Tuesday, 20 September 2022

What exactly is a CTA?

When I use a word... it means just what I choose it to mean

CTA. An industry standard term, that seems straightforward to define: Commodity Trading Advisor. We can all name a bunch of CTAs - I used to work for one. There are indices for them, such as this one or this one (also this, and this, oh and this, plus this, and these guys have one, as do these guys, oh and dont' forget this one ... I probably missed some but I'm bored now).  But in practice, the term CTA is a somewhat ill defined term with multiple overlapping meanings. Let's dive in.

Advising and managed accounts

The most intriguing word in the term CTA is the final one: advisor. CTA's are not fund managers in the normal sense of the word. 

Fund managers normally do this: They take your cash and comingle it with others in a legal vehicle, selling you shares in the vehicle in exchange. Then they go out and buy assets with the cash. You don't legally own the assets - the fund does. There's normally a second legal vehicle which is responsible for actually managing the fund - the fund manager. You don't own shares in that. 

The CTA is a bit like the second legal vehicle in a standard fund structure - it advises but doesn't actually own the assets. But in a traditional CTA structure the assets are not comingled but kept seperate. So it works as follows: you open a managed account and put some cash into it. The CTA fund then makes decisions about what that account buys or sells. Importantly, you still own the assets in the account. If something happened to another customers assets, it wouldn't affect you.

Note that the advisory term is a bit misleading as it implies that you have full trading discretion on the account, and the CTA ocasionally rings you up and advises you about what you might think about trading. That may have been the case in the 1970s when CTAs started to become popular, but nowadays CTAs almost always trade customers accounts for them, often with automated execution algos that are a world away from requiring someone to pick up the phone. 

Choice of instrument

In theory any asset can be put inside a managed account, but they have normally been used to trade futures. The combination of a managed account and futures trading brings us to the term managed futures which is often used interchangeably with the designation CTA. Since CTA is a term of US legal art, this definition is safer and can be used across geographical regions.

An important implication of this is that you need a fair bit of money to have a managed account. To hold a properly diversified portfolio of futures with anything less than a few tens of millions, without running into discretisation issues is tricky, as I've discussed at length on this blog. There are also admin and operational fixed costs associated with having a number of managed accounts.

Over time many CTAs have gradually increased the minimum required to hold managed accounts, or have switched to using non managed account structures, which also allow them to trade assets that aren't futures. 

The asset class 

You might think that commodity trading advisors manage commodities: things like Wheat and Crude Oil. The easiest way to manage such things, especially in a managed account type setup, is through futures contracts.

However it's pretty rare for a CTA to only trade commodity futures. Nearly all of them also trade financial futures like the S&P 500 equity index or US 10 year bonds (there's perhaps an argument about whether metals like Gold are commodities or not).

Over time, CTAs have begun to trade non futures instruments. For example, it's hard to get adequate diversification in FX with just the available futures contracts. Adding FX forwards makes a lot of sense in this context, as they are very similar to futures although obviously OTC rather than exchange traded. This has implications for the legal structure of the CTA, since you can't easily put these in managed accounts.

The legal / regulatory definition

CTA is a US regulatory term. From the horses mouth:

Commodity Trading Advisor (CTA) Registration

A commodity trading advisor (CTA) is an individual or organization that, for compensation or profit, advises others, directly or indirectly, as to the value of or the advisability of trading futures contracts, options on futures, retail off-exchange forex contracts or swaps.

There's quite a bit to unpick there. The most obvious is this: the advisor is expected to advise, suggesting a managed account structure rather than a traditional structure. Secondly, and contrary to what has been stated before, you can be a CTA and manage non futures assets. This is somewhat alien to the concept of managed futures, but reflects the reality of the modern CTA industry. 

Trading style and speed

Until now I haven't discussed exactly how the CTA trades, only what it trades, and the legal structure set up to do that trading. In theory a CTA could be anything from a high frequency futures trader, up to a slow moving risk parity fund. They could be doing pure trend following, or some dangerous combination of carry, mean reversion, and a systematic short position in VIX.

Generally though when people refer to CTAs or managed futures they are mostly expecting such funds to trade medium to slow speed trend following. This is pure path dependence and tradition - there is nothing in the CFTC or NFA definition that says you have to trade like this. But because CTAs have been around for a while, and because trading costs where higher in the past, and because trends work well in futures particularly during the inflation ridden era when CTAs came to prominence, and because trends work better for holding periods between a few months and a year... for all of these reasons the CTA industry grew up as fairly slow trend followers.

(Remarkably this is true of both the US and European 'wings' of the CTA industry; even though the latter grew up fairly independently.)

There is a degree of self reinforcement here. CTAs have done very well in several market downturns, leading to the mythical status of 'crisis alpha'; something that is both uncorrelated and yet provides a positive return, plus nice skew properties. Some of that is just maths - a trend following strategy will have the payoff function of a long straddle and positive skew when judged at the right time horizon - and some of it may be myth, luck, or due to secular trends and correlations that may not hold in the future. But as a marketing story it's certainly become popular in certain circles, which means that many clients expect CTAs to have a certain trading style to fit within their particular style box.

However the fact that there are now seperate 'SG CTA', 'SG CTA Trend', and 'SG Short term' CTA indices suggests there is now more to the industry than slothful trend followers.

Note: The HFRI index family does not use the term CTA, but does have the following confusing set of indices:

  • HFRI Macro: Systematic Diversified Index 
  • HFRI Macro: Systematic Directional Index 
  • HFRI Trend Following Directional Index 

Systematic or discretionary

The very first CTAs can really only have been discretionary; men (back then, always men!) in green eye shades in darkened rooms looking at point and figure charts. However the use of trend following naturally lends itself to a systematic process. Systematisation also allows maximal diversification across numerous futures instruments, something that will improve expected performance.

The term CTA has thus become synonymous with systematic trend following. 

Notice that systematic is not the same as automated. It's possible in theory to have a fully systematic process which is hand cranked, or done in spreadsheets or with a calculator. The original turtles operated in such a fashion. But the easy availability of computer power means that the generation of trades in the vast majority of CTAS is now done in an automated fashion.

The modern CTA

A modern CTA may well still have some legacy managed accounts, or accounts opened for particularly large clients who want that traditional structure, but they are more likely to have morphed into a more typical hedge fund setup.

Instead of opening a managed account clients will buy shares in various legal investment vehicles, and there is usually a good offering of alternative jurisdictions (both onshore and offshore), currencies and types of fund (eg UCITS). In many cases a single legal vehicle may have different share classes, offering different currencies or degrees of leverage. 

(Another possibility is that the CTA uses a master-feeder structure. The client puts money into a feeder, which in turn is invested in various master funds. For example, a CTA might offer a variety of options that blend between a more traditional futures trend following fund, and an alternative that holds OTC assets.) 

These various funds will then have futures accounts opened them. Arguably these are also managed accounts, but the legal owner of the assets within them are funds not the final clients, so this is different from the traditional setup. 

However the investment funds can also go out shopping for assets that aren't futures. These can include other on exchange assets, like options on futures, or equities; or OTC assets like FX forwards, interest rate swaps or cash bonds.  This gives the clients access to a more diviersified set of instruments, something that would be extremely difficult in a traditional managed account structure. Consider for example the hassle of setting up 50 ISDA agreements for 50 $20 million managed accounts, rather than a single $1 billion fund.

It's likely that a modern CTA is fully systematic and automated up to the point of trade generation, although many funds will outsource the execution of their trades to in house human traders or external brokers. 

The variety of trading strategies is probably the area where the industry remains most heterogeneous. 

Many CTAs probably still have some medium speed trend following at their core, and may offer funds that are purer, but will have plenty of other signals such as carry and mean reversion. They may also offer funds that are very different but leverage off their experience, such as leveraged risk parity or equity market neutral. But this is a generalisation, and there are plenty of CTAs that have stuck more to their traditional knitting of medium speed trend following "plus nothing". We can even have a further debate about what does, or does not, constitute the correct use of the word trend following - but perhaps we should not do that today!


In summary, when you say CTA you may mean something quite different from what I mean. There is no such thing as a 'pure' or 'true' CTA. This is most true when it comes to defining the trading style. CTA is a poorly defined term, but it seems we are stuck with it (after all, 'managed futures' is not much better!).