The success of managed futures funds during the unprecedented market gyrations of the past year has brought increased attention to a sector that has grown in tandem with the London hedge fund industry. With major players like Winton Capital Management and Man AHL, among others, London is a key hub for commodity trading advisors and a natural focus for investors across the world looking to allocate to the strategy.

Though returns for most commodity trading advisers (CTAs) have turned negative in the first-half of 2009, the long-term success of managed futures funds means that many firms are still growing amidst the difficulties experienced by the hedge fund sector as a whole. One of the very best performers of the CTAs that have emerged in the past decade is Altis Partners. Though it started trading in 2001 with just $1.2 million in assets, Altis now manages around $1.2 billion and has the infrastructure in place to grow much bigger on the back of its stunning 56.9% return in 2008 (see Fig. 1).

The Altis Global Futures Portfolio originally began trading from what is now fondly remembered as a rather dark basement in Mayfair’s Queen Street. The migration of the front office and investment management functions to the Channel Island of Jersey in October 2005 coincided with continued strong investment performance and the transition from a start-up fund to a proven performer with rapid sustained growth in assets under management (AUM).

Altis trades 189 futures markets with multiple maturities giving around 600 trading instruments. Reflecting the tradition of the CTA sector, most investors access the strategy through managed accounts. Altis uses a combination of different forecasting techniques – indicators designed to capture directional movement, market excess, volatility bursts and inter/intra market relationships – to forecast changes in futures prices over different time periods.

“For me the whole investment process is one of allocation of resources,” says Zbigniew Hermaszewski, one of the firm’s four founding partners and co-Head of Research & Technology, in an interview at its Jersey headquarters. “One has resources in terms of AUM. Then there are sets of opportunities you can see in markets at various times. Mathematically it is an optimisation problem. How do I best use these resources within that set of opportunities and translate it into mathematical language? There is nothing in there about fixed levels of risk or back-fitting of account curves. It’s all about basing your portfolio on what you see will happen in the future. It is quite radically different. One couldn’t employ such methodologies within other existing CTAs. We had to form our own.”

Hermaszewski founded Altis with Natasha Reeve-Gray, who heads business development and marketing and who was a trader with Quality Capital Management, where he was director of research in 1998-1999. The two other founding partners are Alex Brunwin and Stephen Hedgecock, who oversee Research and Technology and Operations respectively. They are both veterans of Sabre Fund Management, where Hermaszewski was director of research from 1994-1997.

London: a CTA hub
The backdrop of London as a CTA hub proved instrumental to the partners developing the business. Hermaszewski also had a short stint at AHL working for David Harding – the H in AHL, which was co-founded with Michael Adam and Martin Lueck in 1987. Today Harding runs Winton, now London’s second largest CTA. “We were helped by being in a slipstream behind people like Aspect and Winton,” says Reeve-Gray. “People would come and see Winton and then they might come and see us.” Hermaszewski adds that both Harding and Lueck, a co-founder and director of research at Aspect Capital, were encouraging, giving set-up advice and business introductions.

In recent years, many CTAs have excelled. Indeed, Winton Capital, AHL, Aspect and Transtrend, the Rotterdam-based CTA, all rose in The Hedge Fund Journal’s EUROPE50 survey of the continent’s biggest single manager hedge funds. The ability of CTAs to retain assets is linked to their performance in an environment characterised by swings in market sentiment and pronounced moves in asset prices.

“There have been some very big changes in valuations of both securities markets but also commodities and energy as well,” says Hermaszewski. “And then, obviously, the mayhem of the second half of last year. I think if you look back through history you will see that CTAs have always done reasonably well. But there was a time in the late 1990s when stock markets were earning 15% a year with not a lot of risk. It is quite difficult to compete in that sort of environment. That’s why managed futures for a period were quite quiet. Obviously we have had some turbulent times. The true risk of equities is now exposed and our product has come to the fore.”

Though the strategy trades daily, the overall change in the portfolio at any given moment is quite small and all trading is automated. Owing to the fund’s early 21st century launch it has used near-direct market access technology to manage broker order flow, although not all of the markets it deals in can be traded electronically. Among the more unusual futures it trades are the yen-denominated azuki red beans contract and the non-genetically modified soybeans contract. Altis is particularly keen on the diversification benefits of commodities and generally expects to have around 50% of its total market exposure there, while yen denominated commodities contracts can sometimes account for up to 20% of the exposure.

The investor base of Altis is about 25% funds of hedge funds with the remainder coming from banks as well as platforms such as Lyxor and some family offices. So far, the programme hasn’t attracted direct investment from pension funds. The initial allocations during the fund’s early years were mainly from US investors but the globalisation of the hedge fund industry means that European, Middle Eastern and Asian investors have allocated more recently.

“The investors that have been more interested are the ones that have already invested in CTAs and have quite a good knowledge,” says Alex Brunwin. “We don’t tend to court people from scratch unless they can show us they have some sophistication. Many pension funds haven’t ventured into this type of product yet. Or if they have it has been by other routes. But I suppose we are at the time in the firm’s life where people will start looking seriously at the size we are. After the performance in 2008 we’ve had lots of interest.”

Portfolio managed as a whole
The essence of the approach Altis takes to investment is to manage the portfolio as a whole rather than manage individual positions. Take the example of an interest rate change. “We know that the interest rate contracts of that particular country or that particular currency will change in price,” Hermaszewski says. “We also know there are going to be knock-on effects in currencies or currency pairs involving that country and in its stock markets. Seeing that piece of information, and creating a trade just in that contract, you are never going to be able to use all the information available. We can do that in our portfolio management scheme because in essence a new piece of information affects the forecasts of those individual markets and we can also get into all sorts of trades where the effects spread through correlated markets.”

The Altis programme is completely systematic and uses a three step system cycle. The process starts with data gathering. New data leads to changes in model forecasts and the changed forecasts result in adjustments to allocations in particular markets. “In essence we know certain things about markets,” Hermaszewski says. “For example, the trend following phenomenon is widely documented. If you look at prices versus some average in the past you will find that prices are higher than average. Then there is some pressure to the upside. Trend followers will tend to buy markets when prices are moving higher and sell them when prices are moving lower. We can turn that around and say: ‘How big is that effect, and how much return should I expect from this phenomenon?’ That is essentially how we compose our models and there are other factors besides. Given that forecast and the fact that every day there is a new piece of data that might change the forecast in some way – either increase the effect or decrease it – that will then have the effect or potentially have an effect on the portfolio. So the portfolio will need to rebalance in order to actually make best use of these forecasts. We then have a series of position changes that are acted on within the day and those trades are reconciled electronically the next day.”

The forecasting focuses on four broad types of market behaviour. One is trend following or persistence. The programme seeks to trap persistent mispricing in the market or a persistent expansion or contraction in value of a particular commodity or market. The second is inter-market relationships which tend to be big drivers of bond, currency and stock markets, yield curve effects or carry trades using different commodity contract maturities. The third element is short-term counter-trend movements, and the fourth is price volatility displayed in sudden bursts of movement.

“There are a number of factors which combine together to give us an overall forecast in a particular market and an overall distribution of prices that you can expect in the future,” Hermaszewski says. “We apply the same models across all markets. We do have some sector specialisations, but in essence we are masters of the technique of trading rather than having specific knowledge of any particular market such as cocoa or crude oil or stocks.”

The programme trades a mix of short-, medium- and long-term outlooks. As a rule, when volatility is low the fund takes a longer term approach to positions. If volatility is higher, and particularly at points of market extremes or at sudden bursts of volatility, then the fund becomes more of a short-term trader. Conversely, in quite volatile but directional periods the programme’s turnover will be quite low if it has the right position.

Data does the talking
“A typical portfolio construction problem starts with a certain allocation of risk to a particular sector or a particular market,” Hermaszewski says. “A number gets fixed. Why? We prefer to let the data do the talking. What we try to build are quite general models which are adaptive to conditions in the market at a particular time. For example, when we see the correlation of one market to the movements of another sector we don’t say: ‘Well that is different therefore I can still allocate even though I am full.’ We don’t really like to have arbitrary constraints or arbitrary parameters. We like our models to be much more general, much more responsive to the data.”

Take the S&P 500, for example. During much of the fourth quarter of 2008 its movements were increasingly correlated with a variety of other assets such as the Australian dollar and US treasuries. Despite being three different markets, Hermaszewski argues that trading in them is linked to one source of risk. This has important ramifications for how a portfolio is structured and serves to underline the responsiveness of the programme.

“One function already encoded within our systems looks to see if correlation is rising on a historic basis and then responds accordingly,” he says. “The second function is to try to diversify that risk into other ostensibly uncorrelated sectors. If we can find other opportunities we will try and put some risk in there even if the returns are potentially not as high, as we are trying to move away from having all the risk in one basket.” Not having constraints on any particular market lets the programme adjust positions accordingly without being fixed in any one of them. The dynamic ability to adjust the portfolio helps the fund to dampen exposures to avoid higher risks of correlation developing.
“Fortunately, correlation is something that builds up over time,” says Hermaszewski. “It is something that is measurable. Every day we will respond to an increase or decrease in the relationship between different markets. You and I notice it once it has kind of already happened. The beauty of having quantitative systems is that sometimes the programme can see it a long, long time before you do or before I do. Essentially it is there and should be adjusted to. Our system had been noticing the build up in effect (of the S&P 500) for some time.”

The programme has fail-safes or safety valves that will limit exposures but there is no set allocation to any one sector or any one market. The overall safety valve on the total portfolio and risk is controlled through the margin to equity ratio, which is capped at 35% and currently stands around 13% (see Fig. 2). The aim is to be pre-emptive, not reactive. “We oversee what is going in the portfolio,” Brunwin says. “But we don’t get involved on a day to day basis to change it. It is very, very rare we intervene.” The only occasion when it was necessary to intervene was after the terrorist attacks of 11th September 2001 when some trading mechanisms for certain markets were disabled since it was impossible to get guarantees of execution at known prices.

Jersey brings benefits
Altis has a team of 40. A dozen staff in London oversee electronic trading and handle brokerage relationships, with 28 in Jersey performing all other aspects of the business, including investment management. The partners believe that the current shape of the organisation is suitable for expanding the assets under management to around $5 billion. Further expansion in the head count would be required if the firm decided to introduce new funds and strategies.

“There is a limited capacity in certain markets that we trade and particularly in small commodities markets,” Hermaszewski says. “They do feature in our portfolio. We have always had a high commodity bias with about 50% of the portfolio in commodities. We would like to retain that. At some point we will have to say we can’t take on any more assets in the existing programme and keep the commodity exposure at this kind of level. At that point we will have to close the programme. Beyond that the securities markets is much, much larger. So there is no reason we can’t manage a subset of that portfolio. But it will be a different product. However, we are not at the stage when we have to make that decision.”

Moving to Jersey has brought a number of benefits. Personal tax and a more favourable fiscal environment for the business were factors but the most important reason for the move is the quality of life. “I can cycle to work,” says Hermaszewski. “I can finish work here and go to the beach. It is a very good place to live. And we feel we pay a fair amount of tax.” Being in Jersey, out of the sprawl of London and south-east England, also lets all four founding partners see more of their families.

Being in an offshore centre rather than in London means that the atmosphere in a business is different, too. “We don’t want to become hugely corporate,” says Reeve-Gray. “We quite enjoy running a business because we can have a direct relationship with the team we work with. Walking into an office having 200 people whose names I don’t know is not something I would feel passionate about. I am passionate about having a small team that makes a big impact on every aspect of the business.” Adds Hermaszewski: “I feel absolutely the same.”

FOUNDING PARTNERS

ZBIGNIEW HERMASZEWSKI
Co-Head of Research and Technology
He has 27 years’ experience in stockbroking, market making, investment research and the development and implementation of trading systems with Quality Capital, Sabre Fund Management, AHL and others. As a co-founder he spent a year developing the Altis system architecture ahead of its launch.

NATASHA REEVE–GRAY
Head of Business Development
She has 16 years experience in trading, institutional sales, middle office management and client liaison for financial institutions and managed futures fund managers. Prior to co-founding Altis she served in increasingly important roles with Glynwed Metal Services, Refco and Quality Capital.