Revealed: Stock Futures Cheaper Than ETFs

It’s no secret that we’re not a fan of Commodity ETFs vs their future counterparts with past posts titled: “Commodity ETFs Suck.” We have a running monthly table going that tracks a simple strategy of just buying the December futures market of that commodity, under the theory that the ETF will have to roll their positions periodically throughout the year and in doing so take on costs the simple strategy does not have.

There’s one part of this discussion we’ve left out, the benefits and risks of Stock Futures Indices contracts, compared to their very popular ETF counterparts. Lucky for us, the CME group just released a succinct whitepaper titled, “The Big Picture: A Cost Comparison of Futures and ETFs.”

What we particularly enjoy was that they took the time to come up with multiple scenarios, and multiple short and long term investing options. Overall, here’s the conclusion the CME came to:

CME roll cost(Disclaimer: Past performance is not necessarily indicative of future results)
Table Courtesy: CME Group

They actually calculate how much better futures are than ETFs in the report, although it’s spread around and a bit hard to find – but don’t worry, we’re here to help. Here’s the cost savings, per CME, of doing futures versus stock ETFs over 12 months given different ‘scenarios’.

bps cost of 12 months

Now, the $10,000 trader isn’t going to lose too much sleep over this – after all, 50bps is just $50 (0.50%*$10k). But 50bps might keep the institutional investor doing $100 million blocks of stock up at night. That’s $500,000 worth of cost savings someone might enjoy saving.

Curiously, it looks like the CME came out with this report just as the advantage has been shrinking – with the “implied financing cost” in the futures rolls getting more expensive, meaning more roll cost, meaning a tougher comparison to ETFs (but maybe that’s their angle, after all, coming out with this report to say “we’re still better, even though not as good”) Here’s the growth in the “cost” of rolling the ES over the past 3 years with their explanation:

Historically, the implied spread to Libor of ES futures was below the lowest management fees on any ETF. Over the 10 year period between 2002 and 2012,the ES futures roll averaged 2 bps below fair value.

Since 2012, the pricing of the roll has become more volatile and traded at higher levels as shown in Figure 1, with the richness averaging 35bps in 2013 and 26 bps in 2014.

This recent richness is attributable to two main factors: changes in the mix between natural sellers and liquidity providers on the supply-side of the market, and changes to the costs incurred by liquidity providers (particularly banks) in facilitating this service.

In a balanced market, natural buyers and sellers trade at a price close to fair value – neither party being in a position to extract a premium from the other. When no natural seller is available, a liquidity provider steps in to provide supply (i.e. sell futures) at a price. The greater the demand on liquidity providers, the higher (and more volatile) the implied funding costs will be.

The persistently strong S&P 500 returns over the last three years – averaging 20.3% annual growth since the start of 2012 – has caused a decrease in the size of the natural short base as investors reduce shorts and bias their positions towards long exposure. This has increased the demand on liquidity providers – especially U.S. banks – to meet the excess demand.

Beginning in 2013, however, changes in bank sector regulation have increased the capital and liquidity requirements for banks, making it more expensive for them to facilitate futures buyers. The result has been a higher implied financing cost in the futures rolls.

Roll Richness High Low(Disclaimer: Past performance is not necessarily indicative of future results)
Table Courtesy: CME Group

Finally, we’re curious to see if the CME ever does such a report on commodity ETFs versus futures. We doubt they will, as the commodity ETFs (at least the ones not holding metals in a warehouse), actually use the CME’s products, holding futures on each commodity in the ETF.  The stock ETFs hold the actual stocks – making them a competitive target for the CME to try a convince people the futures are better than the stock holding ETFs. But the commodities – their winning no matter which structure you choose. But that doesn’t mean the investor is winning no matter which structure.

Speaking of which, we wouldn’t feel right discussing futures vs ETFs, without including our monthly table:

(Performance as of 2/27/15)

Commodity ETF Over/Under Performance 2015

CommodityFuturesETFDifference
Crude Oil$CL_F
0.91%
$USO
-11.00%
-11.91%
Brent Oil$NBZ_F
4.03%
$BNO
2.82%
-1.21%
Natural Gas$NG_F
-6.54%
$UNG
-6.97%
-0.43%
Cocoa$CC_F
3.33%
$NIB
3.21%
-0.12%
Coffee$KC_F
-15.37%
$JO
-18.24%
-2.87%
Corn$ZC_F
-0.86%
$CORN
-3.15%
-2.30%
Cotton$CT_F
2.22%
$BAL
7.26%
5.04%
Live Cattle$LE_F
-5.70%
$CATL
-6.09%
-0.38%
Lean Hogs$LH_F
-5.93%
$HOGS
-20.17%
-14.24%
Sugar$SB_F
-6.06%
$CANE
-5.76%
0.30%
Soybeans$ZS_F
-0.81%
$SOYB
-0.55%
0.25%
Wheat$ZW_F
-12.40%
$WEAT
-13.87%
-1.47%
Average-3.60%-6.04%-2.44%
Commodity Index $DBC-1.52%
Long/Short Ag Trader CTAs0.17%

(Disclaimer: Past performance is not necessarily indicative of future results)
(Disclaimer: Sugar uses the October contract, Soybeans the November contract.)
Long/Short Ag Trader CTA = Barclayhedge Ag Traders Index

The 10 Most Intriguing Attain Alternatives Posts of 2014

We wanted to go back through and reflect on our posts that you found the most interesting this year. Without Further Ado, The Top 10 Posts in 2014 based off of how many of you read it.

  1. What a Hedge Fund Failure Looks Like
    This year, social media cannot get enough of the news that hedge fund legend Paul Tudor Jones is shutting down one of his eponymous funds, the Tudor Tensor Fund. But just how bad was the Tensor performance that they are deciding to shut the fund down?  What does a hedge fund ‘failure’ actually look like? The answer is, not that bad…
  2. A Big List of Alternative Investment Folks on Twitter
    We couldn’t find a list of alternative investment folks, and specifically those focused on commodities, managed futures, and global macro strategies on Twitter. So we went out and did it ourselves. Here’s our compilation of people and firms currently out there on twitter (in no particular order, despite the numbering) providing the latest insight, humor, debate, and news on investments – especially the alternative kind.
  3. CNBC Didn’t Screw up their Interview with David Harding
    CNBC made another attempt at interviewing Winton’s David Harding and this time around they managed to ask questions actually dealing with the Managed Futures industry. Here are our takeaways from the interview:
  4. 23 Commodity, Equity, and Currency Markets since the 2009 Low
    March 2014 officially marked 5 years since we had 700 point down moves in the Dow, Lehman going bankrupt, and new market lows dragging down commodities. We all know where the equity markets have gone since then, but what about 23 other markets since the March 9th, 2009 low? Plus, asset class performance 5 years before and 5 years after March 2009.
  5. A Brief History of Man AHL, Winton, & Aspect
    It’s hard to believe, but three of the biggest managed futures programs in the world, Man AHL, Winton, and Aspect Capital; all trace their roots back to three 20 something Brits at Oxford and Cambridge in the 80’s. Here’s a brief history.
  6. Why Hedge Funds Don’t Care if They’re Underperforming the S&P
    The problem with saying hedge funds are underperforming the S&P 500 is that the grand majority of them aren’t even trying to beat the S&P 500 in returns, for any set period. They are trying to deliver better risk adjusted returns than the stock market, but that doesn’t make for as good of a headline.
  7. Our Interview With Winton’s David Harding
    Since Winton CEO David Harding was in Chicago this summer receiving his pinnacle award, we thought we’d put some questions directly to him on the industry, how they trade, and so forth… enjoy:
  8. Complacency Everywhere” 
    Here’s the thing that was driving those who do more than just stocks — CRAZY. This spring, It wasn’t just the stock market that was seeing record low volatility. Complacency was everywhere. It was for sure in stocks, but it was also in…
  9. Rise of the Robo-Advisors?
    What are Robo Advisors? Why the sudden attention from the financial media? Some believe they threaten to shift the way the financial advisor business model works. More importantly, what would this mean for alternative investments.
  10. Under the Hood: Wisdom Tree’s Managed Futures ETF
    You got to hand it to the marketing folks over at Wisdom Tree…. No sooner had the ink dried on Managed Futures good 3rd quarter and the Dow hit new 8 month lows we started to see Wisdom Tree advertising their Managed Futures ETF ($WDTI) on CNBC. Marketing 101 = strike while the iron’s hot. But how much “managed futures” exposure are you really getting with this product? Let’s take a look under the hood, shall we?

This Year’s Santa Claus Rally

It’s the most wonderful time of year for those heavily weighted in the stock index ETFs… At least if you’re a believer of the famous “Santa Claus Rally,” which simply means that in the past, December has been historically kind to stock market returns. You know how we feel about past performance… it is not indicative to future results.

Santa Claus Rally

But we can’t deny if said past performance has been good for stocks. We talked about the Santa Claus Rally last year, and there is a lot of debate of whether the Santa Claus rally is a myth, or if there is some basis in fact.

Here’s this year’s observation from Stock Trader’s Almanac:

“According to the 2015 Stock Trader’s Almanac, since 1969 the Santa Claus rally has yielded positive returns in 34 of the past 44 holiday seasons—the last five trading days of the year and the first two trading days after New Year’s. The average cumulative return over these days is 1.6%, and returns are positive in each of the nine days of the rally, on average. Nevertheless, each year there is at least one day of declines.

Alternative research over a longer period confirms the persistence of these trends: According to historical data going back to 1896, the Dow Jones Industrial Average has gained an average of 1.7% during this seven-day trading period, rising 77% of the time.”

No one can really pinpoint the cause of such a rally, but this year’s run can be attributed to better than expected economic growth, via NBC news:

“The wind in the stock market’s sails lately has been the pledge by the Federal Reserve last week to be cautious about raising borrowing costs amid signs that the economy is picking up steam. Investors got another signal of the economy’s emerging strength on Tuesday when the government revised upward its final estimate of third quarter economic growth to the fastest pace in 11 years — 5.0 percent from 3.9 percent reported last month.”

Just today, stocks reached new all time highs off of this news but it hasn’t been slow small gains. Just days ago (5 trading days), the Dow Jones Industrial Average was down -4.3% on the month, and is now past 18,000. By our estimation, historically, there’s only been a 17% chance that the index finishes the month positive after a down move like that, let alone only 5 days {past performance is not necessarily indicative of future results).

But it hasn’t just been this rebound, or the last rebound. It’s that it only took the DJIA six months to go from 17,000 to 18,000. Before that, it only took seven months to go from 16,000 to 17,000 {past performance is not necessarily indicative of future results}. Will it take six months to reach 19,000? A year from now, will it be at 20,000? We’ll let others do the speculating.  Enjoy the ride while it lasts, and happy holidays.

P.S – Stocks aren’t the only thing at new all time highs. Managed Futures hit new all time highs in November {Past performance is not necessarily indicative of future results}.

11 things you should know about the Crude Oil Drop

Christmas came a month early for those short Crude Oil over the past couple of months, specifically last week, and even more specifically – Friday.  Since July, WTI crude has dropped more than 30%, with 10% of that coming the day after Thanksgiving. And just about everyone and their mom (mom’s who have a blog about commodities?) have written something about the Crude Oil move.  Here’s 11 insights into what might make this drop more than just this week’s headline.

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