Saturday, July 22, 2017

"STICKY MONEY" IN MANAGED FUTURES: INDIVIDUALS VS INSTITUTIONS


In a recent due diligence call with an emerging CTA manager, we were asked a question that we have heard many times before: which types of investors provide more "sticky money," individuals or institutions? "Sticky Money" is hedge fund slang for investors that will stay around for the long-term.  In contrast, individuals/institutions that tend to withdraw investments quickly are considered not "sticky."
The simple answer to the question is: it depends. When it comes to individuals, the level of stickiness depends on that person's personality.  Sometimes, individuals are not tolerant of drawdowns and that can lead them to pull money immediately upon a small drawdown (in many cases this ends up being a poor decision). In other cases, individual investors can be very patient, and are willing to ride the investment cycle of a CTAs performance - sitting tight through drawdowns, and watching their equity come back to new highs. Since each individual investor has a unique personality, it's hard to bunch this class of investors into one category and declare them either "sticky" or "not sticky."
Institutions behave completely different from individuals - personalities do not matter as there is a group of people making decisions instead of just one person.  An institutional investor's level of stickiness is determined by the length of experience that they have with the CTA manager.  If the institution has had a long, multi-year, relationship with the CTA manager, then their chances of "sticking" around during a large drawdown are much greater.  Conversely, a large drawdown over a short-lived relationship will most likely lead the institution to withdraw their investment from the manager.
It is a common misconception among emerging CTA managers that institutional clients provide more sticky investments than individuals. It is believed that because institutions are larger and more savvy than individuals, that they are more amenable to tolerating drawdowns than individuals are.  Institutions are considered to be better decision makers because they make all decisions absent of emotion - providing the common misconception that they would be more likely to stick around when a CTA is going through a rough patch of performance. 
Moreover, positioning a CTA to only market toward institutions can be a double edged sword.  Yes, the asset allocations will be larger on a per client basis, but when there are withdrawals, the outflows will be just as fast.  For example, a CTA that has a $100M in AUM can either be made up of 5-10 institutions or 40-50 individuals.  In that example, if the CTA suffers a large drawdown, it's possible that that 20% of investors will withdraw, and it is highly likely that the CTA made up of only institutions will lose more assets during the drawdown than the CTA made up of individuals.
A sound strategy for an emerging CTA is to position their program towards both individuals and institutions.  The reasoning for doing this is simple, it diversifies your client base, and better protects your business when withdrawals occur. Moreover, by targeting both types of investors, you increase your market size, which should help grow the CTA more rapidly.

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