The Effects of Incentive Compensation Contracts on the Risk and Return Performance of Commodity Trading Advisors

This paper shows that commodity trading advisors' (CTAs) investment performance may be partially explained by their incentive compensation contracts. Contracts include base, incentive and asset parameters. The relationships between contract parameters and performance are theoretically indeterminate but are examined here empirically. Results indicate that incentive parameters are positively related to return means and standard deviations. The dollar amounts of assets CTAs manage are negatively related to return means and standard deviations, supporting Elton et al.'s (1987, 1989) finding that CTA performance falls after public offerings of commodity funds. Intuitively, since dollar fees are a function of assets, at the higher asset and fee levels achieved through commodity fund offerings, CTAs may safeguard assets and fees by pursuing less risky investment strategies.