Fooling Some of the People All of the Time: The Inefficient Performance and Persistence of Commodity Trading Advisors

Abstract

Investors face significant barriers in evaluating the performance of hedge funds and commodity trading advisors (CTAs). The only available performance data comes from voluntary reporting to private companies. Funds have incentives to strategically report to these companies, causing these data sets to be severely biased. And, because hedge funds use nonlinear, state-dependent, leveraged strategies, it has proven difficult to determine whether they add value relative to benchmarks. We focus on commodity trading advisors, a subset of hedge funds, and show that during the period 1994-2007 CTA excess returns to investors (i.e., net of fees) averaged 85 basis points per annum over US T-bills, which is insignificantly different from zero. We estimate that CTAs on average earned gross excess returns (i.e., before fees) of 5.4%, which implies that funds captured most of their performance through charging fees. Yet, even before fees we find that CTAs display no alpha relative to simple futures strategies that are in the public domain. We argue that CTAs appear to persist as an asset class despite their poor performance, because they face no market discipline based on credible information. Our evidence suggests that investors' experience of poor performance is not common knowledge.

Sensation Seeking and Hedge Funds

“…Because successful funds have a strong incentive to list in an effort to attract capital, these backfilled returns tend to be higher than the nonbackfilled returns. To alleviate concerns about backfill bias raised by Bhardwaj, Gorton, and Rouwenhorst () and others, we rerun the tests after removing all return observations that have been backfilled prior to the fund listing date.…”

Benchmarking commodity investments

“…They are summarized by strategy. Data from Barclay Hedge obtained monthly from December 2006 through December 2014 and verified to be free of the graveyard bias identified in Bhardwaj et al (). CTA summary includes both active and dead funds.…”

“…Some papers have examined Commodity Trading Advisors (CTAs) (e.g., Bhardwaj, Gorton, & Rouwenhorst, ; Fung & Hsieh, , ). These papers have employed diversified (i.e., including non‐commodity factors) factor models because only 19% of CTAs invest exclusively in commodities, despite their name (see Table ).…”

“…One drawback of this model is that the factors are not tradeable, making interpretation difficult. This model has also been criticized by Bhardwaj et al (), who argue that the negative performance of the factors means alpha identified based on this model is spurious . The second model comes from Bhardwaj et al (), who include factors for commodities, interest rate derivatives, and currency futures.…”

Duration Dependence, Behavioral Restrictions, and the Market Timing Ability of Commodity Trading Advisors

“…Such biases can be meaningful. For example, Bhardwaj et al () report that the combined backfill and survivorship bias in public hedge fund databases sum up to approximately 7.8% annualized. Furthermore, because the returns we employ are not manipulated, they cannot be a smoothed version of the true realized returns.…”