Opportunities in the CTA Industry

Copyright © 2014 MSF Enterprises, LLC Copyright © 2014 MSF Enterprises, LLC

MSF Enterprises LLC

Opportunities in the

CTA Industry

January 2014


CTA Manager Quiz

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• Is the velocity of your fund flows 2-3 times the volatility of your fund?

• Do you have the same investors from 5 or 10 years ago?

• Are you tired of watching money flows shift away from the CTA industry to the benefit of other investment strategies?

• Do you have the staying power to withstand more than 24 months of flat-to-negative returns?

• Is your performance negatively correlated to equities? How did you perform in 2001, 2008 and 2013?

• How does your business perform when equities are posting double-digit gains?


Self-Reflection

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• What steps can you take to make your strategies more profitable? • Have you asked your clients about other ways you can help their

portfolios?

• Do higher returns = increased profits?

• How often do you evaluate your business model?

• Where do you see yourself in five years? Where do you see your firm in five years?

“Insanity: Doing the same thing over and over again and expecting

different results.”

- Albert Einstein


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Asset Management Industry Trends

•Performance is important, but it is not the only driver of firm value. Evolution of the Business Model

•Managers must differentiate their business in terms of product diversification and edge. Competition

•The importance of scale has never been more apparent, as the major players in the industry attract the vast majority of asset flows. Scale

•Allocators view many strategies as similar, making it critical for managers to establish a reputation and increase visibility. Branding

•It takes more than outperformance to attract new capital, yet many asset managers overlook their firm’s marketing and distribution activities.

Marketing & Distribution

•Growing the business into a major industry player requires offering more than just a single product, with diversification being key. Product Development

•Clients are no longer satisfied with being thrown into a bucket with other investors. Client relations and customization have become essential for fund managers.

Focus on the Client

The asset management environment is rapidly evolving. Fund managers must quickly adapt to the shifting landscape to position their business for success.


State of the CTA Industry: Stagnant AUM Growth

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Many of the metrics used to evaluate the Managed Futures industry are skewed due to the inclusion of Bridgewater Associates, which is not generally considered a pure CTA. Furthermore, Winton Capital Management has an overwhelming influence on the industry’s capital flows and AUM trends . Without Bridgewater and Winton, growth in the CTA industry has been relatively flat over the past few years.

Source: Attain Capital Management

Without Bridgewater and Winton, the Managed Futures space was actually down $24B in AUM from June 2012 to June 2013.

• Removing Bridgewater and Winton from industry calculations, the Managed Futures space has barely grown since 2009. The rest of the industry only accounted for $23B of the $125B in new assets raised since that time.

• Aside from Bridgewater and Winton, the Managed Futures industry averaged quarterly outflows of $5B from Q3 2012 to Q2 2013.

Growth of Managed Futures AUM ($B) Managed Futures AUM ($B)

Managed Futures Quarterly Flow ($B)


State of the CTA Industry: Performance

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Barclay CTA Index v. SP 500 (1980 – 2009)

80

90

100

110

120

130

140

150

Indexed Performance Comparison (Jan 2011 - Oct 2013)

CTA SP 500 AGGSource: Managed Futures Today, Yahoo! Finance, Newedge *CTA performance calculated using Newedge CTA Index

Over long periods of time, CTA’s have kept pace and even outperformed the S&P 500. During periods of market decline such as 2000-02 and 2008, CTA’s performed exceptionally well relative to other asset classes. The last 3 years have been challenging for most CTA’s in terms of performance. In turn, allocators have become more dynamic in attempting to time allocations to the CTA asset class, seeking to anticipate market cycles.


Shifting Institutional Allocation Models

7 Source: Citi Prime Finance

Institutional Core Portfolio Shifting to Include Hedge Fund Strategies

Rather than merely viewing hedge fund strategies as satellite allocations, institutional investors have been repositioning their core portfolios to include certain types of alternatives. This is a key development for the CTA industry, as it enables managers in the space to compete for a new pool of capital.


Opportunities in Retail for CTA’s

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Publicly Offered US Alternative ‘40 Act Mutual Funds and ETFs

Source: Citi Prime Finance, Morningstar, ICI, Federal Reserve, Cerulli Associates, Deloitte

Managed futures strategies are naturally among the most liquid in the alternatives space. This provides CTA’s with an advantage over other alternative managers in terms of creating products for the retail market. Alternative retail products in the US are projected to increase by a CAGR of nearly 25% over the next five years. This trend could generate significant opportunities for CTA managers to boost AUM by targeting an expanding pool of capital.

Liquidity of Alternative Strategies


How the Market Views CTA’s

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Pros to Investing in CTA’s

Systematic Trading Models • Quant-based investment methods • Proprietary algorithms remove emotion from trading decisions

Risk-Adjusted Returns • Generally lower volatility than other asset classes • Smaller drawdowns than equities and bonds on a historical basis • Certain CTA strategies have the potential to generate returns in any market environment

Transparency • Separately Managed Accounts • Trade activity can be tracked on a daily basis

Reduce Overall Portfolio Risk • Increased diversification when combined with traditional asset classes and other alternative

investments • Low-to-negative correlation with equities and bonds • Downside protection • Generally outperform during adverse market conditions for equities and bonds

Tax Advantages • Profits and losses from futures transactions are neither considered long-term nor short-term in

regard to capital gains • 60% of profits are taxed at long-term capital gains rate, 40% taxed at short-term rate

Investor Concerns with CTA’s

• CTA’s are seen as a black box • Difficult strategy in a zero interest rate environment • Among the highest fees in the industry by strategy • Require volatile or trending markets to produce returns


Opportunities for CTA’s

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•Managers should seek to categorize themselves more broadly as quant-driven investment firms •Managed futures are able to play a key role in many portfolios •In the hedge fund world, CTA’s are seen as an orphan strategy

Break Away from the CTA

Label

•Expand product offerings •Participate in markets with broader scope such as equities and ETFs •Establish product suite with comprehensive set of quant trading strategies

Integrate New Strategies

•Leverage systematic trading strategies in markets other than futures to create products that can perform in any environment

•Dampen performance volatility between market cycles •Reduce the time from peak to trough in terms of overall performance

Broaden Performance

Cycle

•Create bespoke trading models to fit the specifications of individual clients

•Utilize base systematic platform with adjustable triggers and parameters

Customized Trading

Strategies


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Enterprise Value

Fund Performance

Distribution Operational

Efficiency

Firm Structure

Manufacturing

Building Value

CTA’S NEED TO FOCUS MORE ATTENTION ON FUNDAMENTAL BUSINESS PRACTICES

Product Manufacturing • Provide strategies and structures to meet the needs of a wide range of investors • Consider capacity constraints • Separately managed accounts, pooled investment vehicles, ‘40 Act products

Operations • Efficiency of operational structure • Leveragability of systems and personnel

Distribution • Investors by type and geography • Scalability

GOALS: Develop Tool Set, Expand Distribution Channels, Grow AUM, Improve EBITDA and Increase Valuation Multiples


Getting to the Next Level

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Finding a Strategic Partner

•Seek strategic partner(s) with capital and capabilities to assist in expanding the business

•Major institutions, distributors, fund platforms

Branding

•Managers need to develop a strong reputation and brand to be competitive •Create a custom strategy for reaching targeted investors and accessing new markets

•Seek to diversify investor base by type and geography

Publishing Research

•Published research enables a firm to highlight its expertise while facilitating greater understanding of its capabilities •By producing client-facing research pieces, managers have the opportunity to create a dialogue with clients and potential investors

Expanding Team

•Firms should add team members with product development and marketing expertise •Can outsource these roles to third-party advisors and marketers


Appendix

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CTA Fees Remain at the Top

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Hedge fund fees have been pushed down across the board in recent years, yet the CTA space has generally maintained pricing power.

Source: Preqin

Strategy Management Fee Performance Fee

CTA 2.17% 18.90%

Event Driven 1.71% 20.00%

Special Situations 1.71% 20.00%

Distressed Securities 1.70% 19.30%

Credit 1.69% 18.10%

Relative Value 1.67% 16.70%

Macro 1.67% 16.30%

Other 1.63% 18.20%

Multi-Strategy 1.55% 16.60%

Market Neutral 1.53% 18.90%

L/S Equity 1.53% 18.60%

Fixed Income Arbitrage 1.44% 18.30%

Fund of Funds 1.26% 10.60%


CTA Historical Performance

15 Source: BarclayHedge

The S&P 500 and BarclayHedge CTA Index both have a total of 7 down years since 1980 (including 2013). However, the average down year for the S&P 500 during this time was -14.69%, while the average CTA down year was only -1.29%.

CTA Index Performance Since 1980

Compound Annual Return 10.36%

Sharpe Ratio 0.38

Worst Drawdown -15.66%

Correlation vs S&P 500 0.01

Correlation vs US Bonds 0.13

Correlation vs World Bonds 0.00

BarclayHedge CTA Index Performance by Year

1980 63.69% 1990 21.02% 2000 7.86% 2010 7.05%

1981 23.90% 1991 3.73% 2001 0.84% 2011 -3.09%

1982 16.68% 1992 -0.91% 2002 12.36% 2012 -1.70%

1983 23.75% 1993 10.37% 2003 8.69% 2013 -1.41%

1984 8.74% 1994 -0.65% 2004 3.30%

1985 25.50% 1995 13.64% 2005 1.71%

1986 3.82% 1996 9.12% 2006 3.54%

1987 57.27% 1997 10.89% 2007 7.64%

1988 21.76% 1998 7.01% 2008 14.09%

1989 1.80% 1999 -1.19% 2009 -0.10%

CAGR 23.25% CAGR 7.09% CAGR 5.89% CAGR 0.13%


CTA Drawdowns and Volatility

16 Source: Preqin Hedge Fund Analyst

While recent performance has been a struggle for CTAs, the asset class continues to compare favorably to equities from a risk perspective. Volatility in the managed futures space is significantly lower than the S&P 500, and drawdowns have been considerably less pronounced within CTA portfolios.

Rolling 3 Year Volatility: CTA’s v. S&P 500

Drawdowns: CTA’s v. S&P 500


Largest CTA Firms

Source: BarclayHedge, Citi Prime Finance 17

The largest CTA programs are relatively small from an AUM perspective when compared with top managers in other segments of the asset management industry. There are approximately 130 CTA funds above $200MM in AUM.

Rank Firm AUM ($MM) Inception

1 Winton Capital Management $24,700 1997

2 Man Investments - AHL $12,500 1987

3 Transtrend BV $7,100 1991

4 Aspect Capital $5,737 1997

5 Lynx Asset Management $4,963 1999

6 Informed Portfolio Management (IPM) $4,558 1998

7 Two Sigma Investments $4,020 2001

8 Cantab Capital Partners $3,400 2006

9 P/E Investments $3,000 1995

10 Campbell & Co. $2,940 1972

11 Graham Capital Management $2,619 1994

12 Quantitative Investment Management $2,187 2003

13 FDO Partners $2,167 1997

14 H20 Asset Management $2,001 2010

15 Mesirow Financial $1,545 2005

16 Eagle Trading Systems $1,515 2002

17 SEB Asset Selection $1,394 2003

18 Ikos Asset Management $1,360 1992

19 Crabel Capital Management $1,352 1992

20 Millburn Ridgefield Corporation $1,165 1971

21 Harmonic Capital $1,112 2002

22 Armajaro Commodities Fund Ltd $958 1998

23 Ortus Capital Management $951 2003

24 Amplitude Capital $927 2004

25 Boronia Capital $890 1993

Copyright © 2014 MSF Enterprises, LLC Copyright © 2014 MSF Enterprises, LLC Copyright 2011 MSF Enterprises, LLC

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Top 20 Hedge Fund Managers: Past and Present

1 Bridgewater Associates $83,300

2 JPMorgan Asset Mgmt $54,800

3 Brevan Howard Asset Mgmt $40,000

4 BlueCrest Capital Mgmt $35,300

5 Och-Ziff Capital Mgmt $31,900

6 Man Group $29,600

7 Baupost Group $26,700

8 BlackRock $26,635

9 Winton Capital Mgmt $25,700

10 D.E. Shaw & Co. $23,400

11 Lone Pine Capital $22,000

11 Renaissance Technologies $22,000

13 Elliott Mgmt Corp $21,500

14 AQR Capital Mgmt $20,300

15 Credit Suisse Hedging-Griffo $19,985

15 GAM $19,600

17 Viking Global Investors $19,400

18 Davidson Kempner Capital Mgmt

$18,590

19 Farallon Capital Mgmt $18,400

20 Adage Capital Mgmt $18,360

1 JPMorgan Asset Mgmt $33,087

2 Goldman Sachs Asset Mgmt $32,531

3 Bridgewater Associates $30,210

4 D.E. Shaw Group $27,300

5 Farallon Capital $26,200



8 Barclays Global Investors $18,953

9 Man Investments $18,800

10 ESL Investments $17,500

11 GLG Partners $15,833

12 Tudor Investment Corp. $14,850

13 Citigroup Alternative Inv. $14,081

14 Lansdowne Partners $14,000

15 Campbell & Co. $13,600

16 Atticus Capital $13,500

17 Caxton Associates $13,500

18 Citadel Investment Group $13,400

19 Cerebrus Capital Mgmt $12,800

20 Moore Capital Mgmt $12,500

1 Moore Capital Mgmt $8,000

2 Farallon Capital $7,794

3 Andor Capital Mgmt $7,500

4 Maverick Capital $7,500

5 Citadel Investment Group $7,150

6 Angelo, Gordon & Co. $7,000

7 Soros Fund Mgmt $7,000

8 Pequot Capital Mgmt $6,500



11 Caxton Corp. $5,500

12 HBK Investments $5,491

13 Chilton Investment Co. $5,000

14 Duquesne Capital Mgmt $5,000

15 ESL Investments $5,000

16 Highfields Capital Mgmt $5,000

17 Tudor Investment Corp. $4,946

18 Highbridge Capital Mgmt $4,200

19 Perry Capital $4,137

20 Man Investments $4,000

Compare 2001 to 2013. What differences do you notice in the composition of top managers?

2001 2006 2013

Rank Firm AUM [$M] Rank Firm AUM [$M] Rank Firm AUM [$M]

Source: Institutional Investor, Bloomberg Markets

Copyright © 2014 MSF Enterprises, LLC

Answer: Single Product v. Diversified Managers


History US-based AQR Capital Management is a quant-driven firm, partly owned by Affiliated Managers Group, offering alternatives and traditional strategies. In January 2009, it became one of the first hedge fund managers in the U.S. to launch a retail mutual fund, introducing a ‘40 Act version of its diversified arbitrage strategy. AQR subsequently launched five other ‘40 Act mutual funds, one of which was alternatives-focused. By the end of 2009, the AQR Diversified Arbitrage Fund had drawn $236 million in net inflows, the 39th best launch among 510 new funds introduced in the U.S. during the year. Strategy AQR undertook this effort by hiring personnel with retail mutual fund experience to lead the sales effort, including a wholesale distribution force that had experience with both alternatives and mutual fund wholesaling. Importantly, the firm put compliance structures in place to eliminate potential conflicts arising from the same portfolio managers running the ‘40 Act and hedge fund versions of the arbitrage strategy. Of course, AQR already had the trading infrastructure used for managing a complex mix of arbitrage strategies, including convertible arb and merger arb, which can have 250+ long positions and 150+ short positions, and deploy leverage. The AQR Diversified Arbitrage Fund capped its fees at 1.5% for the retail share class, but the real key was educating advisors about the product. The firm targeted sophisticated RIAs, mutual fund wrap platforms, and broker-dealer due diligence/ gatekeeper departments that had familiarity with alternatives. AQR found a number of firms that already used alternatives in a limited partnership format and were looking to offer alternative strategies to a broader spectrum of investors via the ’40 Act structure. Lessons Education continues to be a priority, to both explain that the low-correlated strategy still carries risk and to help advisors understand how the Diversified Arbitrage Fund fits best into portfolios. The educational effort appears to be working. For example, Litman/Gregory Advisor Intelligence, an investment research and due diligence service for independent RIAs, added the AQR Diversified Arbitrage Fund to its Approved List. In January 2010, AQR launched its second retail alternative fund, the AQR Managed Futures Strategy Fund, which had $71 million in assets two months later.

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AQR’s Diversified Arbitrage Fund

Case Study – AQR


MSF Firm Capabilities

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1. Increase Profitability 2. Create Brand Strategy 3. Product Development 4. Raise AUM 5. Maximize Firm Value

1. Create strategy to leverage existing resources and maximize profitability

2. Align professional goals of the organization with personal aspirations of the business owners

3. Provide a road map with clearly defined and measurable steps for execution

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OUR GOAL

WHAT WE DO

Our Value

“Creating a Strategic Plan”


Our Services

Mergers and Acquisitions: We advise domestic and international companies with

individually tailored M&A advice and work to help them accomplish their goals. We structure,

execute and evaluate mergers and acquisitions, joint ventures, strategic alliances and

divestitures in various industries and countries. We have successful track records of managing

all aspects of complex investment projects.

Capital Raising: MSF bankers are experienced in all aspects of capital formation, including

senior debt, subordinated debt, mezzanine capital, preferred stock and common stock. We

maintain an ongoing dialogue with institutional sources of capital, including commercial banks,

insurance companies, pension funds, finance companies, hedge funds, mezzanine funds, venture

capital funds and private equity groups.

Strategic Advisory: MSF’s strategic advisory practice focuses on identifying and executing

strategies to maximize value and create aligned objectives. MSF bankers construct different

transaction strategies – including acquisitions, divestitures, recapitalizations and outright sales

– and evaluate how each strategy impacts shareholder interests. Our analysis is based on solid

research, as well as first-hand experience with the current transactional environment.

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MSF Team

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Michael Fields │ Founder & Managing Partner Michael has spent the past 25 years in the capital markets focusing on alternative investments as a banker, allocator, analyst and placement agent. During this time, he has raised more than $750MM for alternative investment managers including hedge funds, funds of funds, private equity groups and venture capital firms. Prior to founding MSF, Michael was Director of Research for European Markets at Lighthouse Partners, a $7.9B fund of funds. Before Lighthouse, Mr. Fields worked as a Portfolio Analyst in the risk arbitrage department at Tiedemann Investment Group, a $2B family of hedge fund strategies. Mr. Fields came to Tiedemann from Computer Trading Corporation LP, a commodity-trading advisor launched from the Tudor Investment Corp. At CTC, Mr. Fields was on the team in charge of Asian portfolio investments. Mr. Fields has a Bachelor of Arts degree from Hobart & Williams Smith Colleges and received his MBA in Finance & International Business from Fordham University. Michael holds Series 7 & 63 licenses. Dan Urmann│ Chief Operating Officer Dan brings more than 17 years of experience as an executive-level business leader, having worked with a diverse group of privately-held companies from industries such as information technology, consumer products, real estate and financial services. Prior to MSF, Dan served as an entrepreneur and marketing strategist for several start-ups and early stage growth companies. He also served as Director of Business Development for Streaming Media Corporation, an early-stage venture-funded technology firm that was sold in 2006 for $155MM. He began his career in finance with Century Capital Group, a middle-market investment bank focusing on technology, healthcare, retail, construction, ready-mix concrete and real estate. Dan holds a BSBA Management and MBA from the University of Denver.


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Economy & Finance

Opportunities in the CTA Industry