Research

The Conquest Managed Futures Select (MFS), along with other domestic and offshore funds, is managed by Conquest Capital LLC, a Commodity Trading Advisor (CTA) specialising in the trading of futures and FX markets globally. Conquest Capital LLC is a wholly owned subsidiary of the Conquest Capital Group, which also manages a multi-manager portfolio through another subsidiary – Condor Capital LLC. The management firm handles an asset base of about US$382 million, and has ten employees including five investment professionals.

Marc H. Malek has 13 years' experience in managing currency-based investment products, spanning various roles in analysis, trading system design, trading and fund management. These included senior level stints at UBS, first as the worldwide head of the exotic FX derivatives group, and later as the executive director in charge of FX proprietary trading in Europe. He is an engineer by training, with a BS in engineering and applied science from California Institute of Technology.

1. How does the MFS fund fit in with the rest of Conquest Capital Group's portfolio? What portion of the firm's assets is in privately managed accounts?

   Conquest MFS is an exotic beta product for investors looking to efficiently and cost-effectively replicate the returns of the managed futures space. Most of the managed futures space delivers exotic beta, which can be simply and systematically replicated, not alpha. The one part of the managed futures space which provides the opportunity to deliver alpha is the short-term segment. Conquest Macro is an alpha product for investors seeking an exposure to short-term market movements. Both Conquest Macro and Conquest MFS trade futures and forwards and are technically based. Conquest FX Carry is a fundamentally-driven alpha programme which trades pairs of currencies, to capture carry during risk seeking environments and preserve capital during risk-averse environments. Through Conquest Volatility Relative Value (VRV), we provide a highly specialised alpha product seeking to arbitrage volatility mispricings across fixed income, foreign exchange, commodity and equity markets. Conquest VRV can be long, short or neutral volatility.

   About 15.5% of the firms' assets are held in privately managed accounts.

2. Could you outline the fee structure, sources of capital and other key features of the fund?
   
   Given our belief that CTAs provide exotic beta rather than alpha, we wanted to reflect that in the pricing for Conquest MFS. Conquest MFS is available to investors with a flat 1% management fee and zero incentive fees. The biggest selling point of Conquest MFS is its simplicity. It has about 90% correlation to the S&P Managed Futures Index, charges a fraction of the fees other CTAs charge, and unlike other CTAs who are "black boxes", Conquest MFS is open code.

   The fund was initially seeded by the endowment of a very large Ivy League university who worked with us on the design of the programme. Subsequently, another major university endowment has invested as well as a pension plan and one of the top ten funds of funds by assets.

3. What is the rationale behind your fee structure? Does the structure provide a competitive advantage when seeking investors?
   
   As mentioned earlier, we believe that some hedge fund strategies are alpha strategies, and some are exotic beta strategies. Neither class of strategies is necessarily superior; the classification just conveys the methodology used to extract those returns. If you can create a relatively simple, systematic strategy that replicates the returns of a hedge fund strategy, the hedge fund strategy is an exotic beta strategy. The more faithfully your simple systematic strategy replicates the hedge fund strategy, the more the hedge fund strategy is delivering exotic beta, instead of alpha. Generally speaking, one good way to determine whether a hedge fund strategy has a large beta component is to look at correlation of funds in a strategy to each other. If this is relatively high, it indicates the existence of a systematic or beta factor to which they are all subject.

   We believe the pricing of systematic exotic beta should be much lower than alpha strategies, and to that extent, we chose the reduced fee structure for MFS.

   I think the fee structure gives us a tremendous competitive advantage since we are giving back to the investor a significant portion of the fees that other CTAs would charge. For a gross return of 20% per year, MFS would return 19% to the investor, whereas a typical 2/20 CTA would return about 14.5%.

4. How would you describe MFS' investment methodology? How does the fund manage its risks?
   
   Conquest MFS uses 20 different time frames to trade 55 different markets spanning currencies, fixed income, equities and commodities. The investment methodology is systematic and non-optimised.

   Risk is managed via diversification over market and time frame and by sizing of positions which is based on recent market volatility.

5. In your investment mandate, you detail a study that provides access to managed futures as an asset class, as also uncovers their long-term trending characteristics or 'beta'. Could you give us a brief overview of this study and the key findings?
   
   In our study, we found that most CTAs exhibit a very high correlation (70-90%) to one or more simple breakout strategies consisting of trading a diversified group of markets by buying at the nth day high and selling at the nth day low. We chose 33 different breakout lengths, ranging from 1 to 200 days. Each of these breakout lengths was run as an "nth day" simple breakout strategy on Conquest MFS' 55 markets.

   The result is a historical track record for each of the breakout lengths. Our study plots the correlation between a CTA's monthly return stream and the return stream of each of the breakout lengths. We have found that most of the CTAs we tested have a very high correlation to breakout lengths between 30 and 60 days.

   This means that what most CTAs are delivering is in part a beta; an exotic beta, but not alpha. Further studies showed that CTAs were not generally delivering alpha in excess of the exotic beta. In other words, CTAs as a group were not outperforming the exotic beta they delivered. For an investor, therefore, investing in the exotic beta directly would generally be a better strategy than investing in a portfolio of CTAs that would purport to deliver alpha.

6. By contrast, are the CTA funds that were shown in the study to be highly correlated (either negatively or positively) to short-dated breakout benchmarks, a good indicator of the 'alpha' potential of the managed futures space?

   Our analysis of various trend followers and CTAs indicates that the only opportunity for alpha in the space exists in the very short-term trading strategies. Because there is a small sample of trades in the medium- and long-term trend following time frames, managers really "have" to take every trade that looks like a trend, and are typically in the trade for over ten weeks. In contrast, short-term traders choose from thousands of trades, and typically stay in these positions for days not weeks. This diversity of options creates many more opportunities for short-term traders to generate alpha, which is reflected in the lack of correlation amongst the short-term traders. We had believed this intuitively for some time, which is why our Conquest Macro product focuses on the short-term space. We were gratified to see this intuitive view supported by the data.

7. Among the asset classes that MFS trades in, the biggest allocations are to fixed income (30%) and foreign exchange (27%). Would you say this is a reflection of your fund's competencies, or the depth of these asset class markets?
   
   In designing Conquest MFS, we sought to replicate the CTA industry in one fund. To determine the asset class mix for the fund, we did a survey of the largest 20 CTAs, and used an average of their sector allocations and most commonly used markets. Although most CTAs say they trade over 50 or 100 markets, a closer study of P&L attribution reveals that most of the P&L is generated in the largest, most liquid markets such as currencies, fixed income and equities. The concentration of P&L into these three sectors is a reflection of the depth of these markets; a CTA over US$500 million can easily trade these markets without having any effect on them, which is something that cannot necessarily be said about a market like live cattle or orange juice. Our allocation is thus a reflection of the allocation of the industry as a whole, which in turn reflects the depth of markets in these asset classes.

8. MFS is also diversified across time frames and geographic regions. What is the breakdown of the fund's assets by these two criteria? Why?

   Conquest MFS separates time frames into three different buckets:

   • Breakouts less than 20 days (short-term) - 40%
   • Breakouts greater than 20 days and less than 60 days (medium-term) - 25%
   • Breakouts greater than 60 days (long-term) - 35%
    

   However, due to liquidity constraints, Conquest MFS does not trade some commodity and currency markets over the shorter half of the strategy horizons. Consequently, the true breakdown across time frames is: 34.2% short-term, 25.7% medium-term and 40.1% long-term.

   Conquest MFS separates its geographical exposure into three different buckets:

   • Asia/Australia - 20.5%
   • Europe - 34.8%
   • North America - 44.7%
    

   The different time frames were chosen to provide maximum diversification across trading horizons. The time horizons were spaced logarithmically because the marginal effect of each additional day in the breakout calculation decreases as the time horizon increases. In other words, the difference between a 5-day breakout strategies trades and those of a 10-day strategy is going to be significantly larger than the difference between the trades of 160-day and 165-day strategies.

   The geographical exposure was weighted for liquidity and time-zone diversification. We chose markets that were most representative of what other managers trade while attempting to preserve diversification both across regions and within each region.

9. The investment style of managed futures managers is quantitative and systematic, and, by extension, replicable. Would this imply that there is a certain broad investment methodology that most of these managers gravitate towards? How then, does any player in this space differentiate itself? And more specifically, how does MFS differentiate itself?

   This is precisely the point of MFS. When you are a trend- follower, especially a long-term one, an overwhelming percentage of your annual P&L is generated by a few trades. As such, a trend-follower cannot afford to "miss" any of these trades. They all have to get into a trade if it looks like a trend, and reverse when the market reverses. They try to differentiate themselves on the periphery by tweaking the models, but the net effect of these adjustments is negligible, as evidenced by the high correlation they all seem to have to each other.

   MFS recognises that this is a systematic exotic beta strategy, and through its flat 1% management fee improves the risk-adjusted return tremendously.

   Another key aspect of MFS is that the investor is getting under "one roof" all of the time frames from five days to 200 days. CTA investors recognise the importance of diversifying their time frames and allocate to long term-trend followers and short-term traders, hoping to hedge some of the reversal risk inherent in trend-following. Unfortunately, however, the long-term manager can be trading a totally different allocation than the short-term traders, causing a total risk mismatch. In MFS, with the exception of some of the less liquid markets that are not traded in the very short-term models, all models trade all markets in the same proportions. This consistency of allocation significantly enhances the stability of the returns.

10. And lastly, what is your near-term outlook on opportunities in the CTA/managed futures space?
    
    I think the outlook for managed futures is very bright in the medium to long term. This is a very cyclical strategy, and unfortunately most investors get in after CTAs have made their 30-40%, and get out after they lost the 10-20%. I think the time to invest in CTAs is now, when we are at the bottom of the 12-month rolling return charts.

Another very compelling reason is that CTAs usually tend to do very well in risk-averse regimes whereas other hedge fund strategies tend to suffer. For a variety of reasons, we believe that we are entering a risk-averse regime after the longest period in risk seeking since 1997. As a matter of fact, we have written a paper on the topic which can be viewed on www.conquestcg.com.

Contact Details
Condor Capital Management, Inc.
1973 Washington Valley Road
Martinsville, New Jersey 08836
Tel: +1 (732) 356-7323
Fax:+1 (732) 356-5875