Managed futures: The next five years

Tue Aug 19, 2014

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The past five years were phenomenal for investors in equity indices. Will the next five years offer the same opportunities?


 

By Susan Roberts

For the past five years, the annualized performance of the S&P 500 Index has been 18.4% (through May 2014). If you believe that this level of performance from equities is likely to persist, there is little need for portfolio diversification. Looking back over a longer timeframe, however, suggests that the recent results may not be sustainable: in the past 20 years, the annualized return of the S&P 500 was nearly half the recent five-year value. A look at consecutive five-year periods reveals an even greater disparity in results (see chart).

During raging bull markets, like the one we've been in since 2009, it can be difficult to maintain allocations to protective strategies. While put options, for example, were quite useful during such periods as 2000 to 2002 and during the financial crisis of 2007 to 2009, the past five years would have been extremely punitive due to the steady erosion of value incurred by put options during sustained rallies. Investors who relied on managed futures strategies to provide portfolio diversification fared much better: the Barclay CTA Index was approximately flat for the past five years, while the S&P 500 surged 130%. Though managed futures is not a put on the stock market, and will not profit during every single stock decline, the strategy has historically done well during bear markets due to its ability to go short equity indices and dynamically adjust positions to capture trends that may develop in other sectors.

 
   
 

Comparing the performance of the CTA Index to that of a put option provides an interesting but limited perspective on recent strategy returns. The perspective is limited because, in addition to providing portfolio diversification, Managed Futures also seeks to provide attractive stand-alone risk-adjusted returns. From that perspective, the strategy has recently come up short.

There are several possible reasons why the environment has been difficult for the industry. The challenge in identifying these reasons stems from the fact that, unlike long/short equity strategies, which tend to have a consistent positive correlation to stocks, the returns of managed futures strategies are not consistently correlated to any market or sector.

The dominant factor driving global market activity since the financial crisis has been the unwavering commitment by the Fed and other central banks to flood the system with liquidity. While it is difficult to determine causality, market conditions developing concurrently with the unprecedented level of interventionist policy include an increase in correlations across markets, an extreme decline in realized and implied volatility, and a marked uptick in headline-driven trend reversals. All of these effects may have contributed to the inhospitable environment for managed futures strategies. That being said, there have certainly been pockets of opportunities. In 2013, for example, the Quantitative Easing-driven surge in stocks provided an attractive target for trend-based strategies. While many managed futures programs were profitable in the equity sector in 2013, managed futures funds on the whole lost money: the Barclay CTA Index dropped 1.4%. However, as tapering continues and monetary policy reverts, the environment for managed futures may improve, with more opportunities and fewer headwinds.

By some measures, the industry has already started to see a recovery, with gains for the CTA Index in three of the past four months (through May 2014). It will be interesting to see if this is the beginning of a broader shift in performance. As shown in the charts, it is not just the S&P 500 which has historically exhibited cyclicality. Diversifying investments, such as commodities, real estate and managed futures strategies have also shown the same cyclical tendencies, at least over the past few five-year periods.

The global diversification provided by managed futures strategies may prove extremely valuable as we enter the next phase of the economic recovery. The next five years may look like the past five, in which U.S. equities, real estate and commodities all performed extremely well, or perhaps they will look like the previous five years, during which all three strategies incurred significant losses, and managed futures strategies performed well. Regardless, at Campbell we believe in the ability of our portfolio to provide our investors with both attractive risk-adjusted returns and portfolio diversification. We are looking forward to the next few years.

Susan Roberts, CFA, is a director and product specialist for Campbell & Company, a $3.5 billion managed futures firm based in Baltimore, Md. This column was adapted from a Campbell & Co. investor communication.

The views expressed in this material are those of Campbell & Company and are subject to change at any time based on market or other conditions. These views are not intended to be a forecast of future events, or investment advice. Investors are cautioned to consider the investment objectives, risks, and charges of products before investing. The market charts and performance statistics included in this piece were prepared by Campbell & Company.

This does not constitute an offer or solicitation. Investments in managed futures may be offered by disclosure document delivery only, which includes additional information on risks, charges and liquidity. Managed futures employ leverage; they are speculative investments that are subject to a significant amount of market risk and they are not appropriate for all investors. Although adding managed futures to a portfolio may provide diversification, managed futures are not a perfect hedging mechanism; there is no guarantee that managed futures will appreciate during any market condition.

ISSN: 2151-1845 / CDC10004H