July 29, 2010 / 10:30 AM / 9 years ago

Black-box funds perform as bubbles burst

LONDON (Reuters) - Black-box funds based on mathematical models give investors a means of reducing risk and can perform strongly even when asset bubbles burst, the chief executive of one such fund told Reuters on Thursday.

Paul Mulvaney, who owns more than 95 percent of Mulvaney Capital, said managed futures funds or CTAs (commodity trading advisors) performed strongly when the Internet bubble imploded and when the credit crisis struck.

As a case in point, Mulvaney Capital generated returns of 11.6 and 45.5 percent in September and October 2008, when the collapse of Lehman Brothers raised the spectre of global recession and decimated most asset classes.

Mulvaney’s returns call into question the widespread view that funds based on mathematical models built on historical chart patterns or trends do not and cannot apply during shock events such as the Lehman failure.

“Our full-year return in 2008 was in excess of 100 percent,” said Mulvaney.

This year, however, CTAs have been struggling, mostly because global markets have not traded strongly up or down for an extended period.

Mulvaney Capital’s commodity losses totalled around 20 percent in the year to end-June after erratic price action in sugar and cotton was only partially offset by gains in cocoa.

But investors are by no means running for the exits.

“Interest in alternative investments such as our fund has been on the rise over the last few years. CTAs are not correlated to traditional asset classes, and so help investors reduce risk and enhance returns,” said Mulvaney.

“Investors want to diversify into asset classes they may not have explored in the past. Why be restricted to stocks and bonds when there are so many other liquid markets? And CTAs remove human emotion from the risk equation.”

CHANNEL BREAKOUT

Mulvaney Capital had $97 million in assets under management as of July 1, 2010, with 58 percent exposure to commodities. That compares with an average of around 25 percent for managed futures funds in general.

The fund invests in a basket of about 50 financial and commodity futures contracts and buys or sells when a contract trades above the highest or below the lowest price seen in the last several months.

The method is known as channel breakout, and the fund exits its positions at a pre-determined ‘stop-loss’ point if a breakout fails. Nothing else ever leads the trading desk to “over-ride the system”, not even a shock event.

“The system may suffer whipsaw losses if the price action is erratic. Fortunately, throughout the decades of historical data we have analysed, major long-term trends have emerged in every sector with enough regularity to generate profits.”

Mulvaney added that the fund will not alter its commodity weightings in response to losses. It only does so when the computerised system gives signals to change weightings.

The weightings are sized taking into account the volatility of the market, the correlation between the various markets traded and the current level of assets under management.

At present, the fund is long cocoa, coffee and gold futures, which have gained 26, 25 and 22 percent respectively over the past year.

It is short crude oil futures, which have shed 16 percent since the beginning of May, and natural gas futures, which have lost in excess of 50 percent over the last two years.

And Mulvaney himself remains confident that if this is what the maths dictates, this is where the money goes.

Asked if he would invest most of his own money in black-box funds, he replied: “Absolutely, that’s exactly what I do.”

Editing by Jane Baird

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