Managed Futures Becoming Tougher Sell
Showing No Correlation to Stocks or Bonds, Category Rose 20% in 2008
October 12, 2009
In 2007, Philip Moses, a Raymond James adviser at First Federal Bank of Florida in Lake City, had a local physician as a client who wanted to diversify his $1.5 million portfolio.
Moses, long an advocate of alternative investments, suggested a hefty 20% allocation to alternatives, including structured products, a multi-strategy hedge fund and a multi-advisor managed futures fund.
When equities and debt markets declined a year later, the client's alternative holdings "held up, just like they were supposed to," Moses said. Among them, the top performer was a 5% stake in a managed futures fund. "It moved up smartly as everything else was going down," he said.
It was easy to embrace managed futures after 2008, when as a class they showed a 20% gain while markets lost nearly 40%. They are one of the only investments that did well last year, in part because they are not correlated with stocks and bonds.
This year, however, the sales pitch is a little harder.
After hitting a low on March 9, the Standard & Poor's 500 Index recovered almost 50% of lost ground by the end of August. Meanwhile, managed futures as a group declined 6% in the same period.
Insiders are reportedly selling, and some formerly bullish strategists say the markets may be running out of steam. The question: Is this still a good time to invest in managed futures?
Moses says it is, for diversification purposes. "We're opening managed futures accounts for clients as fast as we can explain the strategy to people," he said.
Chris Butler, vice president for alternative investments at Raymond James, said the products are doing what they are supposed to do, which is to be non-correlating assets-that is, instead of moving in inverse relationship to markets, they march to their own drummer, going up when markets go down, or sometimes even going up as stock and bond markets go up.
According to Barclay Hedge Ltd., a Fairfield, Iowa company that tracks alternative investments, managed futures since 1980 have had a zero correlation with the S&P 500, a 0.14 correlation with U.S. bonds and a 0.16 correlation with global bonds.
Brian Kim, president and chief investment officer of Liquid Capital Management, a New York hedge fund, said that the bulk of commodities trading advisers "who run managed futures programs are trend followers. So if there is a market trend-down or up-they can do well." However, when there is a reversal of market trends, they tend to do worse.
That doesn't mean investors should avoid managed futures or try to buy them when they're down, Kim said. "You don't want to pull away your money from a CTA [commodities trading adviser] because he had a bad quarter or two, or invest in one because he's down," he said. "What you're looking for is long-term, non-correlating performance."
Bob Franklin, a senior vice president and director of distribution of alternative investments at Wells Fargo in San Francisco, said advisers need to explain to clients that managed futures are a long-term investment.
"Intramonth, managed futures can be wildly volatile," he said. "Plus 10% or minus 10% in a month is not at all unusual, and typically you get hit during market reversals, which is what has happened this year. But market reversals tend to be short-lived, and longer-term, managed futures have done well." Franklin said from 1998 to 2008, there were four down years for the S&P 500, ranging from negative-0.9% to negative-37%. During the same period, managed futures as a class had only one down year, and that was just negative-1.9%, in 1999. In each of the six most severe market drops since 1980, managed futures as a group showed annual gains.
Managed futures using a long/short investment strategy have been around since the 1940s, said Chris Geczy, a University of Pennsylvania finance professor and academic director of the Wharton School's wealth management initiative. "They were alternative investments before it was cool to be alternative. Empirically, managed futures add value to a portfolio, because they are non-correlated to equities, banks and even traditional hedge funds."
Over $200 billion has been invested in managed futures, but Ben Alpert, a hedge fund analyst at Morningstar, said mutual funds that feature a managed futures strategy are scarce. "It's still a niche area with too few products for us to compare them," he said.
Geczy is wary about recommending managed futures for just any investor. "They certainly have a strong place in a large portfolio, but for smaller portfolios, especially those with less than $100,000, it wouldn't make sense," he said.
Even in larger portfolios, he and other experts recommend limiting a managed futures allocation to 5% to 10%.
Neil Menard, director of sales and marketing for Steben, a Rockland, Md., commodity pool operator that selects CTAs to manage funds for clients, said that the fees associated with managed futures seem exorbitant, but "that's because it's expensive to trade futures and because you're paying for talent," he said.
Not everyone is conservative about managed futures. The managed futures strategy has proven itself, and concerns about issues like transparency and risk are overblown, Kim said.
"I'd say if you are limiting managed futures to 10% of a portfolio, you are not really helping yourself. I think it should be at least a 20% allocation," he said. "Remember, until well into the 1970s, institutions and pensions only invested in bonds. Investments in equities were considered to be far out way back then."
Kim said it is even more critical for retail investors to make use of managed futures, "because they generally don't have the assets to be able to get into real alternative investments." Managed futures funds, he said, often have a minimum investment of $1,000.
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