Joe Arata Speculative Funds

Hedge Funds Impact on Agricultural CommoditiesAugust 15-16, 2006: 

Hedge Funds Impact on Agricultural Commodities August 15-16, 2006 Joseph O. Arata Kansas State University Midwest, Great Plains and Western Outlook Conference

Outline: 

Outline I. What is a Hedge Fund II. Agricultural Commodity Open Interest III. Hedge Fund Impact on Agricultural Commodity Prices IV. Volatility

Definition: 

Definition Webster’s Dictionary of Hedge: Boundary Means of Protection Exploded in the 1990’s $1,400 Billion in assets in over 5,000 Funds

Slide4: 

Growth of Hedge Funds Source: Hedge Fund Research, Man Group (3/21/06) Note: (1) Excluding funds of funds Assets ($Billions) Assets Under Management Number of Funds (1)

Legal Definition: 

Legal Definition Freedom from ICA (1940) controls on: leverage short-selling cross-holding 10% limits incentive compensation derivative positions Limitations on: number of U.S. investors solicitation of U.S. investors public advertising and disclosure

Hedge Fund Location: 

Hedge Fund Location Hedge Fund Research, Man Group (3/21/06)

Hedge Fund Trading Volume: 

Hedge Fund Trading Volume Goldman Sacks

Classifications: 

Classifications Convertible Arbitrage Equity Hedge Event Driven Distressed Securities Merger Arbitrage Equity Market Neutral

Classifications: 

Classifications Convertible Arbitrage: Long convertible bonds or preferred, short underlying common stock and short underlying credit risk. Equity Hedge: Long or short equities, typically with a net long bias. Event Driven: Corporate transactions and special situations. Distressed Securities: Long undervalued securities of companies in financial distress or operating under Chapter 11.

Classifications: 

Classifications Merger Arbitrage: Long/short equity securities of companies involved in corporate transactions. Equity Market Neutral: Long undervalued equities and short overvalued equities, usually coordinated on a factor exposure basis.

Hedge Funds and Futures: 

Hedge Funds and Futures Increase Volatility Drive prices away from fundamental values - “spec bubble” – Manipulate market Extrapolate past trends – “herding”

Open Interest: 

Open Interest The total number of futures contracts long or short in a delivery month or market that have been entered into and not yet liquidated by an offsetting transaction or fulfilled by delivery. Also called Open Contracts or Open Commitments.

Corn Open Interest – CBOT: 

Corn Open Interest – CBOT

Wheat Open Interest – CBOT: 

Wheat Open Interest – CBOT

KC Wheat Open Interest – KCBT: 

KC Wheat Open Interest – KCBT

Soybean Open Interest – CBOT: 

Soybean Open Interest – CBOT

Live Cattle Open Interest – CME: 

Live Cattle Open Interest – CME

3 Month Euro Dollar – CME: 

3 Month Euro Dollar – CME

Open Interest: 

Open Interest Jan 2004 Aug 2006 % Change Corn 450,278 1,399,222 210.8% Wheat 116,310 482,088 314.5 % Soybeans 243,722 342,520 40.5% Live Cattle 96,071 233,026 142.6% Euro 4,894,589 9,899,184 102.5% Contracts

Futures Contracts Value: 

Futures Contracts Value

Futures Contracts Value: 

Futures Contracts Value

Open Interest: 

Open Interest Commercial – CL – CS An entity involved in the production, processing, or merchandising of a commodity. Non-commercial – NCL – NCS Not engaged in business activities hedged by the use of the futures or option markets. Speculators.

Corn Open Interest – CBOT: 

Corn Open Interest – CBOT

Wheat Open Interest – CBOT: 

Wheat Open Interest – CBOT

KC Wheat Open Interest – CBOT: 

KC Wheat Open Interest – CBOT

Live Cattle Open Interest – CME: 

Live Cattle Open Interest – CME

3 Month Euro $ Open Interest – CME: 

3 Month Euro $ Open Interest – CME

Data: 

Data Series of high-frequency time-stamped futures price transactions data: corn, wheat, soybean, cattle and euro $’s futures price data from January 1985 to May 2006.

Corn Futures Continuation - CBOT: 

Corn Futures Continuation - CBOT

Wheat Futures Continuation - CBOT: 

Wheat Futures Continuation - CBOT

Soybean Futures Continuation - CBOT: 

Soybean Futures Continuation - CBOT

Cattle Futures Continuation - CME: 

Cattle Futures Continuation - CME

Volatility - Variance: 

Volatility - Variance The traditional estimator of a price series variance using the close to close prices for a stationary time series is:

Volatility - Variance: 

Volatility - Variance The mean-adjusted variant of the close to close estimator is:

Volatility - Variance: 

Volatility - Variance Parkinson (1980) introduces the following extreme-value estimator for a drift security: Ht – high, Lt – low

Volatility - Variance: 

Volatility - Variance Following Parkinson’s assumptions, Garman and Klass construct a minimum variance unbiased estimator that simultaneously uses the opening, high, low and close prices: Ot – open, Ht – high, Lt – low, Ct - close

Volatility - Variance: 

Volatility - Variance Rogers and Satchell relax the assumption of µ = σ2/2 with the following: Ot – open, Ht – high, Lt – low, Ct - close

Corn Volatility cc - CBOT: 

Corn Volatility cc - CBOT

Wheat Volatility cc - CBOT: 

Wheat Volatility cc - CBOT

Soybean Volatility cc – CBOT: 

Soybean Volatility cc – CBOT

Corn Volatility ohlc – CBOT: 

Corn Volatility ohlc – CBOT

Soybean Volatility ohlc – CBOT: 

Soybean Volatility ohlc – CBOT

Live Cattle Volatility ohlc – CME: 

Live Cattle Volatility ohlc – CME

Cash Corn Prices: 

Cash Corn Prices Annual Daily 1985-96 1985-96 Average 244 243 Variance 879 1,424 Standard Dev 30 38 Skewness -1.64 -0.75 Krutosis 3.38 0.04 1997-06 1997-06 Average 230 232 Variance 2,948 1,206 Standard Dev 54 35 Skewness 2.08 0.64 Krutosis 5.40 -0.39

Corn futures – nearby - CBOT : 

Corn futures – nearby - CBOT Annual Daily 1985-96 1985-96 Average 238 238 Variance 734 1,360 Standard Dev 27 37 Skewness -1.70 -0.41 Krutosis 3.45 -0.07 1997-06 1997-06 Average 233 232 Variance 2,383 944 Standard Dev 49 31 Skewness 2.30 0.77 Krutosis 6.20 -0.05

Wheat futures – nearby - CBOT : 

Wheat futures – nearby - CBOT Annual Daily 1985-96 1985-96 Average 340 241 Variance 1,744 2,810 Standard Dev 42 53 Skewness 0.07 0.17 Krutosis -0.57 -0.82 1997-06 1997-06 Average 315 313 Variance 5,003 2,347 Standard Dev 71 49 Skewness 1.10 0.39 Krutosis 1.73 -0.88

Cattle futures – nearby - CBOT : 

Cattle futures – nearby - CBOT Annual Daily 1985-96 1985-96 Average 69.93 70.15 Variance 38.7 48.4 Standard Dev 6.1 7.5 Skewness -0.52 -0.51 Krutosis -1.19 -0.62 1997-06 1997-06 Average 75.02 74.90 Variance 21.3 85.3 Standard Dev 4.9 9.2 Skewness 0.23 0.73 Krutosis -1.01 -0.45

Exchange-Traded Funds: 

Exchange-Traded Funds DB Commodity Index Tracking – DBC Commodity Weight Light Sweet Crude 33.67 Heating Oil 17.98 Aluminum 15.34 Gold 11.6 Corn 10.78 Wheat 10.63

Asset Class Allocation by Institutional Investors: 

Asset Class Allocation by Institutional Investors Source: NACUBO Endowment Study

Slide51: 

MANAGER MIGRATION Traditional Fund Mangers Who Switched to HF/Alpha Overlay: Jack Meyer Harvard Mgt Alpha Overlay Brian Posner Warburg Pincus Hygrove Partners Michael DiCarlo John Hancock DFS Advisors HF Leon Cooperman Goldman Omega HF Jeffrey Vinik Fidelity Vinik Asset Mgmt Rob Donahue Solomon Brothers Own fund Greg Jackson Oakmark Global Blum Capital HF David Glancy Fidelity Own fund Peter Trapp Needham Own fund Warren Lammert Janus Granite Point Capital Nicholas Tiller Fidelity Hedge fund Chirstopher Zepf Fidelity Hedge fund Dan Szemis Merrill Lynch Hedge fund Gary Schlarbaum Morgan Stanley Schlarbaum Capital