SECTION NAME

ISSUE 1 • 10 FEBRUARY, 2009

In This Issue
Founding Father Q&A
Martin Lueck, president of Aspect Capital and a founder of AHL, talks about last year’s trades and this year’s prospects.........................2

Welcome to our first issue.
We’re here to address the interests of a growing community. Fund managers, commodity trading advisors, commodity pool operators and technical traders are members of this community, as are investors, brokers and service providers. Assets under management by commodity trading advisors grew from a little over $41 billion in 2001 to $225.5 billion in the third quarter of 2008. Despite the financial and economic turmoil, managed futures did exceptionally well last year and it will likely continue to be an attractive investment — for reasons explained in the interviews and research you’ll find in this issue. But there are misconceptions about managed futures. Industry people who agreed to contribute analysis, commentary and data to Opalesque Futures Intelligence tackle the mistaken impressions they have encountered over the years. Pioneer manager Martin Lueck points to the advantage of black box modeling if done properly. Pioneer CTA database builder Sol Waksman offers a nuanced view of managed futures risks. Tim Merryman, a CTA and our editorial advisor, analyzes the benefits of including managed futures in a portfolio. Contributor Walt Gallwas argues for investing in separate accounts. Other sections look at index issues, databases and regulatory developments. OFI will be published twice a month as a PDF file. We’re excited to report on this fast-growing industry and delighted to have you with us. Please contact us, we would love to hear from you. Here are our email addresses: Publisher: Matthias Knab - knab@opalesque.com Editor: Chidem Kurdas - kurdas@opalesque.com Editorial Advisor: Tim Merryman - tmerryman@opalesque.com Advertising Director Denice Galicia - dgalicia@opalesque.com

Index Track

You may be surprised at the variation in returns.......................4

Insider Talk

Sol Waksman, founder of Barclay Hedge, tells us what’s behind MF performance...............................5

Futures Lab

Read about reliable portfolio diversification..............................6

Regulators & Courts

The surge in futures scams.........9

News Briefs

CME, Man Group, IAM, and more..................................10

Practitioner Viewpoint

Simple way to avoid the next Madoff...............................11

Top Ten Managers

From a new database ...............13

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OPALESQUE FUTURES

ISSUE 1 • 10 FEBRUARY, 2009

FOUNDING FATHER Q&A

2

Black Box Advantage in Hard Times
Martin Lueck, Aspect Capital’s president and director of research, reviews the past year and the outlook for managed futures. Mr. Lueck worked on quantitative model-based futures trading for over two decades. In 1987 he cofounded Adam, Harding and Lueck Ltd., widely known as AHL and now part of Man Group Plc. He co-founded Aspect in 1997. Aspect’s flagship fund returned more than 25% in 2008. Mr. Lueck came to managed futures through a happy accident after studying physics. The family of an school chum, Michael Adam, was in business delivering sugar to the futures market in London and ran a small commodities brokerage where Messrs. Adam and Lueck tried to make sense of a new-fangled technical trading model. The rest is not yet history but rather a continuing fascination with money-making black boxes.
Opalesque Futures Intelligence: Last year was a disaster for most types of investment. Why was managed futures an exception? Martin Lueck: 2008 was a showcase year for managed futures. This is not a flash in the pan, something that goes away. For 25 years we’ve been explaining to investors why they need managed futures in their portfolio. A fundamental benefit of the strategy is its non-correlation with equity and bond markets. In 2008, hedge fund investors were rueful at the lack of diversification in their alternatives portfolio. Managed futures is one of a startlingly few strategies that performed well last year and provides portfolio diversification, particularly in times of market stress. OFI: How did you manage to make money in volatile markets? ML: Aspect’s returns during 2008 had diverse sources. We trade such a wide variety of markets that we are very likely to find opportunity somewhere. We trade in over 100 markets, across seven different sectors. In 2008, our models took not only a short position in equities but a whole range of other positions. Early in the year we made money by being long in agricultural commodities and interest rate contracts. We profited from oil as it reached heady heights but we had a difficult July and August as the market reversed. We then unwound the long position in oil and went short, which benefited our performance. In futures, it is just as easy to go short as to go long. It’s absolutely symmetric in the positions you can take. That allows us to be nimble. OFI: What effect did the extreme turbulence in fourth quarter of 2008 have on your positions? ML: Actually, many of the trends were already established by then. For instance, equity markets had begun to slide and interest rate contracts were rising. A quantitative model gives you the

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OPALESQUE FUTURES

ISSUE 1 • 10 FEBRUARY, 2009

FOUNDING FATHER Q&A

3

confidence to stay with statistically established trends. What we trade depends on systematic modeling and statistical analysis of data, not gut feeling. The key is to manage the risk very carefully. Our models automatically scale back positions as markets become more volatile. As an example, our equity short positions were profitable at the beginning of the year, but as volatility picked up particularly in September around the Lehman Brothers collapse, we scaled them down even though the trend was continuing. OFI: How did the credit contraction affect managed futures? ML: The liquidity crunch that hit strategies like arbitrage was not a factor for us. We only trade in highly liquid markets. Our leverage is limited to what’s inherent in futures contracts. You trade contracts on margin—you might trade $90,000 of gold with a margin of $4,000 but there’s no borrowing involved. OFI: Are there opportunities in 2009? ML: My sense is that the global economy is not looking at a return to cheery times any time soon. If 2008 has been a painful year, I believe that there’s still more to run and more time to ride many of the trends. Similarly, the fallout from the collapse of the technology bubble in 2000 created opportunities for managed futures for some time thereafter. OFI: What conditions are bad for managed futures? ML: There are two situations when managed futures are likely to perform less well: very sudden reversals of direction and extended periods of calm when there are no trends. In the current environment, however, there are likely to be more trends, whatever the economic prognosis. For instance, if you look at the money governments are printing, you can certainly discern opportunities in interest rates. OFI: A lot of capital left hedge funds last year. What does that mean for managed futures? ML: I’d like to think that managed futures will get a larger slice of the smaller hedge fund pie. The strategy has certainly demonstrated its mettle.

OFI: What should people watch for when investing in managed futures? ML: A good manager will be willing to articulate to investors the principles behind the trades. Complex models should not be a barrier. The stigma attached to black boxes is misleading. If anything, it’s an advantage: the systematic process avoids the vagaries of human emotion and key-man risk. The models, however, have to be continually updated and developed. The landscape evolves all the time, not only in the markets but also in competition with

What we trade depends on systematic modeling and statistical analysis of data, not gut feeling.
traders, for instance. A manager who continues to use the same model without evolving it is a disaster waiting to happen. At Aspect we spend around 75% of our annual budget on technology and research.. Like a pharmaceutical lab searching for innovation, we try to take advantage of changes in market dynamics and find new nuances. Investors need to consider not only a management firm’s track record but also its investment and progress in research.

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ISSUE 1 • 10 FEBRUARY, 2009

INDEX TRACKER

4

You May be Surprised at the Variation in Returns
Managed futures did phenomenally well in 2008, but exactly how well depends on which index you consult. Here is a selection of managed futures/ commodity trading advisor indexes. The returns for the year range from around 10% to more than 20%--a significant range, with the high end of the spectrum about double the low end. Indexes vary because databases from different vendors do not contain the same set of programs or managers. Databases vary in size as well, from a few hundred CTA programs to thousands. Another reason for the differences is methodology—some use assets under management to weigh funds in calculating the index, whereas others give all funds, large and small, equal weight. There are pros and cons for both methods and the choice depends on a user’s needs. Using assets as weight means that the returns of larger programs dominate the index, which may work for users interested primarily in large programs but not for those assessing small ones. The EDHEC index is not derived from a separate database but rather is a combination of several indexes. EDHEC, a French business school, calculates combination benchmarks using an analytical method to capture as much information as possible from available indexes, so the measure may represent a wider section of the industry. Questions about index construction occur for all hedge fund strategies and even for widely used mainstream benchmarks—after all, even the Standard & Poor’s 500 comes in market capitalization-weighed versus equal-weighted versions. Different indexes have advantages under different conditions. Regardless of the index used, the fact remains that managed futures did spectacularly well compared to other investments. The only mainstream asset class that made gains high enough to be within the range of managed futures returns was—you guessed it, US Treasury bonds, with Barclays Capital US Treasury index making 13.7% .

2008 Performance
Barclay Hedge

14.6% 18.3% 12.2% 10.5% 20.2% 16.2% 15.6%

Credit Suisse/Tremont Managed Futures HedgeFund.Net CTA/MF Benchmark

FTSE CTA MF Index

Greenwich Futures

Hennessy MF Index

EDHEC CTA Global

Other Asset Classes
S&P 500

(-) 37% (-) 43% 5.2% 13.7%

MSCI EAFE

Barclays Capital US Aggregate Bond Index Barclays Capital US Treasury Index

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OPALESQUE FUTURES

ISSUE 1 • 10 FEBRUARY, 2009

INSIDER TALK

5

What’s Behind the Returns?
Sol Waksman is a veteran observer of commodity trading advisors. He started the Barclay Hedge CTA database in 1985 — after he sold his import business in the mid-1970s, lost money in supposedly safe bonds and learnt about futures markets. Here he talks about the reason for the stellar 2008 performance and what investors can expect from CTA strategies. Mr. Waksman grew up in Brooklyn, New York, but left several decades ago and says he enjoys Iowa small-town life.
Opalesque Futures Intelligence: Some investors used to say that they do not want to be in managed futures because of the big drawdowns. What was a bad year for managed futures? Sol Waksman: I’ve heard people say that. There is a lot of variation across managers and they can lose heavily if conditions are adverse. Even then, the loss in a diversified managed futures portfolio is small. 1999 was a bad year; our broadbased CTA index went down less than 1.2%. Like with any investment, you need to diversify the portfolio. OFI: What’s the main factor that accounts for profits and losses? SW: The most predominant managed futures strategy is some form of trend following. There has to be a sustainable trend for the methodology to identify. Much of the time markets don’t trend, they chop back and forth. In that kind of environment trend-following methodologies make a little, lose a little, but on balance tend to be flat. OFI: Last year managed futures indexes show robust gains even as almost every asset class had heavy losses (p. 4). What accounts for the 2008 performance? SW: What set 2008 apart from other years is that there were pronounced trends in all the major sectors. In the first half of the year there were rallies in agricultural commodities, industrial metals and energy. Interest rates went up while the dollar weakened. Then everything reversed in the middle of the year and there was another set of sustained trends across many sectors. Large trends in many markets made 2008 an outstanding year for CTAs. OFI: How does 2007 compare to 2008? SW: 2007 was not a bad year—CTAs made 7.64%. There were some trends, but not as many as in 2008. By the way, the return is positive most years. OFI: How do CTA returns relate to equity returns? SW: Managed futures have a neutral correlation to the stock market, which means you cannot predict the return in one area if you know the return in the other. So it is possible for managed futures to be down when the stock market is down, but typically managed futures do well when the broader market is under stress. That’s because under those conditions trends slowly build up and then accelerate. All the systematic traders get on board. OFI: From investors’ point of view, what’s an important difference between managed futures and hedge funds? SW: We’ve never seen gates come up when investors want to redeem from a managed futures fund. These are liquid markets and there are never any issues regarding portfolio valuation. Portfolios are marked to market every day. OFI: What would you advise an investor who’s considering managed futures? SW: Take a long-term view, diversify your portfolio, and be very honest with yourself regarding your risk tolerance. Managed futures is a basket of directional bets—that’s why you see higher monthly volatility than in other investment areas. So you have to be clear in your mind before you invest as to how much downside volatility you’re willing to accept. If people are too optimistic, the danger is they will get out at the worst time.

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OPALESQUE FUTURES

ISSUE 1 • 10 FEBRUARY, 2009

FUTURES LAB

6

Reliable Portfolio Diversification
In this series, we present research-based insights to help develop the understanding of managed futures, an often misperceived investment area. Sometimes people assume that, because the industry consists of money managers called commodity trading advisors, it is about just commodities. In fact the managers trade futures contracts in a wide variety of underlying markets— grains, foods, fibers, energy and metals, but also currencies, stock indexes and interest rate instruments ranging from Australian government bonds to US Treasury notes. That’s not the only misunderstanding. Some investors believe that managed futures add risk to a portfolio. Here Tim Merryman, a managed futures consultant at Intercontilimited.com and a CTA (Quant-Trade LLC), analyzes certain key risk and return characteristics of futures markets. His point: managed futures represent an ideal way to mitigate both market and systemic risk.
Futures markets are not the “casinos” many believe them to be. Rather, they act as insurers, like Lloyd’s of London or Swiss RE. But unlike traditional insurance or the more recently developed and much criticized credit default swaps, futures have long traded in centralized venues. In these futures exchanges, risk can be passed on by those who seek price stability – such as farmers or oil companies – to others who are willing to take this risk in order to earn extra profit. The two sides negotiate transactions to the satisfaction of both parties. Pork belly producers hedge the price of pork bellies by locking in a certain price for delivery at a future date, while meat processors use the futures contract to ensure they get an adequate supply of pork bellies. Many people who are unaware of futures instruments benefit from the steady, reliable and reasonably-priced supply of goods and services created by this mechanism. This has been going on in agriculture for two centuries in its current form and for millennia in the form of barter. The mechanism has developed way beyond pork bellies—though that specific market continues to be active. Financial futures have been trading for two generations and new instruments like weather futures have created new possibilities for transferring unwanted risk. For the modern investor, futures offer a way to offset risk in the portfolio. The past two years showed that diversification, the Holy Grail of modern portfolio theory, is elusive in a severe downturn. As the credit crisis of 2007 morphed into economic recession in 2008, investments that previously appeared to be diversified went down together. Everybody was forcibly reminded of an old adage—the only thing that goes up when markets go down is correlation. In contrast to other investments, managed futures proved to be a real diversifier and risk reducer. This is not surprising when you look at the historical track record of commodity trading advisors as a group and compare it to other asset classes.

Risk/Return Profile
Managed futures add real diversification to a portfolio for several reasons. For one, futures represent potential hedges against such factors as business cycle movements and inflation or deflation risk.

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OPALESQUE FUTURES

ISSUE 1 • 10 FEBRUARY, 2009

FUTURES LAB
Also, CTAs often target many markets using multiple strategies. These traders are almost uniquely flexible. Unlike mutual funds, managed futures programs are not limited in what they do. CTAs can buy and sell futures, write or purchase options, and speculate in bull or bear markets. They do not need to pursue a single view as a bull or a bear. A trader in futures markets can nimbly take positions across the world. Foreign exchange and financial index futures allow for global diversification without the need for a fine-grained focus on several thousand stocks or bonds worldwide. Moreover, by their very nature commodities are dependent upon global factors. These characteristics make managed futures diverge from major markets, unlike certain hedge fund strategies. Long/short equity returns, for instance, strongly track the US stock market with a correlation of 93%, whereas this correlation is negative 23% for managed futures (Table 1). What is more, CTA performance is not much related to fixed income—the correlation is 30%, according to Barclay Hedge. As last year demonstrated, managed futures tend to do well when equity and credit markets slump.
TABLE 1

7

12.4 12.2 12.0 11.8

25% Stocks1 25% Bonds2 50% Managed Futures3 Standard Deviation: 10.76 Compound Annual Return:

Jan 1, 1980 - Oct 31, 2008 1. Stocks: S&P 500 Total Return Index 2. Bonds: Lehman Long-Term Treasury Index 3. Managed Futures: Barclay CTA Index

Efficient Frontier 50/50 Stocks & Bonds/Managed Futures

Compound Annual Returns

11.6 11.4 11.2 11.0 10.8 10.6 10.4 10.2 9

11.41%

39% Stocks1 39% Bonds2 22% Managed Futures3 Standard Deviation: 9.33 Compound Annual Return:

10.88%

50% Stocks1 50% Bonds2 0% Managed Futures3 Standard Deviation: 11.18 Compound Annual Return:

10.42%

10

11

12

13

14

15

16

17

Annualized Standard Deviation

Source: Barclay Hedge

futures) presents an investor with the greatest risk and lowest return. A portfolio comprising 39% stocks, 39% bonds and 22% managed futures offers the best combination of return and risk. Countless investors might have been spared at least some of the financial destruction they endured in 2008 had they seen fit to allocate a small portion of their investment capital to this sector as a hedge against just the type of economic tsunami we’re experiencing. Indeed, the term “hedge” applies to this asset class much more accurately than it does to a hedge fund strategy like long/short equity or even distressed debt investing.

Correlation of Alternative Strategies to US Stock Market
Long/short Equity* Macro strategies* Distressed Debt Investing* Asset-Backed Lending* Managed Futures**

93% 77% 71 30% -23%

No Fat Tails
There is a common misconception that futures-related investing is a form of “speculation” and hence poses high risk. If anything, the opposite is true for the industry as a whole. While individual CTA programs can have large drawdowns, as a group they have a remarkably stable profile compared to almost any other asset class over the past decade. In a performance scorecard for both traditional and alternative investments from 1998 through 2007, futures returns are remarkable in being persistently positive and avoiding extremes (Table 2). One expects the worst and best performers to vary from year to year, but some asset classes show up frequently in either category. Thus commodity index returns often move from the very top of the ranking to the very bottom from one year to the next. There is a sharp contrast in this respect between the commodity index and managed futures, despite the commodity component of CTAs. Managed futures are never at the bottom of the ranking. Neither are they at the top. Through the market cycles, managed futures come out consistently in the middle of the distribution.

NOTES * From 2000 through 2007. Source: HedgeFund.Net Strategy Focus Report: Asset-Based Funds, March 10, 2008. ** 10-year period ending December 31, 2007. Source: Barclay Hedge.

A study published by the Chicago Mercantile Exchange concluded that for a 20-year period ending in 2008, portfolios with up to 20% of assets in managed futures yielded as much as 50% more returns than portfolios consisting only of stocks and bonds, with comparable risk. The graph below shows that a traditional portfolio (50% stocks, 50% bonds, and no managed

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OPALESQUE FUTURES

ISSUE 1 • 10 FEBRUARY, 2009

FUTURES LAB
Unlike equities or the commodity index, managed futures as a whole does not yield more than 30% a year – although individual managers can make very high annual returns in some conditions – but neither does it lose money. It stays within a
TABLE 2

8

relatively narrow band, ranging from 3% to 18%. In view of this history, CTAs stayed true to form during the 2008 storm. Far from adding to the danger, managed futures acted as a hedge.

Ten Years’ Markets Comparison* Best and Worst Performers vs. Managed Futures
Year Best Worst MF**

1998

Leveraged Equity 39.4%

Commodities (-)35.8%

10.2%

1999

Long/Short Equity 47.2%

REITs (-)6.5%

11.3%

2000

Commodities 49.7%

Int. Equity (-)14%

18.3%

2001

REITs 15.5%

Commodities (-)31.9%

3.3%

2002

Commodities 32%

Leveraged Equity (-)33.6%

3.2%

2003

Leveraged Equity 43.4%

Currency (-)14.7%

4.5%

2004

REITs 30.4%

Currency (-)7%

14%

2005

Commodities 25.6%

Bonds 2.4%

7.6%

2006

REITs 34%

Commodities (-)15%

5.8%

2007

Commodities 32.7%

REITs (-)17.8%

10.7%

* Source: From a scorecard prepared by Rydex Investments. Managed futures is represented by the Standard & Poor’s Diversified Trends Indicator, leveraged equity is S&P 500 leveraged 150% daily, commodities are represented by the Goldman Sachs Commodity Index, currency is the US dollar index, and REITs returns are from the National Association of Real Estate Investment Trusts. ** An asset class performance comparison for 2008 is on p. 2.

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ISSUE 1 • 10 FEBRUARY, 2009

REGULATORS & COURTS

9

Surge in Scams Found by CFTC
Already this year the US Commodity Futures Trading Commission took a number of actions that allege fraud or other violations, several involving foreign currency trading. CFTC acting director of enforcement, Stephen Obie, says there’s an uptick in Ponzi scheme cases because in this economic climate new investors cannot be found to perpetuate the scheme. The spike in cases may also be due to investors becoming more aware because of publicity about Bernard Madoff’s alleged $50 billion Ponzi scheme. And perhaps regulators became more active in the wake of questions as to why the US Securities and Exchange Commission did not stop Madoff despite repeated complaints that go back nine years or more. Recent actions taken by the CFTC include: • Charges against Minnesota resident Charles Hays and his company, Crossfire Trading, LLC, for a $5.5 million rip-off in connection to a commodity pool. The CFTC alleges that Hays falsely claimed Crossfire earned consistent profits from trading commodity futures with no losing months as he solicited money from at least three individuals and a charitable foundation. In addition, he fabricated account statements and misappropriated investor funds to purchase a $4 million yacht, from which he ran the scheme, according to the CFTC. A suit against Nicholas Cosmo and businesses he controlled, Agape World Inc., and Agape Merchant Advance LLC, all in New York state, for defrauding customers by soliciting tens of millions of dollars to invest in bridge loans and merchant advances. In fact the money was used and mostly lost in unauthorized commodity futures trading. The CFTC says the losses were not disclosed to investors and Mr. Cosmo has a criminal history. He pleaded guilty to mail fraud in 1999, admitting to commingling funds, misleading investors and forging documents. At that time he was sentenced to 21 months in prison. A court order freezing the assets of two firms called Atwood and two individuals, Michael Kardonick, who has multiple residences, and Gary Shapoff of New York state. According to the CFTC, the defendants made • extraordinary and false claims to solicit more than $1 million from retail clients to trade foreign currency options. They claimed that Atwood clients will never lose their principal and profits are virtually guaranteed, failed to disclose past criminal records and pretended to operate out of Rochester, New York, while operating out of Rio de Janeiro, Brazil. • Charges against James Ossie of Georgia and his company, CRE Capital Corp., for running a $25 million foreign currency Ponzi scheme. CFTC says Mr. Ossie and CRE promised investors a 10% return within 30 days from trading US and Japanese currency pairs but lost $4.4 million and paid some customers with other customers’ money. A court order imposing a fine and other sanctions against Boris Shuster of New Jersey for operating a forex boiler room that solicited more than 300 customers to trade illegal off-exchange contracts, misrepresenting the profitability and safety of trading such forex contracts. Charges against Joseph Forte of Philadelphia for operating a $50 million scheme in connection with an unregistered commodity futures pool, Joseph Forte LP. CFTC charged Forte with solicitation fraud, misappropriation of pool funds, sending false account statements and failing to register. The regulator reminded the investing public that US futures professionals must register and registration status may be checked on the National Futures Association website, www.nfa.futures.org. Individuals and firms that fraudulently solicit funds for futures and options trading are usually not registered with the CFTC, according to the Commission. Sanctions against four commodity pool operators for failing to file timely reports as required by regulation. Spring Mountain Capital GP LLC, Spring Mountain Capital LP, Fortis Investment Management USA Inc. and UBS Fund Advisor LLC were assessed a total of $275,000 in penalties.

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OPALESQUE FUTURES

ISSUE 1 • 10 FEBRUARY, 2009

NEWS BRIEFS
CME Reports Big Volume Changes
CME Group, the large futures exchange, says trading by members went down 21% from the third to the fourth quarter. It attributes the drop to extreme volatility in key contracts and normal seasonal slowdown as well as the credit crisis. Large hedge funds, one of the customer segments CME reported on, reduced trading volume by 32% and now account for 8% to 9% of the overall volume. But certain markets saw rapid growth in 2008, in particular E-minis, energy and metals products. Electronic trading continued to gain market share.

10

Man Group Offers AHL Notes
On January 26th Man Group Plc, the London-listed hedge fund firm, started to offer globally bonds linked to its futures trading program, AHL. The product, Man AHL Diversified Strategies Ltd, is available in US dollar and euro guaranteed bonds and as non-guaranteed income bonds. The guaranteed bonds come with a capital guarantee from Credit Suisse and target a higher capital return, while the income bonds pay a fixed annual coupon. The underlying AHL quantitative trading program returned 33.2% in 2008 and more than 20% annualized since its inception in 1996. Christoph Möller, Man Investments Global Head of Distribution, says Man AHL Diversified Strategies has the potential to achieve a low or even negative correlation to stocks and bonds and therefore reduce the volatility of a portfolio, whilst bringing an additional source of return.

Aussie Weather Contracts Start Trading Feb. 23
This month CME is expanding its temperature contracts to include the Australian cities of Melbourne, Sydney and Brisbane. CME director of alternative investment products, Felix Carabello, says they’re working with a broad group of customers, including energy companies, retailers and municipalities, to develop weather derivatives. “Like our other temperature-based products, these Australian contracts enable industries that face business uncertainty as a result of unusually hot or cold temperatures to transfer their risk exposure to the capital markets,” he said. The new listings, including Heating Degree Day and Cooling Degree Day contracts on both monthly and seasonal futures and options, are priced in Australian dollars. CME now offers temperature products for 45 cities and other derivatives on hurricanes, snowfall and frost.

IAM Starts CTA Fund of Funds
From press reports: International Asset Management, a fund of hedge funds firm, has launched the IAM Trading Fund with more than US$100 million in capital. The fund will invest in a portfolio of commodity trading advisers, starting with 10 to 15 CTAs. “The CTA strategy has consistently been IAM’s favoured strategy during 2008 based on the attractive risk/return profile, and we continue to be positive on the outlook for returns going into 2009. This fund will capture the opportunities present in the CTAs strategy while better diversifying risk for investors,” said IAM chief executive Morten Spenner, according to reports.

Dubai Contracts Go Electronic
The Dubai Mercantile Exchange Ltd., an energy futures and commodities exchange, completed the migration of its contracts to the CME Globex electronic trading platform where they became accessible for trading as of early February. This means the world’s three crude oil benchmarks - WTI, Brent and Oman will trade on the same platform. CME Group, through its acquisition of NYMEX, holds a 26% equity stake in DME. Other shareholders are a Dubai holding company called Tatweer, the Oman Investment Fund and a group of financial and energy companies including Goldman Sachs, Morgan Stanley, JP Morgan, Vitol, Shell, Concord and Casa Energy.

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ISSUE 1 • 10 FEBRUARY, 2009

PRACTITIONER VIEWPOINT

11

Simple Way To Avoid the Next Madoff
By Walt Gallwas
Mr. Gallwas is president & founding partner of Attain Capital Management, a specialized asset management firm that focuses on alternative investments such as managed futures programs.
It’s easy to say investors should have done more due diligence before giving their money to Wall Street veteran Bernard Madoff, whose $50 billion alleged Ponzi scheme continues to grab headlines. Crooks figure out how to stay one step ahead—more due diligence, questions asked and regulations lead to ever more elaborate schemes. If a smart man like Mr. Madoff really wants to deceive people, he finds a way. One easy solution is often overlooked in the discussions on how to avoid fraud. It’s like the old story about the man who goes to the doctor to complain that it hurts when he moves his arm a certain way. The doctor replies: then don’t move your arm like that. If you are concerned about fraud when investing in privately offered funds, then don’t put your money into a fund structure. Instead, use individually managed accounts. It happens that one of the few asset classes enjoying gains last year, managed futures, is also a pioneer in individually managed accounts. These are accounts in the client’s name, managed by someone else. The manager places trades directly into the client’s account, reviews the balances and positions in that account, and adjusts the positions for that specific account. The checks go to the clearing firm, the client controls the money, and the manager only controls the trading. By contrast, when you invest in a pool, your money becomes part of the fund and you own a share of the fund’s total assets. The manager places trades in a single fund account – not the individual accounts of hundreds of investors – and reviews the positions for the overall fund. He or she controls the fund and has the ability to write checks on the assets. Not to be too cynical, but a manager could decide to cash the whole fund out and head to the Caribbean, if so inclined.

Fund Hazards
That’s not all. Fund structures have other risks, not related to investment strategy or markets, that separate accounts do not have. There is redemption risk, as became glaringly apparent in 2008 because of the huge net outflows from hedge funds. When a large portion of a fund’s investors ask for their money at the same time, the liquidation of portfolio positions causes unexpected losses that can lead to further redemptions, further losses and so on in a downward spiral. Funds usually attempt to prevent this problem by limiting redemptions to certain periods or in some cases not allowing redemptions until the withdrawal requests can be matched with available assets.

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OPALESQUE FUTURES

ISSUE 1 • 10 FEBRUARY, 2009

PRACTITIONER VIEWPOINT
With an individually managed account, by contrast, there is no effect from other investors leaving the program. An investor looking to cash in her investment merely has all of the positions in her separate account liquidated and the cash sent to her. There are no duration or asset mismatches to deal with. There is also transparency risk to consider. An example is the blowup of Amaranth hedge fund two years ago. The fund lost around $4 billion trading natural gas futures. It was supposed to be diversified yet was concentrated in a simple bet on natural gas price spreads. Investors did not know how concentrated Amaranth’s portfolio had become because there was no transparency. Funds lack transparency by design because managers – typically concerned about their strategy being imitated or taken advantage of – do not want the public (and competitors) to be able to see what’s happening in the portfolio. Individually managed accounts, on the other hand, are set up in a way that allows you to see everything that is going on in your account day by day. This insures that there will be no big surprises like 80% of your account turning into a bet on the price of natural gas. If something strange is going on, you will be the first to see it. It is one thing to lose money because a manager traded poorly or market conditions were adverse, quite another to lose because a manager did not match investment duration with redemption structure, put all the money into one huge bet, or committed fraud. Due diligence aims to identify non-investment risks so that you can separate those from trading risks. Separately managed accounts achieve that goal, whereas due diligence can fail to do so, as we saw in the spectacular Madoff affair.

12

Futures Advantage
Now, proponents of funds may say that while individually managed accounts are great, the minimum necessary to have an advisor manage your specific account is too high. The fund structure, they might say, is the only way for smaller investors to get access to trading strategies which may require hundreds of millions of dollars of capital. They do have a point—you can’t do merger arbitrage, statistical arbitrage, or private equity deals with an individually managed account unless you have around $100 million in the account. An insistence on having your own account would keep you out of plenty of very good hedge funds. But most good hedge funds have too high a price tag anyway. Perhaps if you can’t afford to do it in your own account, you shouldn’t be looking at that type of investment in the first place. That brings us back to managed futures and individually managed accounts. Unlike hedge funds with their large minimum investments, there are quality managed futures programs where you can invest using an individually managed account with minimums as low as $50,000—such as Clarke Capital Management. With managed futures you get affordability and the protection of individually managed accounts. The protection means you don’t have to worry about the fraud, redemption and transparency risks associated with funds. The manager does not have access to your money, other investors’ redemptions don’t affect individual accounts and you can see all the trades put on for you. Bad things can still happen in an individually managed account, of course. A manager could put on trades inappropriate for the agreed-upon strategy, say. But such problems can be identified early on, before they progress. That way, you won’t learn from news headlines that your investment is wiped out due to fraud or positions you had no idea you were in.

Copyright 2009 © Opalesque Ltd. All Rights Reserved.

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Global. Personal.
Newedge is an innovative new player in brokerage. Proactive and impartial, we serve institutional clients worldwide. With a dedicated approach based on understanding and anticipating your needs, we partner with you worldwide to facilitate your strategies.

Global Asset Execution Global Asset Clearing Prime Brokerage

www.newedgegroup.com

“Newedge” refers to Newedge Group and all its worldwide branches and subsidiaries. Only Newedge USA, LLC and Newedge Financial Inc. are members of FINRA and SIPC (although SIPC only pertains to securitiesrelated transactions and positions). Newedge Group (UK Branch) and Newedge Group (Frankfurt Branch) do not deal with, or for, Retail Clients (as de ned under MiFID). Only Newedge Canada Inc. is a member of the CIPF. Not all services are available from all Newedge organizations or personnel. Consult your local o ce for details.

OPALESQUE FUTURES

ISSUE 1 • 10 FEBRUARY, 2009

TOP TEN

13

We will feature top managers from a different database every month.
The list below comes from Managed Futures Europe, a relatively new database that contains 574 programs with combined assets under management of $36 billion. The database has investment programs from all over the world, but the emphasis is on companies trading in Europe. Of the programs, 55% are systematic, 11% are option specialists, 19% are forex traders, and the rest are in other strategies.

Managed Futures Europe December 2008 Top Ten Programs
Program Company December 2008 Annual

FTSE 100 Index Options (leveraged and uninsured)

Oxeye Capital Management

34.7%

7.8%

Pere Trading Program

Pere Trading Group LLC

20.3%

131%

Global Diversified

Villano Capital Management Inc.

17.5%

76.5%

International Equity Plus Fund

Schindler Trading

17.4%

-30%

MS4

Futures Truth CO

15%

50.9%

FX & Financial Program

Clarke Capital Management Inc.

13.3%

60%

Magic Capital Fund LP

Washington Asset Advisors LLC

12%

6.5%

Magic Capital Fund LP

Washington Asset Advisors LLC

12%

7.7%

Options

ArborVitae Capital

11.6%

13.7%

Superfund Gold B SPC

Superfund Trading Management Inc

10.8%

44%

Copyright 2009 © Opalesque Ltd. All Rights Reserved.

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PUBLISHER Matthias Knab - knab@opalesque.com EDITOR Chidem Kurdas - kurdas@opalesque.com ADVERTISING DIRECTOR Denice Galicia - dgalicia@opalesque.com EDITORIAL ADVISOR Tim Merryman - tmerryman@opalesque.com CONTRIBUTORS Bucky Isaacson, Frank Pusateri, Pavel Topol, Ty Andros, Walt Gallwas.

www.opalesque.com
Copyright 2009 © Opalesque Ltd. All Rights Reserved.

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