EDHEC Asset Management Days. Workshop B: Revisiting Managed Futures & Commodities

EDHEC Asset Management Days Workshop B: Revisiting Managed Futures & Commodities Monday March 12th 12:00 1:15pm Chaired By: Valere Costello CEO, Invesdex

Workshop Structure Presentation: 20 min Panelist Feedback: 20 min Audience Q&A Session: 30 min

Workshop Panelists: Valere Costello CEO, Invesdex Richard Spurgin Professor, Clark University Hilary Till Premia Risk Consultancy Miroslav Mitev Managing Director, Siemens, PSE E&I Fin4Cast Nicholas Verwilghen Partner, Head of Quantitative Research, EIM Christophe Khaw Head of Research, Calibria Financial

Managed Derivatives in Diversified Portfolios: Current Research Richard Spurgin Associate Professor of Finance, Clark University Associate Director, Center for International Securities and Derivatives Markets Principal, Alternative Investment Analytics LLC

Overview Review of recent performance Key issues related to asset allocation and selection New research: Alternative betas in managed futures Alternative betas in commodities Mar 12 2007 5

Performance of CASAM/CISDM CTA Indexes in 2006 (Asset Weighted) 20% 15% 10% 5% 0% -5% CTA DIV CURR FIN PHYS EQUITY DISCR SYST Mar 12 2007 6

10-Year Performance of CASAM/CISDM CTA Indexes (Asset Weighted) 1997-2006 15% 10% 5% 0% CTA DIV CURR FIN PHYS EQUITY DISCR SYST Mar 12 2007 7 *Physical CTA Index begins Jan 2001

Downside Risk Management Downside Risk Reduction: Some assets reduce portfolio losses while preserving possibility of portfolio gains Put options: Have a negative correlation with portfolio Reduce risk and reduce return CTAs offer downside risk protection for equity portfolios without reducing return Mar 12 2007 8

Equity Portfolio Protection Sep - Nov 87 Apr - Jul 02 Jun - Sep 01 Jul - Aug 98 Feb - Mar 01 Jun - Oct 90 Sep - Nov 00 Sep 02 Dec 02 - Feb 03 Aug - Sep 81 Feb - Mar 80 Dec 81 - Mar 82 Sep 86 Dec 80 - Jan 81 Feb - Mar 94 Jan - Feb 00 Jan 90 May - Jul 82 Jul - Sep 99 30% 20% 10% Declines in the S&P 500 of Greater Than 6% Since 1980 0% -10% -20% -30% -40% S&P 500 Managed Futures Hedge Funds Managed Futures: CISDM (Center for International Securities and Derivatives Markets) Trading Advisor Qualified Index Hedge Funds: HFR (Hedge Fund Research) Fund Weighted Composite Index Mar 12 2007 9

Equity Portfolio Protection Performance of CISDM CTA Index in 20 Worst SP500 Months 1990-2006 12 8 4 0-4 -8-12 -16 Jan-90 Aug-90 Sep-90 Jun-91 Mar-94 Jul-96 Aug-97 Aug-98 Jan-00 Sep-00 Nov-00 Feb-01 Mar-01 Aug-01 Sep-01 Apr-02 Jun-02 Jul-02 Sep-02 Dec-02 Mar 12 2007 10

Managed Futures vs. Long Equity April 2001 to March 6, 2007 2.00 Value of $1 Invested in CISDM "35/35/20/10" Passive Trendfollowing Portfolio and CISDM Global Long Equity Futures Portfolio April 2001 to March 7 2007 1.50 1.00 0.50 0.00 Apr-01 Oct-01 Apr-02 Oct-02 Apr-03 Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Mar 12 2007 "35/35/20/10" are the risk budgets assigned to Currency, Interest Rate, Physical Commodity, and Equity Strategies. Portfolio is 11 levered to a target volatility of 15% per year. All returns (including the long equity index) are excess returns.

Style Persistence Pro forma performance has some uses CTA style persists through time Volatility Standard deviation of CTA returns is predictable Beta Correlation with other CTAs is predictable Portfolios constructed from CTAs with low historical betas perform better than portfolios constructed based on high recent returns Monthly rebalancing adds as much as 1% per year Mar 12 2007 12

Portfolios of CTAs Reduces Volatility 50 Volatility of Randomly Selected Multi-Manager CTA Portfolios Annualized Portfolio Standard Deviation 40 30 20 10 Upper Confidence Bound Average Standard Deviation Lower Confidence Bound 0 0 10 20 30 40 50 60 70 Number of Randomly Selected CTAs Mar 12 2007 13

Accounting for Survival Bias On average, 16% of CTA programs cease trading each year (sample period 1988-1996) These CTAs underperform surviving CTAs by 17% in the final 12 months of trading Survivor bias may result in pro forma returns overstating actual CTA returns by about 2.7% per year Mar 12 2007 14

Performance Prior to Dissolution Performance Relative to All CTAs (%) 1 0-1 -2 Relative Performance in 24 Months prior to Dissolution Monthly Performance of Nonsurving Subsample -3 24 22 20 18 16 14 12 10 8 6 4 2 Months until Dissolution Mar 12 2007 15

New Research on Passive Benchmarks MSFB indexes (Managed Futures Security-Based) is a mechanical trendfollowing model that holds a diversified portfolio of short, medium, and long term signals across 25 futures markets). Has been running since 1998, modified in 2001 and 2003. Mar 12 2007 16

Multi-Factor Model R i = α i + β i,1 F 1 + β i,k F K + e i Where: Ri = Return on fund i α i = Abnormal Return (or Alpha) for portfolio i βi,1 = Beta Coefficient of fund i for Market Factor K or Trading Factor K F K = Return on Market Factor K e i = Statistical Noise of fund i Mar 12 2007 17

Alpha of Selected CTA Benchmarks 8% 6% 4% 2% 0% -2% -4% -6% -8% Benchmark (Excess Return) Comparison of Investible CTA Indices: 2001-9/2006-10% T-Bill Sharpe Ratio CAPM MLM Composite Index MFSB Composite Index CASAM/CISDM CTA Asset Weighted Index S&P Managed Futures Investible Index S&P Managed Futures Investible Index CSFB/Tremont INVX Managed Futures Index FTSE CTA/Managed Futures Index CSFB/Tremont SECT Managed Futures Index Mar 12 2007 18

Summary of Results The trend-following component of a managed futures portfolio is an alternative beta that is easily benchmarked, though may be difficult to replicate. Notes: CTA returns are based on manager-reported fee levels, do not include fund-of-fund fees, etc. No fees/transactions costs deducted from the MSFB or MLM returns. Mar 12 2007 19

Alternative Betas in Long-Only Commodity Investment New research Introduces the cash allocation as a means of reducing risk. Value-weighted: Rebalances each day to maintain target exposure and weight. Dynamic asset allocation strategy overweights certain commodities based on recent momentum. Application of traditional Managed Futures strategies to the long commodity sector. Mar 12 2007 20

Index Allocation Strategy A three- step process designed to enable dynamic exposure to commodities while providing downside protection. Strategic Targets Systematic Asset Allocation Strategy Tactical Targets Daily Roll and Reallocation Allocation Decision Determine commodities to be included Define maximum allocation to each commodity Key price trend signals dictate exposure targets Expressed as a percentage of the maximum strategic allocation Net allocation targets with daily roll requirements Minimize turnover while implementing dynamic allocation Mar 12 2007 21

Performance Attribution While existing commodity indexes offer a single source of return of commodity beta, the sources of return come from 1) commodity beta, 2) daily roll and 3) systematic asset allocation factors. Beta: 70% Position in nearest expiration RV: DR: 70% Position spread over two delivery months Systematic Momentum Asset model ± 30% Allocation +30% 100% Max 40% Min 600 500 400 300 200 100 Cumulative Factor Returns for BCI Systematic Asset Allocation Factor Daily Roll Factor Beta Factor 0 Beta Factor: Daily Roll Factor: Systematic Asset Allocation Factor: The return from holding the active contract until the contract roll date. The return from the forward delivery curve for commodities. Utilizes a momentum-based trading rule to hold more or less of a given commodity depending on recent price movement. Mar 12 2007 22

About CISDM Non-profit academic research center affiliated with the Isenberg School of Management at the University of Massachusetts Editorial center for The Journal of Alternative Investments (an Institutional Investor journal) Supports research in alternative investments and asset allocation strategies For more information and copies of selected articles, go to www.cisdm.org Mar 12 2007 23