Over the past two decades, the CTA industry has grown tremendously in size and scope, and it is now a unique and important part of the alternative investments asset class. This paper investigates the timing of commodity trading advisers’ (CTAs) inception and the relationship between their fund flows and performance. Our results show that performance by the CTA industry has, over the long run (short run), a positive (negative) effect on new CTAs. The flow–performance relationship is strongly evidenced, though its functional form differs across CTA subcategories. Also, we do not observe a ‘smart money’ effect, indicating that investors are generally unsuccessful in choosing subsequent well-performing CTAs.
A commodity trading adviser (CTA) can be defined as any individual or firm that receives compensation for giving investors advice on options, futures, and the actual trading of managed futures accounts. In the US, CTAs are required to register with the Commodity Futures Trading Commission. They invest in equity, commodities, options, futures and currencies globally. From the time of the first CTAs in 1949, the industry has experienced rapid growth in both the number of funds and assets under management (AUM).
The total assets under management have grown from approximately USD 300 million at the beginning of the 1980s to approximately USD 300 billion as at the end of 2012. Despite this astounding growth, little is known about the factors affecting the birth of new CTAs and the associated fund flow patterns.
Our paper examines the lifecycle of CTAs. While a number of studies investigate the flow-performance relation and life cycle of mutual funds, hedge funds and private equity funds, the related literature specific to CTAs is scarce. Very little is known about what causes CTA funds to be created, why some CTAs grow and prosper, and why others disappear very early in their life.
An understanding of the CTA lifecycle is important for investors and the market generally. Our findings provide interesting insights about the formation of capital in the CTA industry.
We also contribute to the CTA literature by being the first study to examine the factors affecting the formation and fund flows of different CTA groups over a longer time period that includes the recent global financial crisis. In addition, our results provide further supporting evidence for the flow-performance relationship and suggests strong competition among CTAs attracts fund flows. We also show that a naive strategy of chasing past winners does not appear to work for CTAs.
Prior studies have mainly focused on traditional questions of performance and persistence in performance. Our study expands this research scope by addressing three questions.
First, we investigate the impact of existing CTAs’ performance on the number and fund flows of new CTAs. We argue that CTA performance in the long run positively affects fund flow to the industry. However, in the short term it makes the competition between CTAs tougher and harder for new CTAs to enter the market. Long-term and short-term effects can be explained by style chasing investor behaviour and intra-style competition. Our findings show that managers appear to have a strategy in timing the inception of their new CTAs when the aggregate long-run performance is good but short-run performance is poor.
Second, we investigate the importance of performance and other fund-specific factors to fund flows throughout the entire life of CTAs. There are noticeable differences in the flow−performance relationship among CTA subcategories. Systematic CTAs have linear, positive flow−performance functions, while discretionary CTAs exhibit concave patterns. It points to possibly higher capacity constraints or more share restrictions among discretionary CTAs. In general we confirm that past absolute and relative performance are a key driver of fund flows for both subcategories. After the crisis, the evidence also suggests that higher order moments have become important for investors of systematic CTAs.
Finally, our study tests the selection ability of CTAs’ investors by examining the performance of new flows to the CTAs. We observe that systematic CTAs with high flows have statistically poorer performance compared to others in the next two or three months. The evidence of ‘smart money’ among discretionary funds at horizons up to one quarter is inconclusive. At a yearly horizon, both subcategories do not reveal any evidence of ‘smart money’.
In conclusion, we suggest that more research is needed focusing on the differences between systematic and discretionary CTAs. As our results show that the two subcategories often demonstrate divergent behaviour. A deeper insight into capacity constraints, share restrictions and liquidity of systematic and discretionary CTAs could provide valuable information for a better understanding of fund flows and performance of CTAs.
This Working Paper was produced by the CSIRO-Monash Superannuation Research Cluster a collaboration between the CSIRO and Monash University, the University of Western Australia, Griffith University and the University of Warwick in the United Kingdom. In addition, the Cluster engages on an ongoing basis with a range of industry supporters, government agencies and industry peak bodies who assist in providing guidance and feedback to researchers, providing data, and in disseminating outcomes. The purpose of the Super Research Cluster is to examine issues pertaining to the future of Australia’s superannuation and retirement systems.