>Five Minutes with Carlton Chin of Adamah Capital

Carlton Chin is chief investment officer and head of research at CARAT/Adamah Capital LLC, a fund manager and CTA focused on systematic managed futures strategies. An investment professional since 1990, he spoke with Managed Futures Newsletter editor Jim Kharouf about his start in the business, whether markets change and how he looks at volatility.

Q: How did you got into the managed futures space?

I’ve been in managed futures since 1993. My first job was as an actuary, a pension consultant actuary where we’d put a price tag on a pension. I always had an interest in finance, so when the company started up the investment finance practice, I jumped at the chance. We did asset allocation, due diligence on money managers, performance attribution in the early ‘90s. Then we started hearing about hedge funds and alternative investments and that’s when I met the folks over at Mount Lucas Management, whose numbers I began to run through the portfolio optimizer. Long story short, I truly believe that the best way to enhance diversification is through managed futures. A lot of hedge funds will use the same basic building blocks – using stocks and bonds – while managed futures uses everything from currencies to commodities. That really adds diversity to a portfolio. I ended up working at Mount Lucas for almost three years.

Q: You’ve been focused on quantitative research and strategies. What has been your approach to new strategies and how has that changed or evolved over the years?

A: Numbers, probability and numerical simulation have been part of me, something I’ve loved since a young age. Numerical simulation was my thesis in college and that kind of quantitative and systematic approach is something I believe in. And in the managed futures industry, it’s a really good way of earning excess returns from the markets. I still focus mainly on systematic approaches. Over the years, I think I’ve made good progress on intermediate to long-term trend-following approaches. I’m starting to do a little more research on fundamental types of term structures of the futures markets. But my core is quantitative and systematic approaches.

Q: I’d like to touch on the old question about the markets “Do they change?” We all know information comes faster through the system. But the structure of the markets have changed – with electronic trading, which has brought in more institutional players into commodities markets. There seems to be more to it than, things are just faster.

A: I agree. When I first started out, Grant Schaumburg and Frank Vannerson of Commodities Corporation were some of the originators in managed futures. Some of them originally looked at the fundamentals but then said we need help with technical trend following. He was one of the first who wanted to use long-term systems. Back in the 60s and 70s, you could hop on some long-term trends and generate some profits. But information flow changes things and what you said is even more astute. The whole market structure has changed. That’s why I’ve done some research on the machine learning approach that helps adapt to how things evolve over time.

I think you have to be careful because you can run into problems of curve-fitting if you aren’t careful. But you can’t sit there with the same static strategies either.

Q: So I get the idea that you don’t think things change too much over time. Why?

A: They do change some, just not a significant jump. I do think when the structure changes, that can be a step function of a change. But I think human nature really helps dictate if person A goes long gold. Those kinds of psychological feelings, even with faster information, are not going to change.

Q: Managed futures and hedge funds are often thought of by investors and outsiders as black boxes. How do you explain what Adamah Capital does in straight forward terms?

A: Some people will look at me as a kind of rocket scientist. But people in the industry know me as sort of well grounded. I think my research and approach is well grounded also, with either an academic or scientific kind of approach. So my core remains in the long and intermediate trend following.

I’ve also looked at shorter-term time frames, some pattern recognition and machine learning components. The great thing about those is that they add a little bit of diversification, or some would call it a bit of mean reversion. And that helps differentiate ourselves. I still think that is the best way to achieve profits, by intermediate to long-term trend following. I try not to say any hocus-pocus. I’ve always loved Mount Lucas’ approach which is based on core reasons why we can earn returns from the managed futures industry.

Q: Managed futures had a great 2008 as an industry. The managed futures industry continues to grow. BarclayHedge says the CTA space managed $320.3 billion in Q3 2011, up from 299.2 billion in Q2 and $291.4 billion in Q1. What’s driving that investment trend?

A: More and more people are seeing the diversification benefits. Some of that trend is driven by the endowments. Years ago, some of the large institutional investors, endowments and pension funds, were mostly stocks and bonds. Eventually they started doing the commodities indexes, such as the Rogers Raw Materials Index and Goldman Sachs Indices. Those helped get their feet wet in commodities and futures a little. Now people see that buy and hold strategies may not be as good as active strategies. 2008 was great because managed futures had positive returns during a crazy time for the stock market. 2010 and 2011 haven’t been the greatest for the industry, but the benefits of diversification are still showing through.

Q: BarclayHedge’s CTA Index also showed a 3.05% drop in 2011 but was up 6.26% in 2010. What’s been the difference in your opinion?

A: It’s not an easy thing. If it were, everyone would be doing it. People love to say, I’m going to buy low and sell high. But futures traders are wanting to buy high and sell higher. That’s a trend following type of motto. Because of that, we need some large sustained trends in the market. One way to describe it is that the managed futures industry captures the Black Swans out there. And 2008 was of course a Black Swan. The end of 2010 we had some big moves that the managed futures industry captured. Sometimes there are going to be periods of consolidation in the market, especially the key major markets in currencies, energy, gold. Those markets are in a consolidation phase after 2008 and 2010. It’s frustrating for the industry but I think it has shown that we will earn the excess returns in the long run.

Q: Volatility is always a part of the markets of course. How do you look at volatility in the market and what have you seen in your research?

A: We’ll look at volatility in just about any way that we can. I love to look, especially for hedge funds and managed futures, at downside volatility. We can look at the standard deviation of the S&P 500, which over the past 30-plus years is 15.6 percent. Interestingly, if you look at the downside volatility, that is 11.7 percent. So the scary, or downside volatility, represents 75 percent of the overall volatility. This is one place where managed futures shines because based on a series of returns, mostly the BarclayHedge CTA Index but also my performance, the volatility has been 17 percent in total. The standard deviation is about 17 percent which is a little higher than the S&P 500 but if you look at just the downside volatility, when the performance for managed futures was negative, that number is just 10.1 percent. Then if you take that ratio, as a percent of downside volatility, the overall standard deviation is just 60%. Even the bond market, 67 percent of the overall market is downside risk, which is greater than managed futures’ 60 percent. That helps managed futures to really shine.

Q: That has to be a key selling point for managed futures.

A: Different investors will ask, what is the volatility of your trading system? I think it’s very interesting that volatility of many managed futures programs is tuned to be similar to the S&P 500. That’s because people understand the risk of the stock market. We have a similar standard deviation to the stock market but if you look at the standard deviation on the downside risk, it’s actually less risky.

Q: Managed futures is often overshadowed by the hedge fund space. What can or should the CTA industry do to raise its visibility?

A: Once people look at the managed futures industry, immediately what they see is liquidity and transparency. Positions can be monitored in real time. Normally, there is no lock up. A lot of CTAs have daily liquidity out there.
On a side note, I’ve been lucky to work with some folks at the University of Chicago and Frank Vannerson was from Princeton. These academic studies can add credibility as well, and show that managed futures/alternative investments have benefits.

After a Delay, MF Global’s Missing Money Is Traced
Investigators have determined what happened to nearly all of the customer money that disappeared from MF Global around the time of its bankruptcy last Oct. 31, but have not publicly disclosed their progress, fearing that doing so might cripple efforts to recover the cash and pursue potential wrongdoing, people briefed on the investigation said.

This is No Bank Robbery – Commentary by John J. Lothian
John Lothian Newsletter
When someone robs a bank and gets away with the money, they have somethinhttp://www.blogger.com/img/blank.gifg fungible (cash) and easily hid. While the authorities may be able to trace the serial numbers on the bills as they start to show up in circulation, there are no other official records for the physical bills to be traced. The MF Global situation is different. Money is missing, like in a bank robbery, but the money all moved into and out of MF Global’s bank accounts where there are all kinds of physical and virtual records to trace the whereabouts and the end location of said funds.

MF Global Executive Is Set to Tell of Concerns
The chief risk officer when MF Global Holdings Ltd. collapsed is expected to tell a congressional committee that he sounded concerns about the firm’s European sovereign-debt bet in July 2011. Michael Stockman is set to testify before the oversight-and-investigations subcommittee of the House Committee on Financial Services on Thursday.http://www.blogger.com/img/blank.gif

Lead Stories

JC Flowers’ former UK boss fined £2.9m in fraud case
Telegraph “Ravi Sinha submitted false invoices to a JC Flowers company in a desperate attempt to recoup multi-million pound investment losses made http://www.blogger.com/img/blank.gifat the height to the credit crunch.
**DA: More bad press for Flowers, on the heels of the MF Global meltdown

Hedge funds brace for euro zone break-up
Nervous hedge funds managers are stress-testing their portfolios and searching for ways of protecting themselves against their worst nightmare — a potential break-up of the euro zone. With talks on restructuring Greece’s debt mountain still deadlocked, and the exit of one of more countries from the euro seen as a small but definite possibility, funds are modeling scenarios ranging from a 50 percent slump in European stocks or a 45 percent fall in the oil price to a 30 percent http://www.blogger.com/img/blank.gifrise in gold.
**DA: As I read this, I was reminded of the immortal words of Helmut Schlesinger, Bundesbank president in 1992 regarding the common currency: “I have nothing against it apart from its name. I think it should be called the Deutsche Mark.”

Hedge Funds Lift Bets to Two-Month High as Rally Accelerates: Commodities
Hedge funds increased wagers on rising commodity prices to the most in two months and the rally in raw materials accelerated as the Federal Reserve pledged to keep borrowing costs low for three more years. http://www.blogger.com/img/blank.gif

Bruising year for commodities hedge funds
The commodities hedge fund industry has suffered its worst year in more than a decade as the sector’s top managers recorded heavy losses amid volatile markets. The average commodity hedge fund fell 1.7 per cent in 2011, according to a closely watched index compiled by Newedge, the first loss since the index was crhttp://www.blogger.com/img/blank.gifeated in 2000 and down from a rise of 10.7 per cent in 2010.

Sentiment an Uncorrelated Investment Strategy
Christopher Foster is known as the architect of sentiment strategy. He is the CEO of Blackheath Fund Management, a managed futures advisory firm (CTA) based in Toronto, and serves as the portfolio manager for their sentiment program. He began developing his strategy during his time with Friedberg Mercantile Group (FMG) where he analyzed crowd behavior and sentiment indicators for making trades.

Managed Futures/Managed Funds

Beating Market Benchmarks: It’s Time to ‘Take Some Risk’
US Business News – CNBC
Investors have gotten a modest break in January from financial markets moving in lockstep, as they employ a variety of strategies to help diversify portfhttp://www.blogger.com/img/blank.gifolios. The persistent 2011 trend of markets trading in either risk-on or risk-off mode crippled returns for active managers in particular, with just one in four beating the benchmark indexes they use to gauge the effectiveness of their strategies.

Bursa Malaysia Readies New Clearinghouse For 1Q Launch
Fox Business
Bursa Malaysia Bhd is preparing to launch a new trade-clearing facility for its derivatives markets that will enable the Kuala Lumpur exchange to offer a broader range of contracts, according to a senior executive. The firm anticipathttp://www.blogger.com/img/blank.gifes the new clearinghouse, built on technology supplied by Korea Exchange, to start operations in the first quarter, said Sree Kumar, general manager of business development for Bursa Malaysia.
**DA: The place to go to trade crude palm oil futures. Malaysia produces half the world’s supply

Mutual Funds Using Hedge-Fund Strategies Haven’t Delivered
Hedge funds’ growing asset base and supposed ability to provide positive returns in all sorts of market conditions have proved a potent attraction to mutual-fund companies, particularly after the financial crisis in 2008. Morningstar cites more than 300 mutual funds that now offer exposure to alternative strategies that have low market correlation, like equity long/short, market-neutral and managed futures.
**DA: This is a brand new sector. At least wait one full business cycle before writing them off.

Hermes Unveils CTA Platform
Fund of hedge funds Hermes BPK Partners has launched a managed accounts platform for commodity trading advisors. The new Alpha Vault Managed Futures program http://www.blogger.com/img/blank.gifwill focus on global, mid-sized CTAs with traditional characteristics. It debuted with some $275 million in initial assets.

Managed Futures Scorecard 2/1/2012

Newedge Indices MTD Return YTD Return
Newedge CTA Index 0.30% 0.30
Newedge CTA Trend Sub-Index 0.23% 0.23%
Newedge Trend Indicator -2.03% -2.03%
Newedge Short-Term Traders Index 0.10% 0.10%
Newedge Macro Trading Index -1.31%
Newedge Commodity Trading Index -4.16%
Newedge Volatility Trading Index 1.32%

Barclay Indices MTD Return YTD Return
Barclay CTA Index -3.0%
Barclay UCITS Index 0.59%
Barclay Hedge Fund Index 3.41%
BTOP FX Index 0.26% 0.26%
Morningstar Long/Short Com. Index 0.65% 0.65%

Pensions & Institutions

Pension funds win time to tackle Emir problems
Deferring a problem in the hope that it will go away is not usually recommended as a good way to deal with challenges, but sometimes it really does work. The Ehttp://www.blogger.com/img/blank.gifuropean asset management industry hopes it has found such an instance with the European markets infrastructure regulation (Emir) requirement that all over the counter derivatives be centrally cleared.

Alternatives secure highest allocations from us college and university endowments in 2011
Hedge Funds Review
US college and university endowments favour allocations to alternatives, including hedge funds. Best returns in 2011 came from commodities/managed futures, energy/natural resources and venture capital. US college and university endowments returned just over 19% net of fees on investments for the fiscal year 201http://www.blogger.com/img/blank.gif1. This was an improvement over 2010 when returns were up on average 11.9% and helped recover the loss of 18.7% in 2009.

13 major global pension markets see 4% asset rise to $27.5 trillion
Pensions & Investments
Retirement assets in the 13 major global markets increased 4% to a record $27.5 trillion in 2011, according to Towers Watson’s annual Global Pension Assets Study. Global pension fund assets have now grown at more than 6% on average annually since 2001 when they were valued at $15 trillion. The U.S. accounts for 59% of total pension assets, followed by Japan at 12% and the U.K. at 9%, according http://www.blogger.com/img/blank.gifto the study.

US most likely to lead equity rally in 2012, say hedge fund managers and institutional investors
Hedge Funds Review
Over half of hedge funds and institutional investors think the US is most likely to lead an equity rally this year. The EU came second with 16%, according to a Hedge Funds Review website poll. A majority (57%) of hedge fund managers andhttp://www.blogger.com/img/blank.gif institutional investors think the US is most likely to lead a global equity rally in 2012, according to a Hedge Funds Review website poll.

Bills would free Florida Retirement System to invest up to 20% in alternatives
Pensions & Investments
Florida State Board of Administration, Tallahassee, would receive authorization to raise its alternative investments allocation to 20% from the current 10% under two bills pending in Florida legislative committees. The increase would allow the board to implement the 16% alternative investments allocation it adopted in 2010 for the $122.9 billion Florida Retirement System defined benefit plan after a study by Hewitt EnnisKnupp, an investment consultant to the board.

Record High Pension Assets Hit by Rising Liabilities
Global pension assets hit a record high at the end of last year, but burgeoning liabilities meant funding ratios were in a worse state than 12 months earlier, a survey has shown. Assets held in defined benefit and contribution schemes at the end of 2011 hit $27.5 trillion, according to investment consulting firm Towers Watson. This figure showed a 3.9% increase in the asset level over the 12 months,http://www.blogger.com/img/blank.gif but this was much lower than the 10.9% rise over 2010.
**DA: Why does bad news always accompany the good news in the pension world?


Frequently Asked Questions – Trading Program Performance Calculations and Presentation by CTAs with Client Assets held at MF Global, Inc.
National Futures Association
As a result of the October 31, 2011 bankruptcy proceeding involving MF Global, Inc. (MFG), NFA has received a number of questions from CTAs regarding how to calculate and present performance information for Trading Programs with client manhttp://www.blogger.com/img/blank.gifaged accounts that were affected by the MFG bankruptcy proceeding. NFA is issuing this notice to address those frequently asked questions.

CFTC Should Have Power to Resolve Futures Brokers, O’Malia Says
By Matthew Leising and Silla Brush – Bloomberg
The U.S. Commodity Futures Trading Commission should have its own authorihttp://www.blogger.com/img/blank.gifty to put futures brokers into insolvency as part of additional powers following the collapse of MF Global Holdings Ltd., Commissioner Scott O’Malia said today.

Taking Your Track Record With You
New York City Asset Management Law Blog
All of you portfolio managers, proprietary traders and research analysts accepting positions with new firms or striking out on your own should know that your track records are not automatically portable to your new situations. The SEC has a lot to say about whether and how you can use your returns. For one thing, your track record belongs to your current employer and not to you. If you’re thinking of uhttp://www.blogger.com/img/blank.gifsing it, you need permission from your employer to do so. Interestingly, if you get that permission, you and your former employer may both be able to use the same track record (with each of you footnoting your separation from the other).
Form PF: Operational Challenges and Strategic, Regulatory and Investor-Related Implications for Hedge Fund Managers
The Hedge Fund Law Report
In October 2011, the Securities and Exchange Commission and the Commodity Futures Trading Commission adopted the much-anticipated final rule for Form PF, which requires reporting of risk measurement information by registered investment advisers regarding the private funds they manage.

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