30 years of managed futures
Over the past 30 years managed futures have migrated from the outskirts of finance to the center of the mainstream investing world, with more than $210 billion under management in the U.S. as of the end of 2009. In fact, managed futures assets under management (AUM) actually grew in 2008-2009 — a period that saw hedge fund AUM decline by roughly 30 percent.
Also, while equity portfolios tanked as the global financial crisis peaked in 2008, managed futures experienced one of their most profitable years of the past quarter century, returning more than 14 percent while the S&P 500 dropped nearly 40 percent. Managed futures are, in fact, entering their fourth decade with a solid long-term track record of offering a non-correlated investment alternative that can lower volatility and enhance the returns of a larger investment portfolio. (“Managed futures vs. stocks” offers a more detailed look at the performance of managed futures and equities during the financial crisis.)
Figure 1 compares the performance of the S&P 500 index (SPX) to the Barclay CTA index, which is comprised of the performance of more than 500 commodity trading advisors (CTAs) tracked by BarclayHedge.com as of April 2009. The method of comparison used in the chart is referred to as the Value-Added Monthly Index (VAMI), which represents the hypothetical performance of a $1,000 initial investment in an asset over time. As virtually all investors are painfully aware, stocks — thanks to two bear markets, one in 2000-2002 the other in 2008-2009 — have essentially been flat for the past decade; buy-and-hold investors who got in the market in the late 1990s have seen little or no profit since then.
However, not only did the Barclay CTA index outperform the S&P 500 dramatically during these periods, it has actually outperformed that equity index since 1980. (Because the Barclay index reflects the average performance of all the CTAs in the index, the performance of an individual CTA could be worse or better than index performance shown in Figure 1.)
What are managed futures?
Managed futures are similar to equity mutual funds or other portfolio investments in that a professional fund manager trades funds on behalf of investors. Instead of stocks or bonds, CTAs trade exchange-listed futures and options on futures, either through individualized client accounts or an investment pool. Futures fund managers must register both with the Commodity Futures Trading Commission (CFTC), which is the futures market federal regulator (equivalent to the Securities and Exchange Commission for stocks) and the National Futures Association (NFA), which is the futures industry’s self-regulatory organization.
There are as many kinds of CTAs as there are futures markets, with advisors specializing in certain time frames, trading styles, or markets. A CTA may offer more than one fund for its clients, offering exposure to different market sectors or trading styles — trend-following vs. contrarian or short-term vs. long-term. Figure 2 shows the VAMI lines for six sub-categories of CTAs tracked by BarclayHedge: agricultural, currency, diversified, discretionary, financial/metals, and systematic.
Individual CTAs can belong to more than one category — e.g., both diversified and systematic, or agricultural and discretionary. For example, of the 533 CTAs in the Barclay overall CTA index, 417 are in the “systematic” category and 335 are in the “diversified” category.
Advantages of managed futures
Managed futures offer several advantages for investors looking to expand an improve their overall portfolios. In addition to the excess returns indicated by Figure 1, managed futures allow investors to diversify their portfolios, both by virtue of the different markets futures fund managers have at their disposal, as well as the historical independence of managed futures relative to other asset classes.
In the U.S. alone, CTAs can trade everything from stock indices, currencies, and Treasuries to precious metals, energy, and grains. Further, futures funds have the opportunity to branch into global markets, increasing their diversity even more. Also, because going short in the futures markets has none of the restrictions present in the stock market, CTAs can take advantage of down moves as easily as up moves.
Thanks to this flexibility, the lack of correlation of CTA returns to stocks and bonds means managed futures can generate returns when these markets are in bear phases. Figure 3 shows the historical correlation (from 1980 to present) of the six BarclayHedge CTA and its six sub-categories to stocks, U.S. bonds, and world bonds. The “correlation coefficient” (see p. 9) simply reflects the relationship between two assets on a scale from +1.00 to -1.00, with +1.00 meaning the assets move precisely together in the same direction (“perfect positive correlation”), -1.00 meaning the assets move exactly in the opposite direction (“perfect negative correlation”), and zero implying no correlation at all. The correlations in Figure 3 range between +0.16 and -0.16, meaning none of the CTA indices have a significant relationship to the stock or bond markets.
As a result, the long-term profitability of managed futures not only opens the possibility of creating excess returns in an investor’s overall portfolio, but reducing the volatility of those returns as well. Table 1 shows that since 1980 the S&P 500 has had seven losing years (yellow) while the BarclayHedge CTA index has had four (aqua). The only time a down year in the CTA index year coincided with a losing year in the S&P 500 was 1994, when the CTA index lost -0.65 percent and the S&P 500 lost -1.54 percent. In all other down S&P years, including the three-year losing streak from 2000-2002, the CTA index posted gains.
The final kicker for investors unfamiliar with the managed futures industry is that, overall, managed futures returns have — on average — been less volatile than the stock market since 1980. The maximum drawdown for the CTA index has been around 16 percent, vs. more than 50 percent for the S&P 500.
Simplicity and flexibility
Futures markets offer the ability to reduce risk
and seek diversified gains, but many investors are hesitant to trade them directly. Different margin rules and complications such as contract expirations and rollovers make them less palatable to some long-term investors. Managed futures offer a solution to these problems by offering diversified investment vehicles supervised by registered money managers.
