Returns to managed futures funds and Commodity Trading Advisors (CTAs) have decreased dramatically. Funds overwhelmingly use technical analysis. This research determines if structural change in futures price movements could explain the reduced fund returns. Bootstrap tests are used to test significance of a change in statistics related to daily returns, close-to-open changes, breakaway gaps, and serial correlation. Several statistics have changed across a broad range of commodities. Lower price volatility is the most likely explanation of the lower returns from technical analysis. The structural changes likely caused the decreased returns rather than increased technical trading causing the structural changes.
During the 1980s and early 1990s, investment in managed futures grew quickly. In recent years however, futures fund returns have decreased and the value of assets invested in managed futures has stagnated along with returns (Pendley & Zurla, 2002). Fig. 1 shows the Barclay Commodity Trading Advisor Index versus time and shows a steady trend of decreasing returns during the past 20 years. The causes of this decrease in fund performance are not fully known. Two possible explanations for the decrease are (a) decreased market volatility (and therefore profit opportunities) and (b) price distortion caused by the growth of the industry. Certainly there must have been changes in the distribution of futures prices in order for returns to have decreased so dramatically.1 This naturally leads to the research question, “What structural changes have occurred in futures price movements?” Knowing the way futures price distributions have changed will help explain why futures fund returns have decreased.Most financial participants are at least superficially interested in the return characteristics of managed futures funds and Commodity Trading Advisors. Technically traded managed futures funds rely almost exclusively on past prices to generate buy and sell signals. Accordingly positive returns to these funds require weak-form inefficiency of the markets. Therefore, the return attributes of managed futures funds are of high interest not only to investors but also to regulators, investment advisors, and policy makers. Research is needed to determine the ways in which the market has changed, thereby allowing technical traders to adjust trading systems to account for these changes.
Most previous studies of returns to managed futures funds focus on the predictability of returns (e.g., Brorsen & Townsend, 2002; Schwager, 1996), factors that increase returns (e.g., Irwin & Brorsen, 1987), and if an increase in the trading volume of managed futures funds decreases returns (e.g., Brorsen & Irwin, 1987; Holt & Irwin, 2000). Some authors have examined the profitability of technical trading (e.g., Brock, Lakonishok, & LeBaron 1992; Lukac & Brorsen, 1990; Osler & Chang, 1995), and Boyd and Brorsen (1992) used simulated technical trading profits to see which price statistics are correlated with technical returns, but no authors have examined possible causes of the recent decrease in returns to technical analysis. Furthermore, many authors have examined the distribution (e.g., Gordon, 1985 and Mandelbrot, 1963) and dependence (e.g., Gordon, 1985; Mann & Heifner, 1976) of futures price changes. The few studies that have evaluated a possible change in price distributions and dependence are limited in statistical techniques and commodities tested. Although not backed by formal significance tests, Hudson, Leuthold, and Sarassoro (1987) suggest that price changes have become more normal over time. No research has comprehensively studied a change in daily return characteristics. This research directly tests the hypothesis that a structural change in futures price fluctuations has occurred that may have affected the profitability of managed futures and technical analysis. Bootstrap resampling techniques are used to test for evidence of a structural change in the distribution of futures prices because futures prices are known to be nonnormally distributed and they must not be independent for there to be positive returns to technical analysis.
Technical trading returns have been lower after 1990 than they were before. Futures prices are examined for evidence of a structural change that could explain the reduced profitability. The results show evidence of a structural change in prices that may have reduced technical trading profitability. The two dominant changes are a decrease in price volatility and an increase in the kurtosis of price changes occurring while markets are closed. There is also a slight indication of reduced autocorrelation. These changes are consistent with the reduced profitability of technical trading being due to changes in the overall economy. The results are not consistent with increased technical trading having caused the structural change, because in that case price volatility should have increased. If economic conditions changed so that prices became more volatile, then presumably returns to technical trading would increase.
