Managed futures strategies have put in a stellar performance since their advent in the early 1980s. The chart below shows the outperformance of the managed futures industry as compared to the S&P 500 since 1980.
(Managed Futures Index is the BarclayHedge BTOP 50 Index)
But, recent history has not been so good. After a stellar 2008, when the managed futures index was up 14% and the S&P 500 dropped 45%, the managed futures index has lagged the S&P 500.
This is especially disconcerting because we have seen a whole slew of managed futures mutual funds recently hit the market that are being sold to retail investors. Investors are concerned that the strategy has lost its charm.
In this analysis we will show:
- Most managed futures strategies have long-term holding periods
- Long-term volatility has not dropped, but curve inversion has increased
- Which has been the biggest culprit for a drop in performance
- Investors should look at shorter holding period strategies like the MAMF Index.
Volatility Has Not Dropped, But the Returns Have
For our analysis, we created an index that contains commodities that represents most of the commonly traded managed futures strategies. The index contains S&P500, Gold, Soybeans, WTI, 10 Year Treasuries and the U.S. Dollar Index. Then we looked at the cumulative absolute move in this index, broken out by time frame, i.e. daily, weekly, monthly, quarterly and annual moves.
Cumulative absolute move is simply adding all the moves in the index over the specific time frame. So, a 195% move in the daily index in 1991 means that the sum of the entire daily moves in the index in 1991 was 195%.
For absolute return strategies that look to make money from both up and down moves, it is best to look at cumulative moves to assess the strength of the market environment for that strategy.
(2012 Returns are until November. Managed Futures Returns are for the BarclayHedge BTOP 50 Index)
The first conclusion that can be drawn from the above results is that the performance has dropped, from an average of 6.0% per annum from 1990-2000, down to 4.0% from 2006 to 2012.
The second conclusion is that the total move in the index has not dropped, but increased across all time frames. Therefore, the explanation often given by managers that a drop in volatility is hurting performance is not borne out by the data as a whole.
Index Constituents Have Long Term Holding Periods
Next we looked at the correlation of the cumulative index moves to the managed futures returns by time period.
This correlation matrix has two clear trends:
- The correlation of the annual moves is the highest to the managed futures returns, showing that most of the strategies in the index have long holding periods and are influenced the most by long-term market indicators.
- This correlation has increased over time. The correlation of the annual moves in the index to the managed futures returns has gone from 30% in 1990-2000 to 91% over the last 6 years. This can be attributed to a proliferation of long-term trend following and momentum driven strategies in the managed futures index.
Short-Term Moves in the Index Have Increased More than Long-Term Moves (Volatility Curve Inversion)
The table below shows the ratio of annual moves to quarterly and monthly moves in the index. This once again has a clear trend:
Comparing market moves by time period
The curve is becoming more inverted over time. Meaning that the monthly and quarterly moves have increased as compared to the annual moves.
This is probably the best explanation for why the managed futures index has underperformed in recent years. We have already recognized the fact that most of the strategies in the managed futures index are trend following type strategies with long-term holding periods.
But another thing to keep in mind is that most of these long-term holding period strategies have risk management that is tied to shorter term market moves.
As an example, a long-term trend following strategy might get its buy and sell signals based on the 200 day moving average, but may still stop out and move to cash if there is a short term adverse move in the underlying market. Therefore, as the size of the short-term moves has increased, the long-term trend following strategies have most likely hit their stop losses and gone to cash quite often in recent times. But given the lower annual moves in the index, these strategies have not been compensated while they have stayed in the market.
Therefore a drop in performance in the traditional long-term trend following strategies is probably better explained by a relative pickup in the short-term volatility as compared to the long-term moves in the market.
Access Shorter Holding Period Strategies
The important thing to understand is that just because the managed futures index has dropped in performance does not mean that the managed futures industry as a whole has lost its charm.
The managed futures industry has grown beyond long-term trend following strategies into short-term pattern recognition, volatility arbitrage and hybrid structures. These strategies are still few in number and are not well represented in broad indices.
Also, they are not picked by most mutual funds that offer managed futures to the retail investor which also explains the poor performance of the mutual funds in this space.
Short-term market volatility is high and is higher than it has been in the past. This is good for strategies that trade often and have short holding periods. Also these strategies will not be subject to being "chopped up" by short-term market moves, because they welcome short-term market moves, given their short holding periods.
Here is an analysis of the MAMF Index that is a diverse index of 15 strategies. The index has:
■ Strategies across trend following, pattern recognition, arbitrage, neural networks and hybrid structures.
■ Average holding period ranging between a few hours to a few days.
■ Dynamic allocation with monthly rebalancing across strategies ranging from 2.5% to 15% capital per strategy.
■ The consequence of adding a diverse group of strategies that vary by holding period and style results is a more consistent and superior performance when compared to the S&P500 or the managed futures index.
■ And the correlation to the market moves by time frame is consistent, which means that the index is not dependent on any one time frame's volatility and makes its performance more robust across different market environments.