Managed futures funds have fared poorly, but could shine in a market downturn

The funds can bet on rising or falling prices, and have a low correlation with stocks or bonds

Sep 19, 2017 @ 2:16 pm

By John Waggoner

Taken as a group, managed futures mutual funds have been wretched over the past five years. But the category has some strong performers, and if you're looking for an unloved area due for a turn, managed futures might be the place to go.

The average managed futures fund has gained an average 1.24% in the past five years, according to Morningstar. That's only slightly better than the average intermediate-term government bond fund. And within that average annual return is a world of variation, and not all of it the good variety.

On the happy side of the ledger is Equinox Chesapeake Strategy (EQCHX), an institutional fund that's up an average 8.41% the past five years and 7.91% this year. Like most managed futures funds, it keeps most of its holdings in cash and bonds, and a relatively small amount in futures — about 17%, in this case. Its futures contracts are mainly in equity indexes (30%), interest rates (26%) and currencies (19%), with some holdings in energy, metals and agricultural commodities.

On the darker side is Direxion Indexed Managed Futures (DXMIX), which has posted a 3.15% average annual loss on its institutional shares in the same five-year period. The fund has lost 20.03% this year. It, too, is largely a mix of cash and bonds, with a 24.5% injection of rocket fuel — managed futures. Unfortunately, the fund's rocket fuel has more closely resembled the kind used in early North Korean ICBM tests.

The Direxion offering follows the Auspice Managed Futures ER Index, a long/short index that provides exposure to 21 futures markets including commodities, currencies and interest rates. As of June 30, the fund was largely been betting against the dollar (good) and against energy (bad).

Why invest in commodities at all? A 1983 paper by the late Harvard professor John Lintner, "The Potential Role of Managed Commodity-Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds," showed that managed futures had substantial diversification benefits for stock portfolios. This makes sense: Managed futures funds can bet on rising or falling prices, and have a low correlation with stocks or bonds.

And limited data shows that Lintner's findings had merit. Guggenheim Managed Futures Strategy A (RYMFX), the oldest open-end managed futures fund, gained an annualized 12.4% during the 2007-2009 bear market, vs. an annualized loss of 42.95% for the Standard and Poor's 500 stock index and a 48.26% for the MSCI Europe, Australasia and Far East index.

If you're worried about a stock market downturn, then, a managed futures fund might make sense, especially since the funds have had such a wretched performance recently. Steben & Co., which specializes in alternative investments, including managed futures, just published a white paper arguing that periods of really rotten performance from managed futures often leads to relatively short bursts of outperformance — in other words, reversion to the mean.

While clearly from a self-interested source, the Steben paper raises some interesting points. The first is that performance for managed futures has been unusually awful, particularly when looked at in terms of their Sharpe ratios, which measures return in relation to risk. The Barclay's CTA Index, which represents the equally weighted average net returns of a large set of managed futures programs, had a 12-month Sharpe ratio of -1.99% in the 12 months ended June 30, its worst 12-month period ever.

The paper, co-written by John Dolfin, Steben's chief investment officer, and Christopher Maxey, a senior portfolio manager for the firm, notes that those Sharpe ratios tend to revert to the mean. If the mean reversion pattern continues, this indicator could bode well for managed futures.

"The consistent result across our tests is that there does appear to be historical mean reversion in managed futures Sharpe ratios, with weaker 12-month periods being followed by stronger 12-month periods, and vice versa," the authors wrote. "This result would justify a strategy of buying the dips in managed futures and moderating positions after a strong period of performance."

Of note: Managed futures' outperformance tends to be in short, sharp bursts. Waiting for a confirmation of the uptrend can mean you'd miss a significant portion — up to 40% — of positive returns. "Since the bulk of returns in managed futures were concentrated in relatively short windows of time, a return-chasing approach such as this can miss the early returns in a run-up and may incur a large opportunity cost," the authors say.

Most entrants to the managed futures arena are fairly new: There are only three ETF offerings, and the oldest one, WisdomTree Managed Futures Strategy ETF (WDTI), made its debut in January 2011. The fund has lost 0.93% a year the past five years.

They are also fairly expensive. The $11.9 billion AQR Managed Futures Stratgegy I, for example, charges 1.20% in expenses, which is cheap for a managed futures fund, but still on the high side of the institutional mutual fund universe. The Superfund Managed Futures Strategy A fund, the top-performing futures fund this year with a 10.78% gain, charges 3.24% in expenses in addition to a 5.75% front-end commission.

The takeaway: It's good to buy low, but, as star manager Peter Lynch was fond of saying, it's always darkest just before it's pitch black. Advisers who want to use managed futures should tread carefully and make sure they're not paying too much for what they buy.

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