OPALESQUE FUTURES

ISSUE 17 Dec 01, 2009

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ISSUE 17 Dec 01, 2009

In This Issue
Founders Q&A
What are the opportunities for global macro investing in the current highly uncertain environment? Third Waves investment chief uses a combination of quantitative and non-quant tools to identify attractive trades. .........................2

Models and Children

Global macro did better than systematic trend following this year. Macro consists primarily of discretionary investment styles; by contrast, trend followers rely on computerized models. You might compare two people trading the same set of futures contracts and find that the discretionary manager made money while the quant did notsee our News Briefs and Top Ten for some comparisons. Of course, 2008 was a different story. In Founders, Larry Smith gives us a perspective on how different methods work under certain conditions. Having talked with Larry over the years, I have long been impressed by his ability to use macro economic themes to understand particular markets. His experience making investment decisions at Credit Suisse and JP Morgan no doubt helped hone his skills. My own impression is that in recent years quant traders including top quantitative managers have on the whole been less successful than they were in the past. But that impression may be misleading, Insider Talk with Rishi Narang suggests. Quantitative strategies are attracting investors. Solidly on the quant side, Rishi literally wrote the book about quantitative strategies and succeeded in getting inside the metaphorical back box. He tells us why he likes to invest with quant managers. I think youll agree that Rishi is a remarkably thoughtful investor, whether or not you share his view. In Manager Profile, Quantum Forecasting presents an excellent example of the novel quantitative methods being applied by CTAs. And in Futures Lab, an expert lawyer discusses how to protect a quants valuable propertythe computer code. Models, it seems, can perform wonders but require human supervision as they churn out signals. They may be like exceptionally clever little children who do mischief if left to their own devices.

Futures Lab

How do you protect your algorithms? Intellectual property lawyer Alexandre Montagu explains. .....................................5

Insider Talk

Rishi Narang, founder of Telesis Capital and author of Inside The Black Box, makes the case for short-term quantitative trading. ..................................8

News Briefs

Managed futures vs. macro returns, Abbey, Altegris, Dubai oil futures and more. .............................................................11

Manager profile

Quantum Forecasting takes a systematic approach but differs from most CTAs. ................................................................15

Practitioner Viewpoint

Trading trends from Saratoga Futures and SunGard. .............................................17

Top Ten

Systematic vs. discretionary traders. ....19

Chidem Kurdas, Editor kurdas@opalesque.com

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OPALESQUE FUTURES

ISSUE 17 Dec 01, 2009

FOUNDERS Q&A

Blending Quantitative and Discretionary Tools

We wanted to present a distinctive global macro perspective on investment opportunities in current markets. Luckily we got hold of Larry Smith, chief investment officer and co-founder of Third Wave Global Investors LLC, an investment advisor registered with the US Securities and Exchange Commission. Mr. Smith has a hybrid style that is an interesting counterpoint to both purely quantitative strategies and purely discretionary macro. Combining quantitative and discretionary analyses, he looks at model-driven trades from a macro economic vantage point. Here, he discusses different strategies in the context of 2008-2009 and gives examples of current applications. Laurence Smith

I try to determine if the underlying economic trends support the models forecast.

Before starting Third Wave five years ago, Mr. Smith was global chief investment officer of Credit Suisse Asset Management, at the time the 15th largest asset manager in the world with around $300 billion in assets. He had responsibility for investments worldwide, including hedge fund offerings. In 2002, he simultaneously served as chief executive officer of CSAM Americas. From 1981 to1999, Mr. Smith was at JP Morgan Investment Management, part of the time as the global head of asset allocation and balanced account management worldwide. At Third Wave, his strategy is more systematic than a typical global macro managers. But it has a large discretionary component and includes economic fundamentals.

Opalesque Futures Intelligence: Whats your take on current markets? Laurence Smith: It seems to me the environment is changing. Stocks, bonds, commodities and currencies all moved in one direction for most of 2008 and then in the opposite direction for most of 2009. We had very big down moves followed by very big up moves. Momentum-based strategies did well on the whole. But the enormous directional trades that worked in the second half of 2008 and in the opposite direction since March in 2009 are now behind us. OFI: What does that mean for investment strategies? LS: Strategies that rely on there being a prolonged move in one direction will have a tough time for the next 12 to 24 months. Strategies that are able to capture volatility and identify valuation mistakes have an advantage. OFI: Whats the lesson from 2008-2009 for macro and commodity trading advisors? LS: Almost everything that worked for a long time did not work in 2008. Momentum was the outlier; it worked even better than it did in the past. This year, theres been a wholesale adjustment in markets and conditions are becoming more normal, so fundamentals should be the winning strategy.

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OPALESQUE FUTURES

ISSUE 17 Dec 01, 2009

FOUNDERS Q&A
As a result, many CTAs are concerned about their reliance on momentum and want to diversify their tools. OFI: How do you know economic fundamentals are becoming more important? LS: One of the things we see is that correlations between risky markets, which all rose dramatically on the downside and remained very high for most of this year, are now starting to decline to a more normal state. Now you see days when the Hong Kong stock market is up while Taiwan is down. All markets are starting to move in directions more consistent with their fundamentals. Even in currencies, it is no longer just one big dollar trade or one big carry trade. Fundamentals are starting to differentiate markets within an asset class. So people who can correctly identify fundamentals should be in very good shape over the next year. OFI: How do you account for fundamentals? LS: I combine systematic modeling with discretionary global macro. There are very few managers in our niche. Most macro traders are either systematic CTAs who use trend- following rules or discretionary traders who try to figure out winners and losers based on broad economic themes. We have a model, but it is based on fundamentals rather than purely technical tools. And then we layer on top a discretionary process that looks at fundamentals in a different way. OFI: Does your approach exclude trend following? LS: There is some trend following but it is a small portion of what we do. Most of the time we try to figure out the direction of the market using fundamental signals, combining signals from different categories of tools. OFI: Why dont you let the model run the trades? LS: Despite all the advances in technology, our ability to quantify market movements is ultimately limited. We know there are relationships out there that we cant model. So I try to determine if the underlying economic trends support the models forecast. When they dont, I intervene. One of the things the model does very well is determine the size of a bet, and this is an area where quantitative techniques have an advantage over a purely discretionary process. We therefore use the model to help figure out how much to put in a particular market. OFI: Would you give an example of how your approach works? LS: Take the Australian dollar, which may now be the most attractive asset on a risk-adjusted basis. Our model loves the Australian dollar. This currency has rallied dramatically over the past six months, but the fundamentals all suggest it will go higher. There is good reason to expect this. Chinese economic policy has been extraordinarily successful in stimulating growth and Australia is a beneficiary of that. Chinas focus on commodities means that they will invest heavily in Australia. So we see no reason not to follow the model with respect to this trade. At the same time, our

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model is not particularly sanguine on the Canadian dollar, yet our discretionary process leads us to believe that it, too, will improve relative to the US dollar. OFI: Why do you like currencies? LS: There is a lot of opportunity in FX, in both developed and emerging market currencies. Take the Korean won. It has gained back some of its previous loss against the dollar but is still low relative to where it was before the crisis. Economic fundamentals came back surprisingly quickly in Asia and strongly favor Korea over, say, the US. There is every reason to expect the Korean won to get back to the higher exchange rate it had two years ago. OFI: Which other markets do you like? LS: Residential mortgages, which got beaten down so badly in the crisis, are an interesting area of the markets. Very liquid mortgages have rallied dramatically, but less liquid mortgages are still priced based on the dire default and recovery rates of the last year. Conditions will get less dire, and these less liquid mortgages will continue to recover. Credit markets, despite having rallied dramatically, have more to go. The bounce-back in economic conditions, combined with explicit government policies aimed at restoring the credit markets, will lead credit spreads to far narrower levels than exist today. OFI: Why are investors nervous? LS: The level of uncertainty is very high. You cant have the greatest financial crisis since the Great Depression and not have extraordinary uncertainty. There is reason for optimism; economic data is on the margin quite positive. In other words, fundamentals are improving. Yet it is not so compelling that you can forget about the problems. Maybe three out of five data points are positive. The remainder are negative.

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OPALESQUE FUTURES

ISSUE 17 Dec 01, 2009

FUTURES LAB

Protecting the Code

A major hedge fund scandal concerning intellectual property erupted this July. A former Goldman Sachs computer programmer, Sergey Aleynikov, was arrested by the FBI for stealing a trading model he had created for the bank. According to court papers filed by the prosecutors, the proprietary computer code in question facilitates sophisticated, high-speed and high-volume trades on various stock and commodities markets. At the time Mr. Aleynikov was employed by Teza Technologies, a new trading business founded by three former executives of Citadel Investment Group, Ken Griffins $12 billion hedge fund firm. Citadel sued the three former executives, accusing them of violating non-competition agreements and committing industrial espionage. The suit revealed some of the measures Citadel takes to protect its software. It is useful to have practical guidelines as to intellectual property, especially as computer models are essential for commodity trading advisors, quantitative traders in general and certain macro managers. This is a complex and changing area of law. MontaguLaws Alexandre Montagu, an expert on intellectual property issues, provided the explanations and pointers below. Mr. Montagu started his career at law firm Sullivan & Cromwell LLP and served as general counsel to a number of companies. He works on international commercial transactions and new media law as well as intellectual property.

Every firm needs to have a strategy on how to deal with intellectual property. If you let events shape your responses instead of thinking through it beforehand, you can end up with unexpected and unpleasant consequences. It is best if there is a unified and documented strategy that everybody in the firm agrees to. With respect to intellectual property in a commodity trading advisor or hedge fund setting, there are key facts and issues to keep in mind, whether youre a manager or an investor. Perhaps the most basic one is that people tend to use the term proprietary loosely. When a manager believes the name of his firm is proprietary or a trader tells an investor he has a proprietary model, the question is what makes that brand name or model proprietary. Here is a summary review of the basic decisions to be made and steps taken.

Checklist
1. Have a thorough trademark search before deciding on the name. 2. Make sure to register the name.
There is a lot of litigation over the names of hedge funds. It pays to start thinking of intellectual property from day one, before the brand name is established. Once it is established, and it turns out somebody else is using the same name, you can end up with an expensive and time-consuming lawsuit.

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OPALESQUE FUTURES

ISSUE 17 Dec 01, 2009

FUTURES LAB

Given the importance of proprietary trading algorithms for commodity trading advisors and quantitative hedge funds, investors as well as managers need to be clear about the status of the property. In order to decide how to get intellectual property protection, you have to first establish what the product is.

3. Is the product copyrightable software?

From an intellectual property perspective, there is a crucial difference between computer software and a trading algorithm. Software is reproduced and disseminated, so it comes under copyright protection. But copyright protection is very difficult, if not impossible, for algorithms. An algorithm is used; it is not meant to be copied or otherwise directly reproduced. Even if you have copyright protection, you will be required to show that someone copied the computer code to make the case that they violated your property right. If they learnt it and used it to trade but did not reproduce it, that is not a violation of copyright. By contrast, if an algorithm is a trade secret, if someone does not download it but memorizes and shares it with another person, it may be possible though difficult to prove violation through testimony. Copyright vests automatically upon creation of the work, although we recommend that our clients file with the copyright office because then you can collect statutory damages and attorneys fees in case of infringement. But this is not essential. You do not need to file for copyright to establish violation and you can file the application after you find out that there is an infringement.

4. Should the product be patented?

A big decision for protecting an algorithm or model is whether to patent it. In order to get a patent, you have to register the invention with the patent office and disclose the secrets. Because of this, algorithms are often not patented. Instead, theyre protected as trade secrets or confidential information.

5. If its a trade secret, what is the jurisdiction?

Patent law is federal, but trade secrets and confidential information are governed by state laws, which are not identical. However, if there are multiple jurisdictions, an infringement complaint may end up in federal court. Under New York law, a trade secret is defined as an idea that youve come up with yourself and that may help you gain a commercial advantage. It has to be kept secret, not disclosed outside the company. The formula for Coca Cola is probably the best-known example of a trade secret. Thus in the case that started this summer against a former employee of Goldman Sachs, the proprietary model was a trade secret as defined by New York law.

6. Who developed the algorithm? 7. Was there more than one person involved? 8. Is there a contract about the ownership? 9. If there is no contract, what protections are available?
Litigation between joint inventors happens in many fields. In developing a trading model, a proper contract should be signed by all parties as soon as possible. Note that in the Goldman case the defendant had written the trading algorithm but the company owned it. Taking it is like taking any other company propertytheft subject to criminal sanctions.

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OPALESQUE FUTURES

ISSUE 17 Dec 01, 2009

FUTURES LAB

10. Is a non-US jurisdiction involved?

Generally speaking, it is easier to get intellectual property protection in the US than in other countries. Consider the following potential scenario. A large and successful US hedge fund works on a series of algorithms that are highly secret. With the help of an Indian outsourcing company, it hires a group of math PhDs in India to help develop the algorithms. When the model starts trading, it emerges that a competitor has access to the algorithms. An investigation reveals that a former employee of the Indian outsourcing company gave it to them. Indian law is different from US law; it protects confidences rather than trade secrets. If I place my trust and confidence in you and you breach that trust, then I can get a legal remedy. But a US business would not have a recourse against the former employee of an Indian outsourcing company because the US firm never had a relationship of trust and confidence with that employee. Under US law, you dont need to have that relationship to enforce your property right to the model.

The Bilski Case

In short, everybody involved in developing a model, whether contractor or employee, need to sign the right kind of agreement. Investors should inquire about this when told there is a proprietary trading model. If somebody who works on the model is in another jurisdiction, before going ahead inquire about the laws of that jurisdiction and the risks under those laws. Even in the US, the legal picture is still unsettled. The Supreme Court is expected to decide a major financial patent case this summer. Bernard Bilski and Rand Warsaw seek to patent a method for hedging weather risk in commodity trading. Their application has been rejected by the Patent and Trademark Office. If the Supreme Court does not overturn the decision of a lower court, the Bilski case will be another argument against seeking patent protection for financial algorithms. The field of intellectual property has changed radically since the Internet brought down the cost of distributing information and made intellectual products more international. We need to think globally as well as in terms of the new capabilities created by new technology. But the laws have not kept up with these developments and there is a lot of uncertainty. Your best bet is to think through the issues beforehand and take the appropriate steps to protect your IP.

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ISSUE 17 Dec 01, 2009

INSIDER TALK

Case for Short-Term Quants

Investors have become more interested in short-term trading strategies. Rishi Narang, founder of Telesis Capital LLC and author of Inside The Black BoxThe Simple Truth About Quantitative Trading, explains the advantages of short-term approaches. Mr. Narang manages a fund of managed accounts specializing in trading strategies. He has been involved in the hedge fund industry, with a focus on quantitative trading strategies, since 1996. He was managing director and co-portfolio manager at Santa Barbara Alpha Strategies from 2002 to 2005 and previous to that was president and vice chairman of Tradeworx Inc., a quantitative hedge fund manager.
Rishi Narang

In general quant strategies have done very well, despite the common perception that they have not.

Opalesque Futures Intelligence: Whats your investment approach? Rishi Narang: I focus on quantitative strategies in equities, futures and options. Our core approach has four components. One is that we want pure alphaI stay away from beta exposure. Even in my personal portfolio, I dont own stocks, bonds or credit. Our second requirement is liquid instruments and the third is mostly quantitative strategies. Non-systematic, discretionary strategies are a very small part of the portfolio. Our fourth goal is to be mostly in short-term trading. I generally do not invest in long- or medium-term trend-following commodity trading advisors. OFI: How do you define short term? RN: In our portfolio, the longest term quant trader holds positions on average for 10 days. The shortest term quant turns over positions many times a day. Overall, the average time for turning over positions is slightly less than two days. OFI: Do you prefer short-term trading because it is more liquid? RN: No, thats not the reason. Long-term trend followers also use liquid instruments.

OFI: Why do you like short-term strategies? RN: Heres an interesting analogue. Take weather forecasts. You can predict the weather really well over the next few hours. The further out the date, the less accurate the prediction. You cant really predict the weather four days from now. Weather systems at this point are not that well understood and the data is so noisy that building a model for long-term forecasting is extremely difficult. Similarly it is extremely difficult to build long-term trading models. Models look into the past to predict the future. The greater the distance from the starting point in the past to the prediction in the future, the greater the odds that the future will change and cause the strategy to fail. A shorter span gives you better odds. OFI: Whats the catch? RN: Transaction cost is the key problem for shortterm strategies. If you can solve the problem of transaction costs, then the risk-adjusted expected return from short-term trading is better than the expected risk-adjusted return from long-term strategies.

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OPALESQUE FUTURES

ISSUE 17 Dec 01, 2009

INSIDER TALK
OFI: Can short-term trading accommodate large amounts of capital? RN: To invest like we do, you cant manage much money. Were in a small corner of the quant niche. We do not aspire to become a big, multi-billion dollar asset manager. Some managers can take more moneyI know one very good short-term futures trader that now manages $4.5 billion. We could increase our capacity by skewing our weighting to traders who can take more money. But our goal is to make the best investments, rather than maximize capacity. Almost all of my own money is in the fund, so I mainly care about making the fund as good as possible. By contrast, most people in asset management look to maximize capacity. OFI: Is it possible to overcome the capacity constraint? RN: Anyone who thinks theyre managing tens of billions of dollars in short-term strategies is either managing Renaissance Technologies Medallion fund or is likely deluded. It is really hard to manage large money with short-term strategies. The problem of market impact is simply too severe and it is very difficult to find people who have solved that problem. Big shops may have short-term trading elements, but on the whole their average holding period is measured in weeks or months, not hours or days. OFI: Havent quantitative strategies performed poorly in recent years? RN: There have been some major headwinds for quantitative trading, but more so for long-term strategies. There were lots of traps for fundamentally oriented longer-term trading. Last year stocks that looked cheap kept getting cheaper; this year stocks that looked like junk kept getting more expensive. Shorter term quant strategies were less affected OFI: Whats tripping up the models? RN: Quantitative models are based on fairly stable behavioral patterns from the past, so dislocations that break with the past can be painful. Weve had a number of such dislocations in the past several years. OFI: Cant quantitative methods account for such developments? RN: Sharp breaks from the past like 9/11, the Iraq war or Lehman Brothers going under are almost impossible to factor into models. A model based on rare events will be wrong most of the timenot a good way to play any game. OFI: What about the quant losses in 2007? RN: The massive sell-off by quants in August 2007 was caused by the beginnings of the credit crisis. Big multi-strategy funds that had credit and quant trading got stuck with too much risk in their credit allocation and had to liquidate something. They reduced their quant allocations, since that was easier than selling credit. Asset prices buckled under the tidal wave of liquidations. OFI: Did these events affect long- and short-term traders differently? RN: In the summer of 2007, longer term CTAs had big drawdowns, but shorter-term traders were more successful. Then, 2008 was great for trend followers while short-term traders

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had mixed results and on average did only half as well as longer term traders. By contrast, this year short-term quant strategies are doing better. Considering this three-year period, it has been less challenging for shorter term strategies. In general quant strategies have done very well, despite the common perception that they have not. OFI: Why is this year difficult for technical trading? RN: Regime changes are painful for technical trading. There were two kinds of regime change this year; a transition from bear market to bull market and a steep decline in volatility. OFI: What do you seek in a quant? RN: I look for a number of characteristics, but a very important one is humility. Yes, they need to be confident enough to believe that they can make money. But at same time they need to have respect for the market and recognize that taking risk is a very serious matter. Some quants believe theyre so smart that theyre smarter than the market. But even if theyre right in the long run, that does not mean that theyll actually win. Long-Term Capital Managements trades were right in the long run, and yet the firm did not survive. OFI: What else defines the ideal quant? RN: The second hallmark of a good quant is a lucid understanding of what theyre good at and what theyre not good at, coupled with the ability to take exposures in the former and avoid the latter. Say someone thinks they have an edge in predicting convergence between stock prices. If they dont control for sector risk, they could take unintentional bets on sectors as they buy under-performing equities and sell out-performers. The good quant would avoid sector exposurewhere theres no edge. A third hallmark is mild pessimism. Most models that predict the future dont work. It is a bad flaw to expect a given idea to work and look to support it. A quant should take the approach that his job is to falsify his theory and only when he cant falsify the theory will he implement it. You can think of this as Type I errors in science which in finance causes blow-ups versus Type II errors which mean not making as much profit as you could. Better quants make Type II errors more than Type I errors. OFI: Whats the future for quant strategies? RN: Quantitative trading is a blend of human intelligence with computer capability. It combines the strengths of the human with those of the computer. How this hybridization will develop further is a very interesting issue. Technology is becoming faster at a faster pace. How does a trader make use of such advances? The object should be not only to do the same thing as other people only faster, but also to do it better and furthermore to do new things altogether. In the meantime, there is more interest from investors in short-term quant trading, because thats whats done well over the past few years. This aspect of human behavior I dont expect to change at all: investors tend to chase whatever has done well recently.

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OPALESQUE FUTURES

ISSUE 17 Dec 01, 2009

NEWS BRIEFS

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Managed Futures Down; Macro Gains from Aussie $

Many CTAs posted negative returns in October, according to the Credit Suisse/Tremont Hedge Fund Index. The manages futures component of the index is down 2.17% for the month and 6.28% for the year. The broad index covering all strategies was about flat for October, up 15.11% year to date. Managed futures and long/short equity were the two strategies with the largest number of managers shifting into negative performance from the previous month. Among CTAs, some high-frequency trading and multistrategy managers made good returns while trend-followers did well early in the month but later lost due to sharp reversals in equity and bond markets. Global macro eked out a small positive (0.21%) for the month and is up 9.32% for the year. Some macro managers profited from the Australian dollars increasing strength as the National Bank of Australia became the first-mover in hiking interest rates and others bet successfully on US interest rates. Energy, gold and platinum were also sources of profit. Credit Suisse/Tremont says that as divergent growth conditions and policy interventions play out in the marketplace, a range of trading opportunities are expected for global macro funds.

Abbey Fund Passes Milestone

Abbey Capitals global macro multi-manager fund recently broke through the $100 million asset mark while completing its two-year track record. The fund currently allocates to eight managers via managed accounts and started offering weekly liquidity a few months ago (See Opalesque Futures Intelligence, September 15, 2009.) Abbey founder Tony Gannon says reaching the milestone demonstrates the demand and appeal of a diversified and liquid approach to the global macro investing. In addition to offering weekly dealing on the fund, there are no gates or lockups in the fund and this feature is of increasing importance to hedge fund investors in todays environment, he said, in a statement. The underlying managers have diverse trading styles and exposure to a wide range of sectors and markets. While discretionary strategies predominate, these are combined with systematic macro trading strategies. This provided the fund with the flexibility to react to the unprecedented volatility in 2008 and has led to strong returns in 2009, Mr. Gannon says. Dublin, Ireland-based Abbey Capital has more than $2 billion invested with managed futures, global macro and foreign exchange managers.
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ISSUE 17 Dec 01, 2009

NEWS BRIEFS Altegris Taps BNY Mellon Exec

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Hedge fund and managed futures investment firm Altegris appointed Ken McGuire as chief operating officer, a newly created position. Altegris chief Jon Sundt says this addition to the team will accelerate the already rapid expansion of our platform. Mr. McGuire comes from BNY Mellon Alternative Investment Services, a large hedge fund administrator where he was a managing director for single-manager hedge funds. Earlier in his career he was in Goldman Sachs hedge fund strategies group, where he became co-head of operations, finance and technology. Altegris currently oversees more than $2.4 billion in alternative investments. Mr. Sundt says the object is to provide a diverse selection of best-of-breed alternative managers at lower investment minimums. The firm includes Altegris Investments and Altegris Premier Managers. (See Opalesque Futures Intelligence, July 14, 2009.)

Bainbridge Starts CTA/Macro Fund

Fund of funds manager Bainbridge Partners announced the launch of the Aperio Master Multi-Trading fund in November with about $20 million from clients already invested in Bainbridge other products. The firm says it expects assets to reach $40 million by the end of this year before it opens this fund to outside investors. Bainbridges total assets are at more than $300 million. Aperio Master Multi-Trading will invest in managed futures and global macro strategies, allocating to around 10 to 15 managers covering all time frames, sector exposures and styles. It targets 15% annualized return with 10% to 12% volatility. Bainbridge founder Antoine Haddad and his team have experience with CTAs. For as long as we have managed multi-hedge fund pools, we have allocated significantly to directional and systematic managed futures programs, benefiting from the positive convexity they add to a portfolio Mr. Haddad says, pointing out that CTAs have the advantage of trading liquid, listed instruments.

Dubai Exchange Reaches Billion Mark

In the midst of the uncertainty created by Dubai Worlds debt restructuring announcement, the Dubai Mercantile Exchange affirmed its continuing growth. DME reported that cumulative trading of its flagship Oman Crude Oil Futures Contract exceeded one million contracts on November 27th, representing one billion barrels of crude oil, at 1,000 barrels per contract. The contract was launched on June 1st, 2007. This year daily trading volumes increased 60% over 2008, averaging 2,037 contracts.

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OPALESQUE FUTURES

ISSUE 17 Dec 01, 2009

NEWS BRIEFS

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DME chief executive Thomas Leaver says, This is a testament to the overwhelming support of our customers and a growing recognition that DME Oman provides the most efficient price discovery and risk management tool to participants in the rapidly growing East of Suez markets.

Newedge Names Financial Futures Head, Launches India Broker

The multi-asset brokerage Newedge started a securities company based in Mumbai that will focus on providing financial derivatives and cash equities to institutional foreign investors. Newedge Broker India Private Ltd., an addition to Newedges established India business, is licensed to trade on the National Stock Exchange of India and the Bombay Stock Exchange. Newedge, a joint venture between Socit Gnrale and Calyon, has identified India, alongside China, as a priority for expansion. The National Stock Exchange of India was one of the top derivatives exchanges in 2008 and two of its contracts are among the top 10 equity index futures and options. Our operations in India will prove important for all our clients as they can benefit from our mix of local knowledge, market expertise and proximity to the exchanges and regulators, says Newedge chief executive Patrice Blanc. In a separate development, Newedge appointed John Ruskin as head of financial futures and options execution. Working from London, he will oversee the global team and facilitate cross-border trading and execution across asset classes. Newedge has more than 300 brokers in 17 countries. Previously Mr. Ruskin was managing director for the Cube division of Fimat, before the formation of Newedge in January 2008. He co-founded Cube, a specialist in executing financial futures and options as well as equity derivatives, in 1997. It was acquired by Fimat in 2006. Nicolas Breteau, Newedge global head of sales and front office, says Mr. Ruskin has been a driving force in the financial futures and options for over 18 years.

New Oil Futures

CME Group launched trading and clearing services for a new physically delivered Gulf Coast sour crude oil futures contract, scheduled to begin on December 6th for trade date December 7th. The contract, listed by NYMEX, will be available on the CME Globex electronic trading platform and the New York trading floor. It will be 1,000 barrels in size with a minimum price fluctuation of $0.01 per barrel. The physical delivery is based on Mars-type crude oil at the Louisiana Offshore Oil Port LLC (LOOP) facilities in Clovelly. Alternate delivery of two foreign crude oil streams will be permitted at fixed differentials.

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ISSUE 17 Dec 01, 2009

NEWS BRIEFS
Separately, the IntercontinentalExchange introduced two cash-settled futures contracts based on the Argus Sour Crude Index and cleared by ICE Clear Europe. One is an outright contract while the other is the differential between the Argus Sour Crude Index and the West Texas Intermediate price. The futures contracts will be listed by ICE Futures Europe and will be available on the trade date of December 7th, pending regulatory approval.

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ICE previously made available two over-the-counter contracts based on the same index, which represents the daily value of US Gulf Coast medium sour crude in physical spot market trades. The daily ASCI price is the weighted average of transactions for three grades of Gulf Coast crudeMars, Poseidon and Southern Green Canyon.

Finnish Bank Partners with MF Global

Pohjola Bank plc of Finland entered an agreement to execute and clear derivatives contracts through MF Global UK Ltd. The partnership will commence with listed derivatives before broadening to other products. Antti Heinonen, a senior vice president at Pohjola, says the partnership gives the banks customers a wider spectrum of financial products and Pohjola can soon offer the most comprehensive derivatives services in the Nordic countries.

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ISSUE 17 Dec 01, 2009

MANAGER PROFILE

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Quantum Forecasts
Quantum Forecasting LLC is one of those relatively few systematic commodity trading advisors that do not fall into the trend-following category. Quantums models forecast market movements for a specified time interval, often lasting 10 or 15 minutes. No trends or economic fundamentals are involved in making the forecasts. Below, Paul Moore, chief executive officer and managing member of Quantum, explains how the approach works. He says they are not highfrequency traders, although they do large numbers of trades on days when there are many buy/sell signals.

Paul Moore

Our research team in Rome, Italy, developed the technology used in our trading systems. It is based on an original, mostly unpublished theory that my partners, Antonio Ballarin and Simona Gervasi, studied and developed over the past 18 years. Their work uses neural networks and cybernetics. Members of our group mostly have a scientific and technological background, not a finance background, so it was an adventure applying the theory to real market data. Since the predictive capabilities are remarkably constant regardless of the time series analyzed, in the past this method was used for purposes like credit scoring, pollution measurements and cancer prognoses. Once we realized that the system consistently predicts financial market movements, we built a CTA business. We chose futures as the instrument mainly because you can go short without the typical limitations on shorting stocks. To begin with we chose the highest volume markets, like currencies and stock index futures.

Intraday Trading

We did 10,000 actual trades during our first 12 months as a registered CTA and established a good starting track record, confirming the results from our proprietary trading and back testing over the years. The markets were extremely volatile so we were able to show how well the system adapts dynamically through changing conditions. Our forecasts are accurate at least 80% of the time. Taking into account brokerage commissions, fees and slippage, that translates to around 60% to 65% of trades showing a profit. As our volume increases we think the clearing firms will offer us lower commissions, which will greatly improve profits especially for the 10 minute and 15 minute models. At the beginning of a day we have no idea what trades well do. The data comes in and the system gives direction forecasts. This is a systematic forecasting method with no trend following and no macro involvement. We make forecasts for a precise short term intraday period. There is less than 5% discretion and that only to avoid rollover periods, system errors etc. However, we dont operate without constant human supervision.
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MANAGER PROFILE

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We look at a selected single market within one chosen time frame. We can take any market tick data and distill it down into the time frame we want to analyze. Say were making 10-minute forecasts every five minutes. In the next 10 minutes where will the price go? There are three possibilities: long-buy, short-sell, middle range-stay in cash. There is another possibility but it is rare, namely the system is unable to understand whats happening in the market and provides no signal. On a curious note, we did experience that condition on a weekly forecast last year, before Lehman Brothers collapsed. We dont know what the system picked up in the data, but it was an interesting coincidence. Trends or macro factors are not part of our approach, but we now apply a filter to catch big news events. During those times the system may be put on stand-by. We do not feel compelled to trade all the time. Out trading volume is about 95% intraday, so theres very little overnight risk As our assets grow we expect to trade almost exclusively intraday. We are not ultra high frequency traders, although we do a lot of trades when there are many buy or sell signals. With the short term models, the platform is currently producing around 5,000 trades a month per million dollars managed.

Returns
When market dynamics change, the models catch it quickly. This is a dynamically self-adapting system. And it works across asset classes, including commodities, currencies, stock indexes and bondswe do not as yet not trade bonds but have tested our method with bond data and other types of time series. We work on a whole suite of models that are not currently used in trading but can be deployed as we increase our AUM.

With great timing, our CTA started trading in July 2008! In fact we did very well that summer and after a rough patch in September and October finished the year with a nice gain. So far, this year has also been good for us. That shows our difference from trend following, which ran into trouble in 2009 after a great 2008. We set up a target of 30% annual growth and beat it again this year as our year-to-date return is already above that. Were extremely bullish on our future, with some amazing new improvements being tested as this goes to press. Quantum can operate in all North America, as well as in the UK starting in January. Recently our partner, Quantum Global Financial Corp., was licensed in Canada as a hedge fund structure. Their Holon Trading Program currently offers the same basic strategy as our US CTA, but over time it will vary as we deploy exchange-traded funds and other instruments to the strategy.

Simona Gervasi and Antonio Ballarin

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ISSUE 17 Dec 01, 2009

PRACTITIONER VIEWPOINT

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Cross-Trading Trends
Futures trading is attracting money managers who previously traded stocks or other securities, not futures. Part of the attraction may be that bank credit is now hard to get and futures instruments enable you to put on more trades with the same capital. At the same time, some commodity trading advisors have become interested in cash equities. Here, several people who work with CTAs, futures commission merchants and hedge funds comment on the trends. Jay Lefkowicz, a principal of Saratoga Futures, an introducing broker that works with a number of FCMs, says traders are crossing over in both directions:
One major trend we are seeing is that more players are trading a variety of asset classes. We have seen traditional equity hedge fund managers begin trading index futures and, at times, commodity futures. Conversely, we see quant futures traders applying their models to cash equities. By working with a number of multi-asset class futures commission merchants, our clients can deal with one bank and cross-margin their holdings. Another trend is that more money is moving into managed accounts. Managed accounts create logistical difficulties for transaction allocation and settlement. By utilizing the right futures commission merchant and trading platform, we can help managers streamline the process.

A fund may trade both stocks and stock index futures. How does risk management work for multiple asset classes? We asked Paul Compton, head of product management in SunGards alternative investment business. Mr. Compton says the key is to integrate multiple asset-class positions and calculate net exposures:
The first object is to have all the positions on the same systems, from both the trade processing perspective and the position and risk management perspective. We offer tools that deal with multiple assets, all in a single frameworkcommodities, futures, options, stocks, bonds. You dont want to do your cash equity risk analysis and stock futures risk analysis separately and then try to put them together, because then they dont fit. Our buy-side system has cross-asset coverage. This is not an empty box application but a whole service, including our extensive data coverage. It does not make sense for customers to build it themselves.

Paul Compton

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PRACTITIONER VIEWPOINT

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With regard to risk management, there are different levels. You have to drill down to the exposures to individual stocks and futures, long and short. Then youll see the net exposures by sector, country, etc. A second level of risk analysis, which our APT product does well, is to look at the economic drivers of asset prices and the correlations. If you have an exposure to the US dollar/euro exchange rate, say, you can analyze how it will affect your portfolio indirectly through patterns of correlations and relationships. We can do this in real time, or update as frequently as the portfolio manager wants. APT does well with extreme events. We saw that last year. It signaled high risk in the weeks before and after the Bear Stearns and Lehman Brothers collapses.

What happens as traders move into new asset classes? We asked Tony Scianna, executive vice president of SunGards brokerage & clearance unit. He says the company offers a complete suite of products from execution to clearance for listed derivatives and provides services to more than 105 futures commission merchants globally.
As new asset classes and futures markets develop, they get integrated into our software. So, for instance, SunGard supports carbon credit futures at a number of exchanges, including Chicago Climate Futures Exchange, LCH Emissions market, ICE, EEX and NYMEX.

Tony Scianna

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ISSUE 17 Dec 01, 2009

TOP TEN Discretionary vs. Systemic Traders

This line-up of discretionary and systematic commodity trading advisors comes from the Managed Account Research database. The ranking is by three-year compounded annual return from October 2006 through September 2009.

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While the top systematic CTAs listed here have higher compounded long-term returns than the top discretionary managers, there are two qualifications that should be noted. One, these systematic CTAs on the whole have less assets under management. Two, their returns may be significantly more volatile than the discretionary programs returns. Managed Account Research provides information on an extensive range of alternative investments, including managed futures programs.

Investment

Three-Year Compounded Annual Return

Year to Date

DISCRETIONARY NDX Capital Mgmt. LLC Shadrach Baldwin Commodity Corp. MAP Dicken Commodities, Inc. Diversified Program Dicken Commodities, Inc. Agriculture Rosetta Capital Mgmt. LLC Rosetta Program SYSTEMATIC Livestock CTA Livestock Program Pere Trading Group, LLC Pere Trading Program Global Wealth Analytics Global Wealth Class B RAM Management Group MRTP-Aggressive TID Company Ltd. Managed Account 70.08% 53.51% 49.55% 48.64% 35.44% - 5.28% - 6.74% 11.95% 4.09% 10.46% 41.51% 28.27% 28.02% 27.99% 25.56% 2.38% 7.23% 6.96% 6.63% - 4.46%

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ISSUE 17 Dec 01, 2009

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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. FOR REPRINTS OF ARTICLES, PLEASE CONTACT: Denice Galicia dgalicia@opalesque.com

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