This article was originally published on Seeking Alpha.
By Jessica Rabe
- Managed futures has been incorrectly described as a bear market hedge due to poor performance over the past few years.
- The strategy is not a hedge; it is uncorrelated, and its role in a portfolio is long-term diversification.
- AQMIX has had strong returns for a managed futures fund since 2012; FMF may be more suitable for the risk-seeking investor who wants to consider a new fund.
Is managed futures broken?
As equity markets tanked in 2008, managed futures reigned supreme: the S&P 500 yielded negative returns of 37%, while the Barclay CTA Index was up 14%, and managed futures hedge funds in Morningstar’s database reaped an average return of over 19%. Over the past few years, the performance has reversed, as equities continue to reach new highs and managed futures consistently underperforms; the managed futures category often struggles in low volatility environments. Thus, many investors have bailed on managed futures: the fees are too high and performance is too low. Fierce competition continues to erode alpha potential, and regulators are growing weary of the high performance fees in many ETFs and mutual funds. After a long period of underperformance, many investors have reduced managed futures to a bear market hedge that fails to add value otherwise.
While finding a managed futures strategy that produces robust risk-adjusted returns after fees proves relatively challenging, managed futures are not necessarily broken; rather, investor expectations are misguided. Managed futures are trend-following strategies that usually rely upon rules-based algorithms, and these may be proprietary.
Given the current risk-on/risk-off environment, systematic, trend-following strategies will struggle to perform due to the unpredictability of the market, which may cause the trade to get stopped out before it turns profitable. In addition, the cost structure of managed futures funds typically have performance-based fees and may have high structural costs. These layered fees can necessitate exceptionally favorable conditions just to break even. The managed futures category has lagged equities during a bull market, which is common for hedge fund strategies that are not correlated with stocks. Investors have less interest in hedge fund strategies of all types during a bull market, which creates a “risk-on” atmosphere, and reduces interest in portfolio diversification.
In reality, managed futures has historically performed well in some circumstances, and 2008 happened to be one of them. Sometimes the strategy acts as a hedge in a crisis, and sometimes it does not. As illustrated in the chart below, managed futures generated positive returns in the 2008 financial crisis, while global equities fell 15%, and managed futures performed significantly better than global equities – though still generating negative returns – following 9/11. The strategy underperformed global equities, however, during the quant crisis. Managed futures may zig when bonds and equities zag, but the strategy’s historical performance over the past few crises suggests that the strategy should not be purchased as a hedge; 2008 remains an anomaly.
Hope for humpty dumpty?
The role of managed futures is diversification, and debatably, rather than alpha generation. Reducing this strategy to a hedge amounts to performance chasing, and wrongly infers that it is positively or negatively correlated in certain environments. Managed futures offers non-correlation and diversification that effectively supplements other alternative exposures over the long-term.
This dynamic does not reflect poorly upon the strategy, though investors must have appropriate expectations. Managed futures is not meant for high trading frequency; it is best used over a long time horizon, such as five to seven years, as opposed to a six-month period. Further, many investors confuse non-correlation for negative correlation. Portfolios have ebbs and flows, and managed futures may fill in the gaps when the rest of the portfolio fails to perform.
Investors also mistake managed futures for a commodity play. Not only is this premise faulty, but it is an expensive approach for a goal that could be solved with a cheap inflationary index product. Trend following strategies often trade dozens of markets not only in commodity futures (wheat, corn, soybeans, cattle, nickel, the infamous pork-bellies, etc.), but also in financial futures (currencies, interest rates, stock index futures). With that said, managed futures is just another idiosyncratic opportunity to capture returns during Black Swan events and other unexpected events.
Tocqueville Provides an Apt Metaphor
Moreover, the role of alternatives within a portfolio should be improved risk-adjusted returns over the long-term. Managed futures impacts a portfolio like democracy – according to Alexis de Tocqueville – impacts society: although there are fewer highs, it creates higher lows. The higher the lows, the greater the net return of a portfolio – when combined with the highs – over time, as the portfolio does not sustain as many losses.
Although managed futures can help portfolios achieve higher net returns by reducing losses, choosing a managed futures fund in which fees do not trump returns proves challenging, as mentioned above. Yet the market rewards contrarians, and outliers have achieved relative success in recent years, amongst a category holding onto its ’08 glory days. I highlight some successful outliers, and struggling managed futures funds below. Subsequently, I dive deeper into the role of managed futures within a portfolio.
The WisdomTree Managed Futures Strategy Fund seeks positive total returns in any market environment by using a quantitative, rules-based strategy; it is one of the largest ETFs in the category, and has $147 million in assets under management (AUM). This actively managed ETF is designed to correspond to the performance of the Diversified Trends Indicator (DTI), and invests in U.S. treasury futures, currency futures, non-deliverable currency forwards, commodity futures, commodity swaps, and U.S. government and money market securities. The DTI is a long/short managed futures strategy that groups twenty-four liquid commodity and financial futures contracts into 18 sectors; it attributes 50% exposure to commodity futures and 50% exposure to financial futures.
WDTI was launched in 2011-thereby missing the golden year for managed futures. The index it seeks to emulate, DTI, was launched in 2004, and rose 8% in 2008 as equities tanked. Keep in mind, however, that WDTI is actively managed, and performance to the DTI will therefore vary.
WDTI’s expense ratio is relatively cheap at 95 basis points, but its performance pales in comparison to its peers. 2012 was a tumultuous year for the ETF, having fallen by almost 11%. WDTI somewhat redeemed itself by returning 3% in 2013, outperforming the Barclay CTA Index and Morningstar’s managed futures category average (but still trailed top performers like AQMIX and AMFAX, which are discussed below).
Considering the fund’s recent gains relative to its extremely low volatility, WDTI could potentially provide diversification to a portfolio with minimal risk.
Investors may want to look out for one new managed futures ETF that was just launched in August of 2013: the First Trust Morningstar Managed Futures Strategy Fund. FMF’s objective is to outperform the Morningstar Diversified Futures Index; the investment team will invest in similar instruments, but will manage contract selection and roles to potentially achieve excess returns. The ETF provides exposure to equities, commodities, and currencies by undertaking a long, short, or flat futures strategy. Similar to its competitor, WDTI, FMF charges an expense ratio of 95 bps, arguably a bargain in the alts and managed futures spheres. While WDTI’s AUM of 147 million far exceeds FMF’s AUM of 5 million, FMF has continued to outperform WDTI since November of 2013. Since both funds have the same expense ratio, perhaps FMF is worth considering, despite its short track record.
The AQR Managed Futures Strategy [AQMIX] has fared well over the past few years despite the headwinds for managed futures; in fact, AQMIX is one of the most successful mutual funds in the category, and has a whopping $6.2 billion in total assets. The fund seeks absolute returns in up or down markets by going long or short based upon quantitative signals in four asset classes: equities, fixed income, currencies, and commodities. Position sizes depend on the instruments’ forecasted risk, and the probability of the trend continuing.
AQMIX has reaped attractive returns over the past couple years, reaching the head of the pack after trailing many of its peers when it was launched in 2010 (when it returned 5.4%). With returns of 3% and 9.4% in 2012 and 2013, the fund beat Morningstar’s managed futures category average by about 13% and 10% respectively (the category had negative returns in both years). Although the fund trailed the Barclay CTA Index in 2011 by about 3% after receiving negative returns of 6.4%, AQMIX outperformed the index over the last couple years, when the index had negative returns of 1.7% and 1.4%. (See chart below.)
The fund’s fee of only 1.25% proves especially attractive in the most expensive asset class and most expensive category (in which most fees exceed 3%, especially for multimanager funds). As indicated above, low fees significantly impact the performance of managed futures; excessive fees often erode healthy gross returns. Although the fund’s low fees are not wholly responsible for the fund’s success, they certainly help.
Please note that AQMIX is an institutional share class and has a minimum investment of $5 million. The N shares are AQMNX and have a minimum of $1 million, though they have a higher expense ratio, as well as a 12b-1 fee. Some broker dealers and investment advisory firms may be able to access this fund with a lower required minimum investment. As of April 5, 2014, AQMIX is not available through Schwab, but it is on the Envestnet platform used by Right Blend Investing. Investors should check with their advisor or broker/dealer for terms and availability.
(click to enlarge)Cliff Asness’ fund is not a lying liar when it comes to performance; investors should take note, especially given AQR’s successful, and long track-record with quant strategies.
Natixis ASG Managed Futures Strategy [AMFAX] is another absolute return and trend-following strategy that takes short and long positions in global equities, fixed income, currencies, and commodities; it was launched in 2010 and has $922 billion in AUM. As indicated in the chart below, the fund has experienced large performance swings, which can be attributed to its above-average levels of volatility relative to the other funds in the strategy. According to Morningstar, the fund assumes a 13.1% daily-annualized standard deviation, compared with 7.7% for its managed futures category; AMFAX has a maximum standard deviation target of 17%, and a minimum of 7.5%.
(click to enlarge)This high level of volatility certainly impacts performance: In 2012, AMFAX declined by 11%, but rebounded in 2013 with a whopping 12.5%, far exceeding the Barclay CTA Index and Morningstar’s managed futures category average. The fund’s 2013 returns also beat AQMIX’s performance since inception. Note, however, that AQMIX’s performance over the past couple years has proven less volatile, although AMFAX outperformed AQMIX in 2011 by about 6.5%.
AMFAX’s expense ratio is less attractive than AQMIX at 1.7% versus 1.25%; nevertheless, the fund’s expense ratio is moderate, and is far less detrimental to performance than multimanager fund expenses, which will be apparent below.
The Altegris Managed Futures Strategy benefits from innovative and effective marketing by Altegris. Unfortunately, this fund has had high expenses and weak performance; it has $323 million in AUM. The mutual fund was launched in 2010, and invests in seven trend-following and specialized (i.e. short-term trading) managed futures managers, mainly through swaps. These managers have dominated the managed futures category in size and experience. These hedge funds manage at least a few billion dollars each, and you may recall second-generation turtle, Salem Abraham (founder of ATC), from Michael Covel’s The Complete TurtleTrader.
|Managed Futures Strategy Exposure as of 2/05/2014||Source:||Altegris|
|Winton Capital Management||Trend Following||38.75%|
|Quantitative Investment Management||Specialized||20.60%|
|Capital Fund Management||Specialized||14.40%|
|Lynx Asset Management AB||Trend Following||11.25%|
|Abraham Trading Company||Trend Following||7.50%|
|Cantab Capital Partners||Specialized||7.50%|
The Achilles Heel of this impressive multimanager structure is the layering of fees: There are management fees and performance fees for the fund’s seven subadvisors, in addition to mutual fund management fees, and fees to indirectly access CTAs through swaps as opposed to direct separate accounts. This structure is very common among managed futures funds. Consequently, although the underlying managers may have performed well over the past few years, the fund’s fees-with expense ratios of 3.6% in 2011, 4.5% in 2012, and 2.4% in 2013-trumped these returns.
(click to enlarge)As shown in a chart above, the fund has produced negative returns for the past four years, and has never outperformed the Barclay CTA index; it has only beaten Morningstar’s managed futures category average twice. The fund may capture the allocations of the top CTAs, but the fees wipe out this benefit.
What is the role of managed futures in a diversified portfolio?
Institutions often use an endowment model that includes allocations to commodities, hedge funds, and private equity. Liquid products have enabled retail investors to capture some of the returns from these strategies, which have traditionally had poor liquidity, high minimums, and structures that limited them to accredited investors. Thus, Right Blend Investing (where I am a research analyst) uses a “mini-endowment” approach that combines ETFs and alternatives. Whereas alternative funds have typically been thrown in an “alts bucket,” RBI takes the fund’s strategy into account. Alternatives have multiple roles, as a diversifier (uncorrelated strategies to help diversify a 60/40 portfolio), equity complement (strategies to boost long-term returns, but have high beta), or fixed income complement (strategies that may generate income, hedge bond duration, or hedge the equity portion of a portfolio); please see the illustration below.
(click to enlarge)As noted above, managed futures is an uncorrelated strategy and a portfolio diversifier. Hence, investors could use FMF and/or AQMIX, for example, as uncorrelated strategies to diversify a 60/40 portfolio (i.e. SPY/AGG), with a five to seven year time horizon. (Please review the following Seeking Alpha article for an example of an equity complement.) In the current bull market, equities only seem to go higher, making managed futures a hard sell. Nevertheless, this approach is not prudent because it does not anticipate or prepare for “black swan” events. The uncorrelated allocation just described provides some protection against tail risks, thereby making an investor’s portfolio more robust in the long run.
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