CTA: Differentiated Managed Futures ETF (NYSEARCA:CTA) (2024)

In my most recent article on managed futures ("MF") funds, I compared the KFA Mount Lucas Index Strategy ETF (KMLM) with the iMGP DBi Managed Futures Strategy ETF (DBMF), and the WisdomTree Managed Futures Strategy Fund ETF (WTMF) and suggested KMLM was my favorite of the three. However, users highlighted another managed futures fund that I should review, the Simplify Managed Futures Strategy ETF (NYSEARCA:CTA).

Upon close review, the CTA ETF does have many qualities that I like. First, the CTA ETF claims to add a fundamental reversion factor when trading commodities to reduce inflection risk. In rates, it also looks at intermarket relationships and carry, in addition to just price trends.

My only hesitation with the CTA ETF has to do with a large drawdown in March 2023 that is hard to explain given the fund's exposures.

Overall, the difference in performance of the managed futures ETFs in the past year is leading me to change my approach to this asset class. Rather than trying to select the 'best' fund, I believe investors may benefit from a basket approach, as different managers appear to have strategies that outperform at various times. I believe CTA should be considered as part of this allocation.

Fund Overview

The Simplify Managed Futures Strategy ETF is an absolute return fund that seeks long-term capital appreciation by systematically investing in futures. The CTA ETF is designed to have a low correlation to equities and may provide a hedge during risk-off events.

The CTA ETF deploys a suite of proprietary systematic models designed by Altis Partners, a commodity trading advisor ("CTA") with over 20 years of experience.

The CTA ETF was launched in March 2022 and currently has $158 million in assets while charging a 0.78% gross expense ratio (Figure 1).

What Are Managed Futures Funds?

For those not familiar, managed futures funds use trend following and other quantitative models to take long or short positions in multiple asset classes using futures contracts (Figure 2).

Historically, managed futures funds were difficult for retail investors to access, as commodity trading advisors (the managers of MF funds) typically only accept investments from accredited investors (those with income greater than $200,000 / year or net worth greater than $1 million). So it is encouraging to see the ever-expanding roster of MF funds available to retail investors (WTMF, KMLM, DBMF, CTA).

Simplistically, a managed futures fund takes a long position when it determines the asset class is in an uptrend and a short position when it is in a downtrend (Figure 3).

MF funds typically trade dozens of asset classes in order to diversify their portfolio returns, since there is always a trending market somewhere.

CTA's Differentiated Strategy

What differentiates the CTA ETF is its portfolio construction and strategy design. Unlike some of its peers that trade all asset classes, the CTA ETF restricts itself to trade only 15 assets ranging from US/Canadian interest rates, industrial metals, precious metals, energy, and agriculture (Figure 4).

The CTA ETF notably does not trade equity futures or currencies, as the manager wants to minimize portfolio correlation with equities, and believes commodities and rates have historically exhibited superior trend performance (Figure 5).

Furthermore, when trading commodities, the CTA ETF employs a fundamental reversion factor to complement its pure trend models, reducing the risk of sudden trend reversals that can occur in commodity markets (Figure 6).

In rate trading, the CTA ETF adds an intermarket factor and a carry factor in addition to trend following (Figure 7). The intermarket factor analyzes the relationship between equities and bonds, for example, and if the relationship is negatively correlated while equities are experiencing a downtrend, that might be a positive factor for bonds.

"The carry factor seeks to position the rates on the optimal point of the yield curve" and can enhance returns in a period of flat or falling rates.

These additional factors like fundamental reversion for commodities, intermarket, and carry for interest rates are novel ideas that I have not come across when analyzing other MF funds.

Portfolio Holdings

Figure 8 shows the CTA ETF's current portfolio. The CTA ETF's largest short positions are gold futures at -34%, Canadian 10-year futures at -26%, and 3-month SOFR rates at -18%. The largest long weights are cattle at 18%, cotton at 13%, and copper at 5%.

As an aside, investors may be shocked at first glance at Simplify's webpage, which shows CTA being short 580% notional in SOFR futures (Figure 9).

However, while the notional exposures appear large, different futures have different specifications, so it is difficult to assess their underlying economic exposures just from the notionals listed.

It would be helpful if Simplify could 'simplify' the fund's disclosures and add the estimated risk profile table that can only be found currently in the holdings Excel file, so potential investors can get a better sense of the fund's economic exposures.

Historical Returns Have Been Modest

Moving on to the fund's returns, the CTA ETF has delivered modest returns since inception, with 2022 total returns of -3.5% and since inception returns of 4.4% annualized (Figure 10).

CTA Has Beaten Peers

However, comparing CTA, DBMF, KMLM, and WTMF, the CTA has done well, with the highest total returns among the peer group since its inception (March 8, 2022) with a 15.0% total return (Figure 11). In contrast, my favorite fund, KMLM, has actually performed the worst, with a -1.6% total return since March 8, 2022.

However, there are some features of this performance record that should be pointed out. First, CTA only began operations in March 2022, so it is less than 2 years of performance. It may be hard to pass judgment with the limited performance data.

Second, in the trailing 1 year, we can see that the CTA ETF had a precipitous fall in March, far larger than the other MF ETFs (Figure 12).

If readers can recall, this period coincided with the March U.S. regional bank crisis when investors were worried about an impending recession and dramatically reduced their expectations for higher interest rates. The 2-year treasury yield plummeted from over 5% to 3.8% in a matter of days (Figure 13). This event appears to have led to a steep drawdown for the CTA ETF.

In fact, stepping back, the CTA ETF's price chart has a surprisingly strong correlation with 2 year treasury yields, with peaks and valleys occurring at roughly the same time (Figure 14).

This is a surprising result, as I do not see any explicit bets on 2-year yields within CTA's portfolio (Figure 8 above). The closest driver I can think of is CTA's bets against SOFR futures, although I do not understand the volatility given 90 SOFR's gradual rise in the past year (Figure 15).

Finally, the other notable feature in the MF fund returns is that since October 31st, KMLM's performance has dramatically lagged its peers (Figure 16).

November saw the Federal Reserve begin its pivot to an easier monetary policy stance and a decrease in interest rates across the curve, so it appears KMLM was caught in the interest rate reversal and suffered heavy drawdowns as interest rates declined. In contrast, CTA's drawdown since the end of October has been more modest, and it has already surpassed October month-end levels.

Furthermore, the Fed's pivot boosted risk assets across the board which heavily benefited WTMF, whose mandate can hold equity futures as well as bitcoin futures.

Which Managed Futures Fund To Use?

With regards to which managed futures fund is the 'best', I believe that is a loaded question requiring a nuanced answer. It depends on what one is trying to achieve with their managed futures allocation.

If investors are only interested in the highest absolute returns, then since CTA's inception, it has performed the best, as per Figure 11 above. However, as part of a larger portfolio, different funds may serve different purposes.

For example, looking at the correlation between the MF funds, I would not recommend the WTMF as a portfolio diversifier, as it is positively correlated with both stocks and bonds (Figure 17). Incidentally, in the time period analyzed (since CTA's inception), stocks and bonds were positively correlated.

As a portfolio diversifier/hedge, DBMF and KMLM both have strong negative correlations with stocks and bonds, although KMLM does not trade equity futures directly.

Overall, the past few quarters of relative performance between the different managed futures ETFs is showing me that the managed futures asset class is not hom*ogeneous and that investors may need to utilize a 'basket' approach.

Conclusion

The Simplify Managed Futures Strategy ETF is Simplify Asset Management's entrant in the managed futures ETF space. The CTA ETF primarily trades commodities and interest rates to provide uncorrelated returns to investors.

In addition to using trend-following strategies, the CTA ETF also uses differentiated fundamental reversion factors to trade commodities. In rates, it also considers intermarket relationships and carry.

Since its inception in March 2022, the CTA has performed the best amongst its managed futures ETF peers. However, it may be premature to draw firm conclusions from such a short performance history. Furthermore, the CTA ETF did have a steep drawdown in March 2023 that is difficult to explain given its portfolio exposures.

Overall, I am rethinking my allocations to managed futures ETFs and may consider a basket approach to diversify within this asset class. CTA is definitely one of the funds I will consider. I am initiating on CTA with a buy recommendation.

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