[Editor's Note: Occasionally I get a guest post that is well-written and otherwise interesting, but find myself in disagreement with the recommendations in the post, or perhaps just feeling like the post lacks an important point of view. I generally offer the submitter the opportunity to do it as a “Pro/Con” post. They generally write the Pro side and I write the Con side. This is the case with today's post on Managed Futures, written by Jeannette Showalter, CFA. I'm at a bit of a disadvantage in this argument, in that Jeannette almost surely knows more about managed futures than I do. However, I do plan to make full use of my sole advantage- whether or not you invest in managed futures makes no difference to my financial well-being. Jeannette and I have no financial relationship.]
Pro -Managed Futures Help Manage Portfolio Risk and Simplify Portfolio Composition
2008 offered many a surprise to high net worth investors. Post-crash, they realized that their supposedly diversified portfolio failed to yield any benefits of risk reduction; that investments promoted as liquid were illiquid in the crash; and that seemingly simple portfolios were actually complex. A solution to these various portfolio problems is found by inclusion of managed futures in a portfolio.
Managed futures overview
Managed futures is an asset class that has grown from 37.9 billion in 2000 to 316.8 billion in 2014 (BarclayHedge.) 
Assets Under Management in BarclayHedge CTA Index
But what is it exactly? The money managers (who are registered by the National Futures Association) who manage portfolios invested in global futures markets are called Commodities Trading Advisers (“CTAs”).
Some CTAs offer broadly diversified managed futures portfolios (e.g. commodities, currencies, and financial indices etc.); others are narrow in focus (e.g. solely agricultural or solely currencies.) As futures contracts are a leveraged asset, tight money management rules are often employed. The majority of CTA portfolios are systematic in that they rely on computerized rule sets; they are further disciplined to exclude human interpretation of the rules.
The benefits of managed futures: attempt at risk reduction, simplicity, liquidity, and transparency. Portfolio benefits have been empirically proven and were observed in the last equity crisis.
Risk reduction: In 1983, Harvard Professor, Dr. John Lintner, showed that the risk-adjusted return of a portfolio of stocks and bonds exhibited substantially less variance at every level of expected returned when combined with managed futures. This empirical evidence went largely unheeded until 2008 when research turned into reality. The CME updated the 1983 research in 2012 and reached similar findings about risk reduction (“Lintner Revisited: A Quantitative Analysis of Managed Futures”) In normal equity periods, managed futures is non-correlated to equities … and in periods of crisis, as per the chart below, managed futures moves to a nearly perfect negative correlation. That is what we consider to be true diversification: to have an asset class deliver gains while equities deliver losses. (Past performance is not necessarily indicative of future results.)
How can this be? Nassem Taleb’s characterizes asset classes by their ability to handle market volatility; equity and bonds are “fragile” asset classes and managed futures is an “anti-fragile” asset in that it thrives on volatility. How so? Most systematic portfolios are designed to find and take positions in strong trends (up or down); typically strong trends emerge in crises.
Liquidity: Global futures contracts, the underlying assets, are highly liquid and remained liquid during the 2008 crisis.
Transparency: Clients are provided with detailed daily reports for every account.
The costs of managed futures
A typical CTA receives a 2% management fee and, if/when the CTA rises above the previous high water mark, a 20% incentive fee is earned. The commodities broker who represents the client receives commissions on trades.
Standard high net worth investment process
Medical professionals often find their RIA by referral and they skip the step of interviewing several advisers. Typically, this single adviser is an RIA affiliated with a local, large investment firm which touts an exclusive/almost exclusive access to “top tier, institutional grade” portfolio managers whose funds are not available to the general public.
The RIA then identifies client “risk tolerance” and allocates a portfolio within the confines of their firm’s risk models. Often low risk skews the portfolio into greater bond allocations and higher risk into greater equity allocations (although we may soon approach a period when government bonds might not be a safety net… and when all traditional assets are higher risk.)
Bond/equity allocations can be complex and might not reduce risk
Most portfolios are allocated to seven (+/-) of these select managers. Simple…but as each manager will generally own 100 plus names, the client, resultantly, will own hundreds of small/odd lot positions. e.g. 35 shares of X, and 155 shares of Y and $5000 of Z bonds! Clients wrongly assume that such extensive holdings deliver diversification. Unfortunately, diversity across managers does not necessarily reduce risk in an equity crash; if all the assets in your “diversified” portfolio go downward in unison in an equity crash, then there is just diversity in your losses!
Managed futures offers what we consider to be true diversification
What truly diversifies a portfolio in our opinion is the inclusion of an asset that moves to a nearly perfectly negative correlation with equities in a crash… namely, managed futures. Per the chart below, in 2008, managed futures outperformed the S&P by over 50%.
Expect your RIA to change portfolio allocations AFTER you are in the next crisis
Case in point: I asked a client’s RIA how he handled risk in the prior 2008 crisis. Answer (paraphrased): In the middle of the crisis, the firm’s allocation committee decided that clients should buy junk bonds as they were deeply oversold; that change in allocation made a lot of money that buffered losses. Well…my client then knew that 2008’s portfolio allocations did not work and it took a major portfolio change to recoup losses. Talk about risk!!!!!
Commodity broker investment professionals have a unique perspective.
Commodity brokers are outsiders looking inward at their client’s traditional asset portfolios. Though not an RIA, many commodity brokers bring relevant expertise to the portfolio discussion. A commodities broker’s perspective should not be discounted.
Commodity brokers are not looking “to take an account away” from any RIA as 80-90% of a client’s money will remain managed by an RIA and 10-20% of the portfolio will be allocated to managed futures. . Some RIAs are on the leading edge of risk reduction and have created a blended portfolio for clients that includes managed futures. Most RIAs do not have the expertise to address optimal portfolio risk reduction because they simply do not have expertise in managed futures.
It’s not all roses for managed futures.
BarclayHedge CTA Index
Per the chart of historical returns, from 1980 – 2008, managed futures experienced three losing years, since 2009 the managed futures index has experienced four such years of losses. Why? It is partly due to global economies being manipulated via governmental intervention which has translated into slow and steady growth ( good for “fragile assets”) and low volatility in the commodity markets ( bad for “anti fragile” assets.) (In contrast, since mid-2014, volatility has returned to markets.)
Next steps
Calculate your portfolio’s performance hypothetically for 2008 and answer a core question: how would your current portfolio have performed then? Review your current holdings. Hundreds of positions might reduce alpha, adds to complexity, and might not reduce risk. Most importantly, supplement your investment advice to include a commodities professional as risk management through managed futures is their area of expertise.
Footnotes and Disclaimers:
The Investment Company Act of 1940 allowed for up to 25% managed futures to comprise a fund offered by an RIA. Outside of such a fund, RIAs are able to structure a relationship with a CTA so that the CTA product is offered to their clients and is part of their asset fee base. An investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. The addition of managed futures to a portfolio does not mean that a portfolio will automatically be profitable, that it will not experience substantial losses or volatility and that the results of studies conducted in the past may not be indicative of current time periods or of the performance of any individual CTA. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. This article contains information that has been prepared by third-parties that Postrock Brokerage LLC believes to be reliable. At this time we have not however independently verified any of the information contained in the presentations we have included in this article. Please review and utilize this material at your own risk noting that all Futures and Options trading involves the risk of loss. Also that the use of managed futures in an investment portfolio may not mean that you as an investor will be profitable, not experience losses, and/or be able to materially reduce overall return volatility. Worldwide Futures Systems is a registered branch office and dba of Postrock Brokerage, LLC [NFA ID: 0413763] Full disclaimer page here.
Con – Managed Futures Cost A Lot and May Not Help Much
The original post submitted to me looked quite a bit differently from the one you just read. It did not include any information about the cost nor any information about years when managed futures did not perform well. Even worse, the original post included a nearly 600 word disclaimer (3 times the size of the one above.) I understand that financial firms have to deal with many compliance issues, but any time the disclaimer gets to be that large, you've got to pause for a second and say to yourself, “Now why would the government require such a massive disclaimer?” The answer is because lots of people have lost a lot of money investing in this investment. That doesn't necessarily make something good or bad, but it sure should make you wary about investing in it. Let's look at a few of the specifics in the disclaimer:
- A registered investment adviser can not offer a client a fund where more than 25% of his assets are invested in managed futures. Hmmm…why would the government put this regulation on a “safe asset class” like managed futures but not on a risky one like stocks. Very curious.
- The investment is speculative. I prefer to invest rather than speculate.
- This investment is high risk. What? I thought it decreased risk. I don't need more risk in my portfolio.
- You may lose more than your entire investment. Even rookie investors know that investing on margin isn't a hot idea, yet this asset class seems to require it.
- Past performance may not be indicative of future performance. Pretty standard, but always worth remembering when the main selling point is “look how great it did in 2008.”
- Managed futures are derivatives, like options. Derivatives have a function for insurance purposes, but in general are a drain on returns. The expected after-expense return for options is negative. Insurance isn't free. To make matters worse, the guy on the other end of your trade almost surely knows more than you do.
The Effect of 2 and 20
Jeannette mentions in her post that typical costs for your managed futures investment are “2 and 20.” But what does that mean, exactly? This is a relatively standard amount charged by hedge fund managers. It means 2% of the assets being managed each year, and if the asset makes money, 20% of the gains go to the managers. Would you invest in a mutual fund or with an advisor that charged EITHER of those fees, much less BOTH of them? I wouldn't. I don't even pay that much to have syndicated real estate managed, and as most investors know, investing in real estate is more like a second job than anything.
Add it all up. Let's look at two scenarios. The first where the asset gains 12% before fees, and the other where the asset gains 4% before fees. At “2 and 20” the investor in the 12% scenario gets 8% and the manager gets 4%, or 1/3 of the profits. The investor in the 4% scenario gets 1.2% and the manager gets 2.8%, or 70% of the profits. To make matters worse, since the manager gets 20% of gains but does not share in the losses, he is incentivized to take a lot of risk in the hope of generating an outsized gain. All of the benefit, none of the risk. Sounds like a great job, but not a great investment! Even if it was just 2%, consider what that means.
This chart, from a paper by Neufeld in the Journal of Financial Planning in 2014, demonstrates “the tyranny of compounding costs.” The Y axis is the percent share of market gains that the manager gets from various fee levels. The green line is an AUM fee of 0.5%, the pink line is 1%, and the black line is 2.5%. The moral of the story is that if you're paying 2% plus over 30 years, your manager will take half or more of your gains. But that data is from investing in stocks. Is there any data specific to the managed future funds Jeannette is advocating? There sure is. According to data filed with the U.S. Securities and Exchange Commission and compiled by Bloomberg, 89% of the $11.51 billion of gains in 63 managed-futures funds went to fees, commissions and expenses during the decade from Jan. 1, 2003, to Dec. 31, 2012. And you thought 50-60% over 30 years was high. How about 89% over 10 years?
A Cheaper Way to Invest In Managed Futures
Are there cheaper ways to invest in managed futures? Sure, there are some ETFs out there. In fact, there are currently three-WDTI, FMF, and FUTS, with ERs ranging from 0.75-0.95% per year. Those are still more expensive than the vast majority of my portfolio, and 40 times as expensive as some of my holdings. But they're 1/3 the price of an actively managed fund at 2 and 20. Not to mention only one of the three has been around even three years. Not exactly a proven commodity.
What Is The Barclay CTA Index Anyway?
When looking at the charts in the Pro section, you, like me, might be wondering what the Barclay CTA index really is. Well, if you go to their website, this is what you find:
The Barclay CTA Index is a leading industry benchmark of representative performance of commodity trading advisors. There are currently 535 programs included in the calculation of the Barclay CTA Index for 2015. The Index is equally weighted and rebalanced at the beginning of each year.
To qualify for inclusion in the CTA Index, an advisor must have four years of prior performance history. Additional programs introduced by qualified advisors are not added to the Index until after their second year. These restrictions, which offset the high turnover rates of trading advisors as well as their artificially high short-term performance records, ensure the accuracy and reliability of the Barclay CTA Index.
Let me translate. It's the average of the returns of all the managed futures funds they felt like putting into the index. That means there is some serious survivorship bias going on. If you look at the fourth table above, you'll notice all the really good performance seemed to be in the 1980s. Well, there weren't nearly as many of these funds in the index in the 1980s. Rather than the 535 in there now, there were as few as 15. Perhaps, like with other expensive hedge funds, the talent has been severely diluted along with the returns. It is also not clear to me if that performance is pre or post fees, but it would not surprise me to learn the index does not include fees.
Even ignoring the survival bias, the return for this index over the last ten years annualizes out to just 3.4% per year. To put that in perspective, consider the 10 year annualized returns for other asset classes:
- US Stocks: 8.36%
- International Stocks: 5.06%
- ST Bonds: 3.42%
- LT Bonds: 7.45%
- TIPS: 4.38%
- REITs: 9.51%
So what did managed futures beat in this ten year period that includes the worst stock market crash since the Great Depression? Well, they beat cash in its worst decade in recorded history (1.6%.) Seems like expensive insurance against 2008 happening again. Besides, if your goal is really to insure against another 2008, there is an asset class that did far better than the 14.1% return that managed futures reportedly had. The Vanguard Long Term Treasury Fund had a 24% return that year. An even better strategy is to simply ride out the 5 or 6 bear markets you know your portfolio will pass through during your investment horizon by using a “know-nothing” fixed asset allocation. My 75/25 portfolio lost 33% in 2008. But you know what? The annualized return from 2004 to present is still over 9%, and my portfolio balance has increased every year from 2004 to 2015, including 2008.
The Straw Man
My opponent compares the return of managed futures to the return obtained by a typical RIA who thinks diversification is putting your money into the hands of multiple active managers who all then buy the same stocks in different proportions and change their asset allocations during bear markets. That's a bit of straw man argument. I don't disagree with Jeannette; that is a stupid way to invest. But the solution to that problem isn't to add even more manager risk by adding an actively managed futures fund charging 2 and 20. It's to get rid of the managers, the overlap, and the expense by investing in a diversified portfolio of low-cost, passively managed funds.
Jeannette also suggests that investing in managed futures is simple and transparent. We apparently have different definitions of simple.
Now, all that said, if someone wants to add a small slice of managed futures to their portfolio, say 5 or 10%, and can keep their expenses for doing so to less than 1%, then I say more power to them. There is certainly a compelling diversification story there. But a 5-10% slice of managed futures would not have prevented an overall portfolio loss in 2008. If you really want an “anti-fragile” investment, you need something that would have gone up 100% or more in 2008. Managed futures is not that asset.
PRO Rebuttal – Jeannette Showalter, CFA
Wow! Not sure how to respond to a shot in the head…. but I will begin with relevant facts and end by addressing your peripheral concerns.
Fact #1: Your extensive analysis of fees relative to performance is not relevant to my post about CTA product as yours is based on a 2013 Bloomberg column which took a little bit of understanding and very wrongly applied it to all asset classes with “managed futures” in their name. The column’s SEC statistics applied to products offered by broker/dealers (i.e. managed futures fund or managed futures mutual funds…which are expensive fee-laden products) …but NOT to CTAs.
Fact #2: The ROR for equities (before fees and commissions) has been approximately equal to the ROR for managed futures (net of fees and commissions) with much less risk taken by managed futures. Over the period 1980 through 2014:
- Performance comparison: The return for the S&P 500 has been 339%. The ROR for managed futures has been 388%. The S&P is a price index for 500 large companies and therefore is NOT net of fees, commissions, loads, etc. The Barclay’s CTA Index is an index of reporting CTAs, NET of all fees and commissions. So any performance comparison is skewed to favor the S&P and yet the net of fees CTA index is comparable.
- Risk comparison:
-The largest drawdown for S&P is 51%; the largest drawdown for managed futures is 16%
-Volatility (as measured by yearly standard deviation) for the S&P is 16.2%, for NASDAQ is 24.1%; volatility for managed futures is 14.7%.
Fact #3: Performance is best measured from equity peak to peak, not arbitrary time periods. How so? Normally uncorrelated with equities, managed futures become nearly perfectly negatively correlated in a crash.
Fact #4: We deal with rational investors who want the highest level of return for the lowest level of risk. Just take a look at the below charts and you can see the portfolio risk reduction by inclusion of CTAs (net of fees).
Fact #5: Futures ETFs are not a solution. They traded like stocks in 2008. The equity market is a market of buyers selling to other buyers; the futures market is sellers and buyers mutually creating a contract; in a crash, there are natural buyers.
Disclaimer wording:
- The standard medical disclosure is expansive language required by their business; catastrophic is not their norm … but is possible and needs disclosure. So, too, for us.
- As to “high risk” and “speculative”, such absolutely characterizes individual futures contracts…managed by inexperienced investors…using minimal margin …using a buy/hold strategy (e.g. the typical equity strategy). CTAs are professionally managed, actively managed (minimize losses and let profits run), and substantively capitalized. Investors should seek a broker with an unblemished record, other money management credentials and breadth of investment experience.
We work directly with clients and with independent RIAs and family offices who seek efficiency in risk reduction.
If any readers would like more information, please do not hesitate to contact me directly.
*Statistics from Yahoo finance
CON Rebuttal – The White Coat Investor
A shot to the head? You clearly haven't spent much time in the comments sections of the posts on this site about whole life insurance if you thought that was bad! At any rate, a few last comments:
Fact # 1 Fees are always relevant to performance.
Every dollar paid in fees is a dollar that is not compounding toward the future. You state the Bloomberg column doesn't apply to your specific model of managed futures but only to “high-fee” models. Yet you also state that 2 and 20 (plus commissions) is standard for your model. 2 and 20 is high in my book. I can't imagine that doesn't add up over the years to a significant portion of the gains of the strategy.
Fact # 2 S&P 500 Returns without dividends is a straw man.
Ms. Showalter states the S&P 500 return from 1980 to 2014 was 339% (and that CTA returns were comparable or even better.) I don't have a great source of data on CTA returns and am somewhat skeptical about the quality of your sources. However, I have an excellent source of data on S&P 500 returns from 1980 to 2014. It shows an average annual return of 13.3% per year, an average annualized return of 11.87% per year, and over that time period, a $1 investment in stocks would have become $50.70. I'm no mathematician, but that seems an awful lot more than 339%. More like 4970%. Kind of dwarfs the claimed 388% return on CTAs. Yes, that is before fees. But when there are investments out there like the Vanguard 500 Index Fund available for under 5 basis points a year, that doesn't seem like much of a crime.
Fact # 3 Performance is best measured over my investment horizon.
While it may be convenient to measure equity peak to equity peak, the only performance that matters to me is the performance from the time I invest the money until the time I withdraw the money. So that's the performance I measure. I suppose it is interesting to see what the performance of CTAs are from equity peak to equity peak, but it does make you wonder how bad equities can be if they are the benchmark against which other investments are measured! At any rate, I agree that what really matters is overall portfolio investment performance. If CTAs can increase performance, or maintain performance while lowering risk, they seem a wonderful asset class to include in a portfolio. I'm just skeptical they can do that if you're paying 2 and 20 for them.
Fact # 4 That chart shows that adding CTAs lowers returns.
Ms. Showalter's chart shows yet another “index” (the BTOP 50) that I'm sure readers are not familiar with. Again it's a list of the average returns of 50 traders who have been in business at least 2 years. The list itself has been around less than 5 years. Not quite the same thing as the S&P 500. At any rate, as near as I can tell, adding any amount of it to a 60/40 portfolio lowers returns. If my goal were simply to lower volatility and I were willing to accept lower returns for that, then I'd just add some bonds or heck, whole life insurance. Having a standard deviation 2 or 3 percentage points lower doesn't do much for me. I can't eat standard deviation. But lower returns take money out of my pocket. There's also kind of a disconnect with the chart. It shows 9% annualized returns for CTAs. Yet she states the ROR for managed futures from 1980 to 2014 is 388%, or about 4.1% per year. One of the things I really don't like about this asset class is that getting solid returns in it seems highly dependent on successfully picking a highly skilled manager. The track record for investors doing that with mutual funds is so bad that I don't have much faith in my ability to do so. I'd rather avoid manager risk whenever possible.
Fact # 5 Futures ETFs don't work either?
My opponent says futures ETFs don't work. That may or may not be true; I have no idea. They certainly haven't around very long. But there goes any hope we had for getting into this asset class for less than 1% a year.
Well dear reader, it's time for you to weigh in. What do you think? Do you invest in commodities? Do you invest in managed futures? Why or why not? If so, how do you do it? How much are you paying in fees? Do you feel like the diversification benefit is worth the costs? Comment below!
I think Jim wins this one on the fees argument alone. I’m very unconvinced that the “risk reduction” or diversification argument makes this a worthwhile asset class. The arguments sound a little too much like the ones I hear from whole life salesmen…
BTW Jim, I love the Pro/Con posts. You should do more!
Seconded!
This felt quite a bit like a sales pitch. The redeeming part was that Jim’s cons at least made me aware of another potentially harmful sales pitch out there.
It all seems to come back to the adage of keep it simple with low expenses.
I agree with Matt the whole 2/20 hedge fund fee structure is almost too much to handle. Unless an asset class outperforms on a consistent basis, which based on Ms Showalter’s argument the Managed Future’s asset class only protect’s during big down markets, it seems incredibily difficult to make enough return net of fees.
I think a valid point that can be taken away from this post is that people do dumb things in big down markets and if you can’t protect yourself from yourself it may be wise to think a little outside the box. We all know multiple people who after the 40% drop at the end of 2008 moved a majority of their investments to cash, thus missing out on the great returns from 2009 to 2011. People’s emotions don’t change and if someone believes they cannot stay in the market for the long run after a drop of 20, 30, 50% then having an asset class that decreases their volatility and keeps then in the market makes sense to me.
I’ve got to give Ms. Showalter credit for standing up in front of a potentially hostile crowd. That said, in her rebuttal, Fact #1, she seems to be using the same tactic I’ve heard from permanent insurance salesmen, that you have to buy managed futures from the right person (presumably her).
Also, a refutation of your points on the disadvantages 2 and 20 are conspicuously absent.
I’m an actual CTA who has traded client capital in a managed futures program for the past 7 years. I think Jeannette and Jim have done a nice job debating the pros/cons of the industry.
Yes, a GOOD managed futures program is one of the best anti-fragile investments in the universe, and an absolutely wonderful diversifier. Hundreds of academic papers have proven this. BUT, to Jim’s point, they do come at a high price/fee. The issue is, because of the elevated fees, the industry attracts a ton of bad managers which waters down “average returns” and clouds discussions like these which attempt to analyze the product’s “effectiveness.” The barriers to entry to become a CTA are very low (ie study 10-20 hours, pass the Series 3, and register with the NFA/CFTC); the average lifespan of a futures trader is less than 1 year.
But please do recognize that there are still fantastic managers out there. I find that people are more than willing to pay 2&20 for 15-20%+ CAGR (net of all fees) that is -0.05 correlated to equities, with an ability to create massive returns during recessions (yes, over 100% in ’08 for some managers). This is not a sales pitch for my company, or my strategy; I already have plenty of clients and don’t need any more money, and simply love to trade. I just wanted to lend support to the fact that, if you find the good programs, they certainly are worth the effort and price. I just wish the barriers to entry for the CTA industry were much higher so there wasn’t such a variance in manager ability/performance; then the “Pro” picture would become much more lucid.
Just imagine if you evaluated the advantages/disadvantages of surgery if the training to become a doctor was 20 hours! There’d be a plethora of bad outcomes, and no one would ever want to have surgery!! Unfortunately that’s the “arena” we managed futures traders have to play in, and it makes it very difficult to articulate the advantages when there is so much negative “noise” in the discussion created by the terrible managers.
Obviously everyone will agree that paying 2 and 20 is well worth it if you make 15-20%+ CAGR on average over your investing horizon. However, that’s obviously not only not guaranteed, but seems very unlikely for anyone. How do you propose someone choose an advisor who is likely to achieve those types of returns over a very long period of time? Past performance?
That’s the big question right there: how to find the good managers. It’s tricky for sure, but I’d say start by paring down the CTA universe to only include managers who have a repeatable process/edge with past performance through all types of market environments (bull markets, bear markets, flat markets, crises, bubbles, flash crashes, etc…). This means a track record since the ’08 crisis minimum. This will eliminate most CTAs.
The catch 22, like most everything in markets, is that once the good managers are discovered, their price (ie minimum investment) increases substantially. Such managed futures traders/CTAs (ie David Harding, Dr. David Druz, Seykota, Jerry Parker, etc…) have minimum investments upwards of $1-10million once they became “discovered.” Sure there’s cheaper managers out there, but the risk of searching in the bargain bin for a good manager can be very high if you’re not careful.
So how do you tell the lucky ones apart from the talented ones in the bargain bin (i.e. the only place most readers of this post can shop?) From what you’re saying, it’s such a hard task it doesn’t sound like it’s worth doing.
I think it’s certainly worth doing, but then again that probably depends on how many bad managers you need to go through before you find a good one!
In a perfect world, financial advisors, RIAs, Introducing Brokers, etc…would vet managers and do this work for you in order to help find the good managers. That’s what they’re paid to do. But in reality, the incentive structures are so perverse in the industry that the managers who get “recommended” are the ones who churn accounts and rack up commissions for the recommending brokers/advisors. It’s crazy how many brokers, IBs and RIAs call me but quickly end the conversation once I tell them how infrequently my system trades. But I get it, they need to eat too.
So at the end of the day, if you want access, you either do the research yourself, or find a trusted advisor who will find you good managers since they know what to look for.
But I wouldn’t lose sleep over trying to find a good manager. Like I tell many of our friends in my wife’s residency program, doctors will do just fine (more than fine actually!) following your general guidelines. The act of saving is many many times more important than where exactly you put those savings, even though the latter is what 99% of discussions are about.
Wow, talk about a sales pitch. Fails a lot of investing principals; complex (favors the seller) and high fees (favors the seller). A lot of scare-mongering regarding 2008. I don’t get the liquidity argument, on which day in 2008 was the stock market closed unexpectedly and you could not sell an S&P 500 ETF or mutual fund? Maybe the bid/ask spread was far apart, but you could certainly sell the investment vehicles that the retail investor should own.
If you really want “insurance”, the KISS principle would lead you to buy deep out of the money, long-dated puts on the SPY. I am not arguing that one SHOULD buy puts, I am just arguing that if you want protection, there are simpler ways to do it.
SPY is currently $212. A 10% correction would drop the SPY to $190. I can buy a December 2017 $190-strike put for $18.2/share (8% of the value of the current SPY share price). I now have 2.5-years of protection. I need the market to drop by 18% (SPY at $172) for the value of the put to equal the cost of its current price. If I am really afraid of a 50% decline (I am not, personally) I will earn $66/share from this put. Plus I can earn some money by selling shorter-dated puts against my position.
Again, I am not advocating trading options (or even owning them as protection). But, my point is, there are simpler ways to hedge against a downturn.
I don’t hold managed futures in my portfolio (never >5% in a 65/30/5 portfolio) because I want to hedge against a crash. Rather for me, the gains I see at times (20% in one month) typically outweigh the losses (7-10% in a month). The past is never predictive of the future, just anecdotal experience.
I think a lot of managed future investing has to do with finding the right fund manager. The arguments above are all negative on the 2-20 fee structure, but let me just pose that the upside to potential significant returns (especially with a looming bear market) is far greater than potential losses. In my book, “you gotta pay to play”. I don’t mind paying someone who is going to give me a 15-30% return on my money, again certainly not a guarantee, but I can think of a lot risker assets, ehhemm, look at the P/E ratios of the current market to tilt to.
As they say, “the only free lunch in investing is diversification”.
“The column’s SEC statistics applied to products offered by broker/dealers (i.e. managed futures fund or managed futures mutual funds…which are expensive fee-laden products) …but NOT to CTAs.”
Sooooooo… 2 and 20 is inexpensive and not fee-laden???
Any product that is complicated to understand is meant to be sold (and not meant to be bought)
Also- The 2/20 model does not make sense. The 20% of profits is benchmarked at the original investment dollars (and not the alpha over the market). I am not surprised that the majority of the gains are going to the managers and not the investors.
Just by holding a plain gold ETF (GLD) would have given you better returns in 07-09. Without the need to pay those astronomic fees.
The devil’s advocate argument to that is what happened in the following 2-3 years, almost a complete reversal of said gains. I am STILL down 50% in my silver holdings and 30% in gold and platinum from the peak of the market.
If, by chance, you got in to gold which is very un-diversified by the way, and made significant gains (a novice move at the minimum-no real investor would make a significant investment in a market downturn just to precious metals) then there is absolutely no way one “rebalances or sells out” of those investments before giving up the gains.
I consider myself somewhat savvy, and I still made the mistake. I’m holding a negative gain, just waiting to use it next year for tax loss harvesting.
Just info not applicable to any long term intelligent investor
Many other useful topics
Way over my head and another sold financial product with more in the pipeline
Anyone paying 20/2 in fees needs their head to be examined
Managed futures strategies seem to vary, with everyone having a procedure and take on the process, but the core principle of most seems to just be loading on momentum. Usually in commodities, but other asset classes could be fair game too.
AQR, which runs a managed futures fund, has a paper on what’s going on:
https://www.aqr.com/library/journal-articles/demystifying-managed-futures
You can check Morningstar to see the recent performance of several managed futures funds in mutual fund format. Of course, especially in an area like this where the leverage and implementation can vary dramatically, you may see a wide dispersion of returns from the individual CTAs and hedge funds, and as always there will be claims that if one only screened for and found the right manager, then… (which may be true, but good luck)
Pro side was very deftly set up to show only what was in their favor and left off anything that wasnt. One, bonds are usually negatively associated with equities, thats pretty much why they are there. If you had bonds in 2008, you made a killing, dont know how they picked the lamest bond return of that time. Bonds up until very recently have bee doing great even since then, they even out performed the s/p several times. A pair switching momentum style of trading would have handily taken care of you during the crash (+29% in 2008, +38% in 2011) and been simpler and far cheaper.
Right now is one of the few times in history when stocks and bonds are both highly valued, and even in these kinds of situations it doesnt last long until they again move to more negative correlation.
Fees are outrageous and there is no such thing as liquidity when you actually need it. When you are desperate for it, so is everyone else and all trades are crowded. This is true in all asset classes. You may get out, but it can be much worse than you hoped for. Managed futures are no different and in all likelihood worse. Futures trading is already a zero sum speculative adventure as it is.
Further, during the most recent crash commodities did not act in the expected negatively correlated fashion that is expected of them, they were a total bust. There have been several academic papers discussing this. Also, commodities when viewed on the inflation, commodities, bonds, equities performance chart from 1929 to present basically had a flat return, only being better than inflation.
In the end you cannot manage away all risks, if you think you are doing so the only thing you’ve managed to do is fool yourself. Corrections and crashes do and will occur and besides decent allocation, you can only do so much.
Zach,
I think you’re missing the point entirely. But it’s not your fault-the managed futures industry has done a poor job in the “education” department. Or maybe it is your fault-you have your personal “perfect” portfolio and hesitate to acknowledge that any other style may work since that would be a shot to your ego. I don’t know which group you fall into, but I’ve seen plenty of both over the years.
Managed futures is not about just buying and holding a basket of commodities. I agree that would be a total bust and adds very little value to a portfolio. Such a basket has done very poorly since 1929. Yes, papers have been written about that. Managed futures on the other hand is very different: we use systematic trading strategies (yes, that use commodities/futures) to create an uncorrelated alpha stream for investors. We’re systems traders, not commodity traders. This is one of large issues that the managed futures industry faces: we’ve been branded as managers who trade pork bellies and read crop reports, when in reality we just use the futures markets as our means to employ our systematic risk management strategies. These approaches would work in private equity, housing price markets, equities, sports cards prices, beanie babies, or any market that has humans acting to buy and sell since that translates into booms and busts, trends, and trading opportunities. The reason we use futures markets as our playpen (thus we’re known as CTAs, or Commodity Trading Advisors) is because futures markets offer us the most diverse, expansive, uncorrelated group of markets to play with which translates into increased trading opportunities (ie we get to trade metals, grains, interest rates, currencies, energies, equity indexes, etc…). If they made futures markets for baseball cards or beanie babies, I’d trade those too.
It is hard to find out exactly what “managed futures” really is, so thats on them.
I fall into the exact other camp, expecting there is some all weather perfect portfolio out there that can do everything in all times, is a huge fallacy that is hazardous to your wealth. Expecting such is the biggest danger of all.
Im sure its fine for traders, a good trader can make money in any market environment, but I like to manage my own portfolio and given the paucity of info for this arena I would neither do it or let someone else. There are after all several ways to get similar results. I just prefer more broad momentum/trend strategies to something like this. Its costs and time effort are minimal and 30s every 2 weeks.
Zach, the complexity, if there is even any, is in the marketing of it. In general, relatively simple rules do encapsulate what we do. Most successful CTAs actually have programs/rules that can be written on the back of a 3X5 card and take 30 seconds per day to run (myself included). But no one likes to admit it because it makes it much harder to charge 2&20 then. And so they (and CNBC, the WSJ, etc…) try to make it sound and look much more complicated by using descriptors like “algorithmic” and “computer rocket scientists” while showing photos of trading rooms with 20 computer screens. It’s pretty entertaining actually. The reality couldn’t be more different. I agree with you, and am very adamant, that complexity is almost always inversely related to positive performance. The simple, clunky, and volatile managed futures CTAs tend to be the ones that are the most robust, stable, and resilient over the long run.
Didn’t Enron trade in energy and energy futures?
Maybe it would be worth explains just how trading futures works and where the actual profit comes from.
Thank you for reading my posts.
I think many posters are long on their investment self-confidence but seem short on facts and understanding and then wrongly connect their dots of data.
It is not for me in a brief column to explain all of managed futures and, frankly, it is a $300 billion plus asset class that rapidly grew in the aftermath of the 2008-9 crisis.
As to Barclay’s reporting of the CTA database. I think I would be slow to suggest a willy nilly approach to their data base reporting…as they are the primary source of data for not just the $312 billion CTA industry but they are the foremost reporting source for the $2.5 trillion of assets in hedge funds. Do you really think that the SEC and NFA would tolerate misleading reporting in these regards?? We live in a highly regulated industry and regulators are keen to shut down those who misrepresent their results or
Fees are relevant to performance… But in comparing asset classes to each other, you look at performance AFTER after-fees, after transaction costs. The Barclay’s CTA index is an after fee and after transaction cost performance. Hate any product that has 2/20 fees despite what it has capacity to deliver to a portfolio?
Measuring performance equity peak to equity peak is not arbitrary; it is reasonable. When bonds or equities turn down, who will care what happened in the last two years, last five years, etc.? Do you care what you make or what you keep? IF you only care when you cash in your chips, then pray tell what methodology will rightly time/announce that propitious moment …
I am very sorry if I have not made clear that many managed futures funds (in order to pass registration requirements within the securities industry) are 90% fixed income (and layered with management fees, underwriting and advertising costs) and 10% managed futures. So you tell me, how can you do well with a bloated fixed income product that might earn 3%? 4% and then is layered with fees? The point is not denying that hedge funds and CTAs largely operate under 2/20 rules… but it is to say that you cannot weigh a fund down with fess on poor paying fixed income and do well on a net basis.
I think you must be kidding to suggest adding bonds to lower volatility! To suggest that the past equity/bond correlations created during a bind bull market have applicability to the present…. Scarily, maybe you aren’t kidding. Who in their right mind would add something that pays close to zero percent during an environment in which the FED has stated that they want and expect to raise interest rates? Adding bonds in an environment of an intact bond bull market (past 30 plus years) was ONCE an option with some merits. As to non-correlation… you are taking an average of high correlation with low correlation, varying from close to negative 1 to close to perfectly positive 1 correlation…but again, this was in the context of a 30 year bond bull. However you could be right on a bond bull market and continuation of your bond equity correlations IF you think rates are declining from 2% into negative interest rates. At -13% rates, then you might be right!
Quite obviously futures ETFs were not shut down… and I did not write such. There was continuity of trading during the crash… but with the lack of market efficiency (In managed future, there are natural buyers offsetting short contracts and natural sellers offsetting long contracts which creates price efficiency.) Many ETFs traded at deep discounts to their underlying futures value…. in 2008-2009, yes, you could sell your real estate, the market had such little liquidity that a sale might have been at a haircut of 25% to a price of the last week. In the futures market, a contract is created by a buyer and a seller and in a crash the sellers provide the liquidity as they are NATURAL buyers. There is no escaping it.
The original study of managed futures by the Harvard professor has not been debunked. The study was repeated by the CME in recent years to prove that the former findings still hold true.
There are limitations with every product and service and you do not stop delivering yours because there are some limitations…. Or prescribing medicines because they have multiple pages of disclaimers next to the advertisement. And best I know, the best paid medical practices are not shunned or ridiculed as to their success and willingness to pay themselves well. If someone could do what they do for less $, I assume that is where the business would flow.
Put options…sure …fine…while the market is not volatile or in distress or crisis. Behaviorally, no one wants to buy a put at 190 strike at a cost of 18 pts when the market is at 212. If the market crashes, you suffer/absorb the first 30 point decline from 212 to 172 for the protection to have intrinsic value… a 15% hit before you make money. And further you addressed protection for equities…not for bond holdings… which are often a part of a portfolio and in some ways are thought to be of highest risk of price depreciation in years to come. And lastly, purchase of puts is put forth as a reasonable cost/value strategy and then the poster writes that they are not recommending use of put options …so what is the point???
Everything is complex to investors who are unfamiliar. Everything remains complex to investor who do not educate themselves upon learning that they do not know.
Managed futures need not be complex but lack of complexity does not mean that it can be created, executed and managed by a retail investor. The rule set might be simple for going long and short…but there are a myriad of rules for managing portfolio exposure, cutting losses, locking in gains, letting profits f=run, managing correlations within the portfolio, etc. he universe can be quite simplistic : approximately 20 futures contracts…not thousands of equity and bond names,
Managed futures is not limited to futures commodities; it includes currencies, financial induces etc. Managed futures is designed to MANAGE bath long and short…. not buy and hold only. Equity investors are momentum long only in equities only; manage futures is momentum market neutral commodities, currencies, and financial indices. Managed futures does not need a fundamental theme, to believe its stories, a positive economic environment, a bond bull market, predicting the Fed’s next steps, a rational for higher equity multiples, and the list goes on. Robots do some surgery and it does not diminish the surgeon’s skill.
WCI any current thoughts on Vanguard’s relatively new VCMDX managed commodity futures fund with an expense ratio of 0.20% to add commodity exposure as an inflation hedge in our current environment of never ending stimulus? I’m considering a 3.5-4% allocation to this fund. Appreciate any insight.
It’s from Vanguard so the cost is relatively low. I’m not a huge fan of commodities in a portfolio, but if you like them, this isn’t a bad way to get them.