the Securities and Exchange Commission for three ETFs with alternative strategies—one is managed futures. WisdomTree is an index and ETF specialist. The to-be-launched managed futures ETF will use a quantitative, rules-based model to trade futures and other instruments with the goal of achieving positive returns in both rising and falling markets. Again this month, Index IQ announced the launch of an ETF designed to replicate the risk/return characteristics of global macro and emerging markets hedge funds. The IQ Hedge Macro Tracker ETF trades on New York Stock Exchange Arca. Index IQ previously sponsored two other hedgefund replicating mass market vehicles, one an ETF and the other a mutual fund. The firm says the products “bring hedge fund style investing to a broad range of investors, from sophisticated family offices to retail investors.” The ETF Option This March Deutsche Bank launched an exchange traded fund that invests in hedge funds and CTAs. Part of the db x-trackers platform, the db Hedge Fund ETF is linked to a Deutsche Bank index of systematic macro, equity hedge, market neutral, credit and convertible and event-driven strategies. Well-established managers of large funds are among the constituents of the index. Table 2 shows the constituents of the systematic macro portion. The ETF is listed on Frankfurt Stock Exchange. Pending approval, Deutsche Bank expects to list on the London Stock Exchange, Euronext Paris, Borsa Italiana and SIX Swiss Exchange. Since it is exchange traded, the fund has intra-day liquidity. Deutsche Bank is the market maker and offers twoway prices on and off the stock exchange. The ETF’s underlying funds are Jersey unit trusts listed on the Irish Stock Exchange and managed by Deutsche Bank affiliates. Outside managers are sub-contracted as trading advisors to manage the portfolios. Deutsche Bank has sole control of the assets. The Deutsche Bank hedge fund ETF is compliant with UCITS III regulation for European mutual funds. However, it does not target the retail market. The prospectus states that “the db x-trackers db Hedge Fund Index ETF is intended for non-retail investors and, therefore, is appropriate only for Manager Interest Managers worldwide appear to be very interested in going the regulated mutual fund route. Every European hedge fund that can do its business without leverage is interested in launching a UCITS III vehicle, says a manager. Because of regulatory Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 FUTURES LAB rules, that mostly means those trading futures or forwards and other derivatives—CTAs and global macro managers in particular. Notable recent offerings include BlueTrend, a UCITS fund with a systematic, diversified trendfollowing strategy that targets 15% to 20% returns annually. It was launched in December 2008 and is sponsored by Merrill Lynch International and managed by BlueCrest Capital. This is the first CTA on the Merrill Lynch UCITS platform. BlueCrest manages $7 billion in the same strategy. Interestingly, BlueTrend and several funds in the DB index (Aspect Diversified, Winton) are among the best funds in terms of long-term performance according to a large allocator—see our Top Ten for this issue. Early in 2009, Hamburg-based Aquila Capital started offering a CTA fund in UCITS III format. AC Pharos Evolution has daily liquidity and a strategy focused on short-term, systematic trading. Like the other offerings, the Aquila fund is for larger investors as well as the mass market. The firm says it received attention from pensions, insurance companies and funds of funds. The same strategy has been available in the hedge fund format. Some of the hedge fund clients reportedly switched to the UCITS version. TABLE 3 7 The trend toward mainstreaming alternative investments is not new, but has become stronger and more widespread. There’s been a dramatic shift, says Mr. Goldman of SGI; hedge funds that used to offer only private partnerships are now interested in working within the 1940 Act. An example of the hedge fund-mutual fund convergence is US-based AQR Capital, started some 10 years ago by a group of managers from Goldman Sachs led by Cliff Asness. The firm is known for quantitative high-frequency trading hedge funds. Mr. Asness was director of quantitative research at Goldman Sachs Asset Management. This year AQR started to launch a series of mutual funds. JP Morgan Highbridge Statistical Market Neutral Fund is an early instance of the convergence. The long/short equity strategy is managed by Highbridge Capital, a hedge fund business that is part of JP Morgan Chase. The fund has been in operation since 2005 and has $3.14 billion in assets under management. That AUM could be seen as an indicator of the growth potential of mainstream alternative products, but JP Morgan’s distribution network doubtless gave this fund a big advantage. The real potential of mainstream alternatives is yet to be seen. The funds mentioned in this article (table3) are likely only a beginning. Funds Mentioned in This Article Name Rydex/SGI Managed Futures Strategy Fund Deutsche Bank Hedge Fund WisdomTree Managed Futures IQ Hedge Macro Tracker BlueTrend Fund AC Pharos Evolution AQR Funds JP Morgan Highbridge Statistical Market Neutral Format US mutual fund ETF, UCITS US ETF US ETF UCITS UCITS US mutual fund US mutual fund Strategy Replicates an index Multi-strategy, including macro Quantitative Combines global macro and emerging markets Trend-following Aquila Capital’s CTA program Various quantitative trading strategies Long/short equity Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 INSIDER TALK 8 EU Passport for Global Macro Millennium Global, an alternative investment manager with around $12 billion under management, is working with a bank to launch a UCITS III-compliant version of the Millennium Global Quantitative Fund. Arne Hassel, head of Millennium’s Global Tactical Asset Allocation program, discuses this major new development. Mr. Hassel founded and was chief investment officer of Corylus Capital, a systematic global macro hedge fund, before joining Millennium. Earlier in his career he worked for seven years at Goldman Sachs Asset Management, where he was a managing director and led global currency management before becoming head of the hedge fund strategies group in London. He was also a member of the GSAM international asset allocation committee. Arne Hassel UCITS III, or “Undertaking for Collective Investment in Transferable Securities III”, is a European regulatory framework that aims to set protective standards for the retail fund industry. This framework is now established as a “Good Housekeeping” seal of approval not only for retail investors but just as importantly for institutions. Currently around €4.6 trillion of assets are managed in UCITS III funds, which account for some 75% of the European fund industry. Opalesque Futures Intelligence: What does Millennium do? Arne Hassel: Millennium was founded in 1994 and started with currency management, which is still the main part of the business. Since 2000 the firm has developed into an alternative investment manager with a suite of products, including global quantitative macro. Our client base has so far been mainly institutional, but Millennium is looking to increase its presence in the retail market by moving into UCITS III for macro and currency strategies. OFI: Do other European hedge fund managers want to develop this type of fund? AH: There is interest in offering diversified alternative products in the retail market. We’ll probably be one of the early participants. We plan to launch our quantitative global macro program in UCITS III format this summer. OFI: Why did you pick global macro? AH: After the events of last autumn, the focus has been on investments that held up well during the crisis and that are liquid and properly regulated. I think that is why we have had requests to launch UCITS III funds of our macro and currency programs. OFI: What is the impact of UCITS III? AH: The broadening of the investment opportunities within European fund regulation makes sense. Regulation has to protect investors, but without preventing diversification and flexible risk management. Skill and opportunities are key to performance. The more flexibility you have, the more efficiently you can manage the investments. And this allows you to reach the return target with less risk. At the same time, investments have to be monitored and investors have to know what they are buying. UCITS III is a step in the right direction and will make it easier to strike this balance. OFI: How will this affect the fund market? AH: We now have a chance to offer diversified investments – with low correlation to major asset classes – to a wider spectrum of investors. Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 INSIDER TALK This both improves the range of available investments for mutual fund investors and takes away some of the risks with hedge fund investments. OFI: What are the safety measures for investors? AH: The UCITS III framework provides several advantages to investors. The first major benefit is increased transparency, with regulators raising the bar and demanding detailed reporting, including semi-annual and annual audited reports. This makes it easier for an investor to evaluate the fund. The second advantage is liquidity. Bi-weekly liquidity is a minimum requirement and some funds are now offering daily liquidity. UCITS funds are prohibited from using “gates” or any other restrictions on redemptions. The third plus is risk management, with clear diversification requirements and limits for market and counterparty risk. For example, a fund is not allowed to have more than 10% exposure to any one credit provider. OFI: What happens when there are problems? AH: You have to submit reports outlining any problems such as delays in valuation or settlement. This provides incentives to avoid problem areas, increasing investor protection. OFI: How did you decide to launch a mass market fund, given that the firm has an institutional focus? AH: We are very client-driven when it comes to new products. When several clients asked us about UCITS III, we had a close look at it. We fit within the regulated framework because we provide highly diversified investments in the most liquid futures and currency markets. This means that we can offer daily liquidity and actively manage our risk. OFI: What does a manager get in return for the work necessary to comply with the regulations? AH: The framework offers advantages to fund managers as well as investors. Previous regulations were well meant but did not allow for the kind of diversification that we provide. The UCITS III directive allows funds to invest in a wider range of financial instruments, including derivatives such as futures and currency forwards. This is the key reason quantitative global macro funds – such as ours – can be launched within the format. By meeting the regulatory standards, the funds get an “EU passport” for retail distribution. This stamp of approval is increasingly recognized by investors globally. 9 “By meeting the regulatory standards, the funds get an “EU passport” for retail distribution. This stamp of approval is increasingly recognized by investors globally.” OFI: What’s the interest of the bank involved in this launch? AH: Many banks are now looking for diversified UCITS III products on their platforms. Our macro program seems to fit the bill. OFI: Would you describe the program? AH: Millennium Global has been active in discretionary macro investing for several years. In 2007 we started a quantitative program and in 2008 the system was expanded to a fully diversified global quantitative macro program. The system invests in close to 45 markets worldwide, using over 60 models organized in eight different strategies—a relative value market-neutral strategy and a short-term directional strategy for each of the four major asset classes. So there is plenty of diversification. The program has performed well. Last year we were up around 7% with a low risk target and we are positive this year as well. Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 PRACTITIONER VIEWPOINT 10 UCITS for Alternative Investments European UCITS (Undertakings for Collective Investment in Transferable Securities), a framework created in the 1980s towards establishing a unified financial market, has been evolving. The system was extended with UCITS III, which gives funds a European “passport” so that they can be sold anywhere in the EU without further regulatory approval. UCITS III has sophisticated vs. non-sophisticated versions. The sophisticated version accommodates alternative strategies utilizing leverage and short exposure. Managers can use futures and options, hedge fund and financial indices, repurchase agreements and other derivatives. Funds under this umbrella meet investors’ demand for liquidity, transparency and regulatory oversight while allowing some flexibility in the investment strategy. UCITS products are widely recognized and distributed in over 140 countries (table1). To get a better understanding of this type of fund, we turned to Kinetic Partners, Dublin-headquartered providers of services to asset managers. Strategies that use futures and options fit the framework, while certain hedge fund strategies do not. “A key feature of UCITS alternatives is that no physical shorting is permitted; instead, shorting must be through a synthetic means such as use of derivatives,” writes John Hamrock of Kinetic Partners, who advises asset managers on compliance and cross-border fund distribution. Further regulatory changes are coming with UCITS IV (table2). In the meantime, different types of alternative investment products have been introduced, including a number of “130/30” or “short extension” funds, according to Mr. Hamrock. New products are in the making. The discussion below is by Killian Buckley, who heads Kinetic Partners’ Dublin office and manages the Irish Stock Exchange Listing service. Many UCITS funds are listed on this exchange. Mr. Buckley’s article was originally published in Kinetic Partners’ newsletter. Killian Buckley Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 PRACTITIONER VIEWPOINT Hedge fund managers are turning their eyes to UCITS III as the elixir the industry needs to bring back spooked investors, tap into wider asset gathering networks and diversify their businesses in such demanding times. Many in the industry of course think of UCITS as a retail distribution vehicle, but the beauty of it is actually the possibility to create a transparent institutional riskcontrolled regulated structure, whilst gaining access to the profile and global brand of a UCITS, with the attendant robust and powerful distribution network that an EU passport brings and the strong UCITS links with Asia, Africa and South America. TABLE 1 Hedge fund managers are noticing this and are further impressed with the range of strategies that are now possible within UCITS III structures. These funds can now invest in money market instruments, derivatives, fund of funds, bank deposits and index tracker funds, to name but a few. This has been achieved with continued guidance from the Committee of European Securities Regulators on the definition of certain “eligible assets” to ensure a consistent interpretation across Europe. UCITS III permits the use of synthetic shorting through derivatives. These rules also effectively allow funds to be leveraged up to 100% and permit funds to enter into 11 UCITS are distributed in over 140 countries. Sample countries: Australia Bahrain Canada Chile Cyprus Finland Gibraltar Hong Kong Indonesia Italy Luxembourg Mauritius New Zealand Panama Qatar Singapore South Africa Switzerland United Arab Emirates Austria Belgium Cayman Islands China Czech Republic France Greece Hungary Isle of Man Japan Macau Monaco Norway Peru San Marino Slovakia Spain Taiwan Bahamas Bermuda Channel Isles Columbia Denmark Germany Guernsey Iceland Israel Jersey Malta Netherlands Source: Irish Funds Industry Association opalesque.com Oman Portugal Saudi Arabia Slovenia Sweden Thailand United Kingdom Copyright 2009 © Opalesque Ltd. All Rights Reserved. OPALESQUE FUTURES ISSUE 10 • June 16, 2009 PRACTITIONER VIEWPOINT credit derivatives such as credit default swaps as a means of increasing revenues. This synthetic shorting possibility has also allowed long/short exposures. A UCITS is free to structure such strategies subject to certain counterparty exposure limits, not exceeding an overall global exposure through the use of derivatives of 100% of Net Asset Value. UCITS III also allows the creation of structured financial instruments through the use of Over-The-Counter derivatives, for example total return swaps, linked to underlying assets such as bonds, currencies or indices, including broadly diversified hedge fund indices. Effectively then, subject to certain diversification and counterparty limits, OTC instruments can be purchased by a UCITS fund. Hedge fund managers, well versed in the art of shorting and derivative based strategies, are now increasingly looking to UCITS III. In a deleveraged world, a framework which provides the possibility of alpha type-returns combined with greater transparency and liquidity, and sound risk controls subject to independent oversight, has a lot of appeal. UCITS as a structural concept is also evolving with guidance coming from various regulators as to the interpretation of certain parts of the Directive; indeed the Irish regulator has recently issued guidance clarifying the absolute Value-at-Risk limit. VaR is now explicitly referenced as 20% of a fund’s NAV specifically for a 20 day holding period, with the additional flexibility to appropriately scale this VaR limit for different holding periods and confidence levels, for example the previous 5% limit for a one day holding period is still maintained. At an EU level there are various discussions continuing to make UCITS more relevant to the industry and to keep pace with the many changes occurring in the industry. For example, consideration is being taken now of such issues as master-feeder structures on a crossjurisdictional basis. As a living, breathing brand, UCITS continues to evolve and become more popular. Here at Kinetic Partners, many of our hedge fund clients are attracted to the breadth of product possibilities combined with the regulated hat. We are confident we will see an increase in these types of fund launches. TABLE 2 12 UCITS IV Target implementation date: July 1st 2011 Status: Jan. 13th 2009 - informal acceptance by the European Parliament. Final ratification required by the European Council of Ministers. What to expect: • Centralized delivery of fund products (versus separate regulated entities in each local jurisdiction) • Streamlined administration of cross border distribution • International fund mergers, facilitating cost efficiencies • Master feeder structures, leading to greater pools of assets (economies of scale) • • Key investor information document Enhanced cooperation mechanisms between national regulators Source: Irish Funds Industry Association Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com We don’t believe in one-size-fits-all. Dedicated services for hedge funds and CTAs. Multi-asset prime brokerage, cross margining tools, cutting-edge risk calculation, start-up services and in-depth market intelligence. We work with you to develop customized solutions that match your needs. To help power your performance worldwide. EXECUTION CLEARING PRIME BROKERAGE “Newedge” refers to Newedge Group and all of its worldwide branches and subsidiaries. Only Newedge USA, LLC is a member of FINRA and SIPC (SIPC only pertains to securities-related transactions and positions). Not all products or services are available from all Newedge organizations or personnel and restrictions may apply. Consult your local office for further details. OPALESQUE FUTURES ISSUE 10 • June 16, 2009 REGULATORS & COURTS 14 CFTC Seeks Comments on Contract The Commodity Futures Trading Commission wants to determine whether the Henry Financial LD1 Fixed Price contract traded on the Intercontinental Exchange performs a significant price discovery function. Using a new power provided by the US Congress last year, the CFTC intends to subject previously exempt contracts to certain rules such as position limits, emergency authority and large trader reporting requirements, if they perform a significant price discovery role. A notice about the Commission’s intent is to be published in the Federal Register. After that there will be a 30-day comment period. trading day in history. If we take a quick trip in the Wayback Machine to the origins of these markets in the 1990s, it is obvious that the global market for carbon emissions has grown tremendously. In 2002, the World Bank estimated the volume of carbon emissions traded globally at 32 million metric tons with a value of approximately $100 million. For 2008, these values were 4.8 billion metric tons, and a total dollar value of $126 billion. What does all that mean? It means that the market value of global carbon trades has experienced an average annual growth rate of about 329 percent since 2002! Taking this a step further, we observe generally that in developed markets, futures trading is conservatively 10 times the size of the cash market for many commodities and can even be as great as 30 times that of the cash market for certain financial products. Even with the conservative assumption of 10 times the cash market, this would imply we are looking forward to a $2 trillion dollar futures market! In terms of volume, a $2 trillion market would be the equivalent of anywhere from 60 to 180 million contracts. To give you an idea of the magnitude of this, in 2008, Light Sweet Crude Oil traded on NYMEX saw a volume of about 135 million contracts. Natural Gas experienced an annual volume of almost 39 million contracts, and all metals combined on NYMEX, about 53 million. So, we are talking about a really incredible potential for emission markets. Make no mistake, these carbon markets can be the world’s largest commodity markets in a few short years. Some think these Green CAT markets will be fraught will fraud, abuse or manipulation and we should simply put a tax on carbon emissions. By the way, that is one reason why the CFTC recently expanded an advisory committee, which I’m pleased to chair. The Energy and Environmental Markets Advisory Committee, or EEMAC, is seeking to do something all-too-often not Carbon Can be Largest Commodity Market CFTC Commissioner Bart Chilton told the annual meeting of the Chicago Climate Exchange and Climate Futures Exchange that “Green CAT” markets—emissions cap-and-trade markets—are going to be good markets and good investments. Selected quotes from the June 11th talk: A testament to that goodness is the diversity of membership here today—the diversity in this room. Folks representing entities from aerospace, agriculture and automotive; chemicals, and commercial interiors; electric and ethanol interests; financial, food and forest firms; manufacturing, mining, municipalities and other state and local governments; technology and transportation interests, and even healthcare and academia. Also critical to making this market concept work are the offset providers and aggregators, liquidity providers, and market makers, who help make these markets function while also contributing to the goal of greenhouse gas reduction. Just last Friday, CCFE established a new record for daily volume. Total open interest on the CCFE is up 143 percent in 2009. CCX also recently had its largest Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 REGULATORS & COURTS 15 done in government. We are trying to get ahead of the curve to ensure that we are ready for these new mandatory markets. We read about regulatory reform in the newspapers. What I want to make clear is that we need it and need it now—especially as we look to Green CAT markets. As part of the Waxman-Markey legislation, there are important regulatory reforms that would be put in place at the CFTC—amendments to the Commodity Exchange Act to provide greater transparency of dark markets, that is regulation of certain over-the-counter trading that could have an impact on price discovery. The CFTC would place position limits to avoid undue speculation that could result in manipulation. We all saw what happened last year with crude oil and gasoline prices. They went through the roof. Long passive investors flooded to these markets. I think they had an impact on raising the prices to $147 a barrel for crude oil. Unfortunately, we don’t have all the rules and regulations that we need in place to ensure that there is no excessive speculation in these markets. Don’t get me wrong, we need speculators. Speculation shouldn’t be a four letter word. I understand that. I’m also not suggesting that speculators were the single cause of the large run-up. Certain fundamentals also played a role. But when consumers pay more for any commodity than they should, it is my job as a regulator to try and stop it. While some solid efforts have been made, nothing has been approved to give us new tools since last year. All of this as we are once again seeing oil and gas prices moving up fast. Energy Investigator Becomes Top Regulatory Lawyer CFTC Chairman Gary Gensler appointed Dan Berkovitz as general counsel. Mr. Berkovitz previously worked for the US Senate, where he led several investigations into energy markets, including the role of speculation in the trading of natural gas and crude oil contracts. He was counsel to the Senate Permanent Subcommittee on Investigations chaired by Senator Carl Levin. In 2008 he played a role in the passage of legislation to regulate electronic trading facilities for energy commodities. Forex Ponzi Scheme Targeted Asians SNC Asset Management and SNC Investments chief executive Peter Son and chief financial officer Jin K. Chung were charged with operating an $85 million foreign currency scam involving about 500 investors in the US, South Korea and Taiwan. Korean-Americans in particular were solicited with the promise of 2% to 3% guaranteed monthly returns. SNC claimed to have a track record of 50% annual returns. “This is yet another example of the insidious nature of fraudulent investment schemes that target affinity groups,” according to Stephen Obie, CFTC acting director of enforcement. “Based on personal relationships, people were lured into parting with their hard-earned money, only to learn, too late, that they were the victims of a massive forex fraud.” The money raised was used to pay certain investors and for personal expenses that included paying the mortgage on a multi-million dollar house. Mr. Son faced criminal charges in federal court in Oakland, Calif., and both he and Mr. Chung face civil charges. Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com OPALESQUE FUTURES ISSUE 10 • June 16, 2009 TOP TEN We feature top managers from a different database every issue. 16 Truth to tell, this list is not from a commercial database. These managers do not necessarily report to any databases. Some have been operating for decades and manage many billions of dollars in assets. The list comes from a long-time large allocator to managed futures. We thought it might be of interest to our readers as a measure of what CTA programs can achieve. Several of these managers are involved in the mainstream products discussed in Futures Lab. It should be noted that the funds have different volatility and risk profiles. And returns can vary with share and currency class. The year-to-date numbers are as of May. The managers have other funds, with different inception dates and of course different returns. Top Funds in a Large Investor’s CTA Portfolio CTA program Annual Return Since Inception 40% 25.8% 21.7% 18.8% 18% 15.1% 14.8% 14.6% 14.6% 11.3% Inception Date Year-to-Date Return The Clive Fund Tulip Trend Fund Blenheim Markets LP BlueTrend Diversified Winton Futures Fund Graham Global Inv. Tewsksbury Inv. Fund Tudor Tensor Fund Crabel Fund Ltd. Aspect Diversified Nov. 2007 Mar. 2003 Dec. 1986 Mar. 2004 Sep. 1997 Dec. 1998 Dec. 1990 Aug. 2005 Feb. 1998 Dec 1998 10.3% -3.55% 10.4% -4.22% -5.8% -3.08% 7.5% 0.95% 6% -8% Copyright 2009 © Opalesque Ltd. All Rights Reserved. opalesque.com accurate professional reporting service No wonder that each week, Opalesque publications are read by more than 600,000 industry professionals in over 160 countries. Opalesque is the only daily hedge fund publisher which is actually read by the elite managers themselves 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. www.opalesque.com PUBLISHER Matthias Knab - [email protected] EDITOR Chidem Kurdas - [email protected] ADVERTISING DIRECTOR Denice Galicia - [email protected] EDITORIAL ADVISOR Tim Merryman - [email protected] CONTRIBUTORS Bucky Isaacson, Frank Pusateri, Pavel Topol, Ty Andros, Walt Gallwas. FOR REPRINTS OF ARTICLES, PLEASE CONTACT: Denice Galicia [email protected] www.opalesque.com Copyright 2009 © Opalesque Ltd. All Rights Reserved.