How did Managed Futures do while the Dow was Down 1000

Now that the dust has settled somewhat after the mini crash of last Friday and Monday – we’re getting calls fast and furious asking how managed futures fared during the Dow losing a few thousand points.

Here’s how the Managed Futures indices did on Monday, and how they stand so far for August and YTD versus the S&P 500.

Managed Futures Indices August 24thSource: Newedge

But people don’t invest in indices, they invest in actual programs – which usually wait until the end of the month to report performance. Thinking that may be a little too long for many to wait in order to see how specific programs handled this volatility – we compiled some estimates of different programs we work with each day:

(Note: All performance for August 24th and MTD are estimates.)Managed Futures Managers Performance August 24thHere are how the Attain Funds are doing:

Attain_funds_chart_PEF

Past performance is not necessarily indicative of future results, but this is a real time, real life example of why investors put programs like these in their portfolios, zigging while the market works out one heck of a zag…

P.S. – Systematic trending following strategies typically rely on trends that last multiple weeks or months to capture returns, especially the ones referred to when talking about crisis period performance. If this volatility is just the beginning of a substantial move lower, we could see some big numbers as we enter fall. But If Monday was the peak for this bout of volatility, this could be quickly forgotten by trend followers.

P.P.S. – It’s worth noting that that the managed futures space has not only different categories but also different strategies within those categories. The strategies that have been experiencing good returns (like options traders) over the past couple of years have been giving back those returns rather drastically since the recent uptick in volatility.

 

Todays Moves Across Different Markets

Volatility is in the air. China is in freefall, crude oil is in the 30’s, the euro is up 2% on the day, and the U.S. markets can’t seem to shake the volatility. The chart below does a pretty good job of showing the markets moves in equities, both internationally and domestically.

Stocks Plunge(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Bloomberg

These are today’s moves:

Money Values:

$182 Billion – The amount the worlds 400 richest have lost from moves in the markets according to Bloomberg

$17,951 – The dollar amount in today’s range in the DAX

$6,687.5 – the dollar amount in the Emini-S&P range Today (113.75* $50 per point)

Percentage Moves:

35.50% — Move up in the VIX Today

5% — The percentage that triggers a limit down move in the Emini S&P before or after day trading. It happened early this morning.

-3.36% — WTI Crude Oil move today

-8.5% —  The down move in the Shanghai Composite Index

-10% — Decline in the CSI 300 Index

 

P.S. – We in the Alternatives space welcome the volatility in the market.

This Easy Table will Help you Understand Correlation

The reputation around the alternative space is that Managed Futures is an asset class you need for diversification when the stock market goes into crisis. After all, it was one of the only investment strategies out there that not only showed a positive return, but showed double digit returns (Newedge CTA Index) during the 2007/2008 financial crisis.

But that type of thinking about diversification leads to a dangerous mindset, where investors see Managed Futures as negatively correlated to US stocks (going up while stocks go down, and down while stocks go up). We don’t have a problem with the first part of that, managed futures going up while stocks go down… but the other part isn’t always true. Managed Futures aren’t always down when stock go up.

Statistically – this is because they are NON-correlated versus negative correlated. What’s that mean?  It means that managed futures goes up and down independently of the stock market, at times doing the same thing, at times doing the opposite – to average out as doing something different, and tending to do the exact opposite when there’s a violent or prolonged move down, because that tends to cause a sell off across various markets from Crude Oil to Aussie Dollars.

So, if investors are aware of the managed futures profile during down markets – how familiar are they with the profile during up markets (beyond the small sample size that is the past 4 years), and moderately up markets, and sideways markets?  In our recently updated, “Managed Futures: Performance Profile,” we broke down stock market performance based on 12 month rolling rates of return of the S&P 500 going from 1994-2014, and then created different “buckets” of performance representing seven different market environments – ranging from the very good (rolling 12 month returns of over 30%) to the very bad (rolling 12 month returns of -25% or lower). From there, we simply looked at the rolling 12 month rates of return for managed futures on those dates which fell into each “bucket,” and averaged across all such dates. And because we’re overachievers, we analyzed world stocks, bond, and hedge fund performance in the same manner.

Stock_market_cyclesDisclaimer: Past performance is not necessarily indicative of future results)
Data Span = 1994-2014

Our takeaway from the Whitepaper:

There are a few important takeaways here. For starters, the other so called diversifiers out there-hedge funds and world stocks- aren’t exactly the diversifiers you think. World Stocks, on average, lost more than the S&P 500 during down periods, and, in most instances, underperformed during the good times. Hedge funds posted positive returns on average during the down periods, but when the down periods were really down, the numbers weren’t exactly impressive. For those looking to diversify based on market cycle performance, these may not be the magic bullets you were hoping for.

Managed futures, on the other hand, on average, posted positive returns in each of those stock market cycles- the only asset class outside of bonds to do so. For those into such cycle period performance, the takeaway equation should be:

Managed Futures = Good when stocks are bad + OK when stocks are good.

To learn more about Managed Futures performance, its track record with consistency, and our rankings, download our “Managed Futures Performance Profile.”

A Wealth of (Managed Futures) Common Sense

If you haven’t had the chance to check out the work of Ben Carlson over on his blog, “A Wealth of Common Sense,” we highly suggest it. We’ve written about his thoughts and ideas a couple times (here and here) and we couldn’t help but notice the subject of his musings on doing what works for you in his latest post, “The Importance of Intellectual Honesty in the Markets” is of Managed Futures.

“Managed Futures is a trend following strategy that trades futures contracts both long and short depending on the direction of the markets. The strategies are typically diversified across stocks, bonds, interest rates, commodities and currencies and follow a systematic approach. Also called CTAs (commodity trading advisors), these funds got a ton of attention following the 2008 crash because they were one of the few places to earn positive returns when stock markets around the globe sold off anywhere between 35-55%.

I looked at the Credit Suisse Managed Futures Index going back to 2008 and compared it to the annual returns on stocks, bonds and a 60/40 stock/bond portfolio through June of this year:

Asset Class Performance since 2008(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: A Wealth of Common Sense

But it wasn’t just his feature of explaining the asset class of Managed Futures, it’s about how investors tend to chase performance, getting in at the highs and out at the lows. As Ben puts it:

“The biggest problem most investors face is that they invest in something like managed futures after they see the impressive results it had in 2008. Then they bail when it falters. Or they change their strategy to a low cost indexed buy and hold approach after seeing how well it’s done since 2009. Once again, many will bail during the inevitable down period.”

Which fits quite nicely with our “In at the Highs out at the Lows” Managed Futures chart.

Managed-Futures-Performance-vs-asset-flow-1024x521(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: In at the Highs, Out at the Lows 

Back to Ben Carlson:

“Despite these numbers, I don’t think it makes sense to completely write off (or pile into) a strategy simply because it’s had a poor (or good) run over the past cycle. This is just one fairly short time frame. I’m all about intellectual honesty when discussing the markets. I don’t believe in disparaging someone else’s strategy just because I don’t invest that way. My motto has always been, ‘do what works for you, as long as it helps you reach your goals and allows you to sleep at night.”

We couldn’t have said it better ourselves, but since we’re in the Managed Futures space, we can’t help but take it a step further. We want to add one of Ben’s sentences.

“It’s worth noting that the Credit Suisse index isn’t representative of all trend following strategies, but it does give you an idea about the struggles the space has endured following the crash.”

The fact that the index isn’t representative of all trend following strategies is definitely worth noting, and shows Mr. Carlson is no newcomer to this game. But here’s where things get even a little more interesting. Because not only is the index not representative of all trend following- but trend following is not representative of all Managed Futures. As we talk about in our Managed Futures strategy review every year, there’s also Short Term, Multi-Strategy, Specialty, Agriculture, Spread, and Options strategies.  Not to mention the managed futures-like Global Macro programs. Which is why those who find managed futures ‘works for them’, in Ben’s parlance; may not have found it to be as much of a struggle as the chart suggests.

For instance, in 2013, the Barclayhedge Agricultural Traders sub index was up 5.71%, when the Credit Suisse index was down -2.6%. In 2011, The Barclayhedge Discretionary Traders Index was up +2.75%, while Credit Suisse was down -4.2%. In 2012, the Attain Short Term Fund was up 10.29%% while the Credit Suisse was down -2.9%. {Disclaimer: Past performance is not necessarily indicative of future results}. Of course, you would need a crystal ball to know which of those sub strategies was going to perform each year and which weren’t; but you get the point. Just like small cap stocks can diverge from large cap, or Asian stocks be up while US stocks down; different types of managed futures strategies can, and will (and have), diverge from the poster child trend following strategy. That’s why our Philosophy is to surround a core allocation to trend following with these other strategies to ‘diversify the diversifier’.

How about a Longer View:

Which brings us to a tweet asking for a little more data – something we’re happy to dive into.

 

 

Here’s what a 60/40 portfolio looks like using Carlson’s same table, with the Sharpe ratio added in to compare the different return and volatility levels (although you know we’re not huge fans of the Sharpe):

Asset Class Ratio Addition of Managed Futures
(Disclaimer: Past performance is not necessarily indicative of future results)
Data = (60/30 MF) is 60% SPY & 40% DJCS Managed Futures Index
Other data from: A Wealth of Common Sense

But as Mr. Carlson said, this is a “fairly short time frame.” What does it look like if we push it out back to the inception of the Credit Suisse index?  And while we’re at it, we’ll be the first to tell you managed futures isn’t meant to replace bonds (although that might not be a terrible idea in a rising rate environment). So what does it look like when diversified into managed futures and Bonds with an allocation of (45% Stocks / 28% Bonds / 30% Managed Futures)? Here you go:

Ratio Two 1994-2015
(Disclaimer: Past performance is not necessarily indicative of future results)
Data: DJCS Managed Futures Index
S&P 500 = SPY Bonds = Barclays Global Aggregate Bond Index

You can see argument for a managed futures allocation in these longer term stats, which speaks directly to Carlson’s main point:

“I don’t think it makes sense to completely write off (or pile into) a strategy simply because it’s had a poor (or good) run over the past cycle.”

For more information on Managed Futures Performance, check out our Whitepaper highlighting the “Performance Profile: Managed Futures

Is Managed Futures Secret Weapon Coming Back?

A long time ago, in a galaxy not so far away – where China was preparing for the Summer Olympics, Kosovo declared independence from Serbia, and Crude Oil was hitting levels at $140; a small band of rebels called short term interest rates were actually whole numbers (like 1%, 2%, and 3%).  That may sound like science fiction to some, but it was real. People could purchase a 1 year T-Bill for say, $97,000, and have $100,000 returned to them 12 months later; compared with the ability to purchase a 1 year T-Bill in 2014 for say, $99,875 ; and get back that $100,000 12 months later.

Fast forward to today – and something exciting is happening in short term rates. We’re not talking science fiction exciting just yet, but there’s significant movement for the first time in years… in short term rates as the world prepares for Ms. Yellen to finally announce an increase in interest rates. Via Zerohedge, we see that the One Year T-Bill has reached rates it hasn’t seen since 2010:

“The US Treasury sold $25 billion of one-year T-bills at an interest rate of 33bps yesterday, the highest since June 2010. It appears the short-end of the yield curve is increasingly pricing in ‘liftoff’ sooner rather than later (and the long-end is responding by rallying – lower in yield – as medium term growth expectations fade) but it raises significant questions about the economic trajectory after the hike (and the ebbing confidence in The Fed).”

Chart 1 Year T Bill(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Zerohedge

Now, trying to 1/3rd of one percent in interest surely isn’t the type of return anyone outside of the money market or commercial paper industry is likely to get excited about. But what if instead of the option of earning 1/3 of 1% (33 basis points as they say in the biz) OR 7.5% on xyz investment, the choice was to earn 1/3 of 1%  AND the 7.5%. AND is certainly more enticing than OR in that scenario.

Managed futures secret weapon, so to speak; is its ability to harness the power of US Treasury Bills at the same time it is putting trades on with commodity futures. In short, the secret weapon is the ability to earn both interest and trading returns on the same money.

What? How can you have two investments at once?  You can’t buy a house for $500,000 and earn interest on that $500K for example; nor can you purchase $100,000 worth of stock, and at the same time earn interest on that $100K.  Turns out managed futures playground of exchange traded futures allows for investors to invest cash into a futures account to invest in a managed futures program, and at the same time earn interest on the majority of that cash.  This works because the futures exchanges and FCMs clearing the trades there allow for T-Bills to be used to cover margin requirements. Bear in mind, futures account margin is not the same thing as stock account margin. Futures account margin is essentially just needing to have a certain amount of money in an account for them to allow you to enter into trades, versus stock account margin where you borrow money to purchase shares.

At the end of the day, the exchanges and FCMs want you to have collateral to act as a buffer against any moves against your positions in the future. So they can take money from those who lose money on a trade to pay those who made money on it. That’s what the exchanges do. The good news – they view T-Bills and cash essentially the same. So you don’t need to have $100,000 in cash to act as collateral; and another $100,000 to put into T-Bills. You can use the same $100,000 to both buy T-Bills and cover margin for your investment in a futures program. That’s right, the T-Bill does double duty – with the clearing firm posting the T-Bill to the exchange on your behalf to cover margin and you earning the interest on it while it sits with the exchange.

Now, the clearing firms do build in a little buffer for themselves as a risk precaution, and usually only allow around 90% of the T-Bill’s face value to be used as margin, and those fees and haircuts made it a breakeven (to losing) proposition when 1 year interest rates were at 0.10%. But with the potential gain 3 times that now… it’s starting to make sense again. And should we get back to the 1% to 3% environment, it’s a must have for any serious investors. Who doesn’t want an extra 100 to 300 basis points per year tailwind.

PS – For those investors having their accounts professionally managed. You don’t want to purchase a T-Bill in the account the advisor in managing. The interest earned will increase the value of that account, and you don’t need to be paying the advisor 20% of the profits due to interest, just pay him or her on the profits due to their trading.

PPS – The exchanges also allow certain stocks to be used as collateral. So if you loath to sell that Apple stock, but like the managed futures value proposition – there’s ways to use your stock as collateral in much the same way as T-Bills. Call us for more information on how that works (312-870-1500).