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Managed Futures: Is This Time Different?

Managed futures strategies have provided one of 2022’s few bright spots in the investment management industry, with data and analytics provider Preqin showing that its CTA strategy category is up 6.07% through the end of July this year. Investors have taken note, putting a net $5bn into these products in Q1 of 2022 alone.

The strategy has produced negative correlations to equity markets and positive incremental returns over most periods since the 1970s. In 2008, the strategy delivered stellar numbers as public equities plummeted; that year, the Preqin CTA Index was up +23.32% and inflows followed again. And then the industry endured a disappointing decade, with many traders delivering meagre returns, prompting investors to pull money.

Industry disciples believe that this time, it’s different.

“We all know equities were the place to be the last ten years and anything else was a disappointment. But that can’t go on forever, and this year the macro environment became challenging for equities and bonds and favourable for futures traders,” said Lee Gladden, CEO at Princeton, NJ-based managed futures fund of funds provider Witherspoon Asset Management. “After this recent sea change in the markets, I believe that there will be better opportunities for commodities and futures traders for the next several years. “

Much of the challenges in the managed futures space in the post-GFC decade can be attributed to quantitative easing programs by central banks fuelling price rises in risk assets and dampening volatility, meaning that there were fewer opportunities for futures traders. Now, rates are rising, inflation is up, stocks are down, and a global recession looms.

It is still early in this new regime but investors who might be looking at getting back into managed futures or allocating for the first time might be forgiven for taking a more cautious view. Gladden says that part of the reason that an investor might be unwilling to pull the trigger on an allocation is their experience during the past decade or so.

“There are definitely myths about managed futures, but they are based on investor experience. Investors bought the idea that there is a portfolio benefit, but most jumped in with the largest trend followers and had a disappointing experience. Single manager risk and single strategy risk limited their success, but that doesn’t mean that managed futures aren’t in a good spot today."

Commodities and managed futures are long-established bedfellows. This year, long commodity positions have been paying off for managed futures strategies. The Societe Generale Trend Indicator, a publicly available trend following model, is up +41.66% this year, and returns from commodities are responsible for 7.15% of that (at the time of writing). Compare that with equity index positions, which have contributed -2.95% to the model’s performance this year.

Witherspoon has a tactical bias towards commodities markets and traders. Gladden says that commodities specialists can have an impressive edge and they are playing on a less crowded field, which supports the ability of these programs to deliver strong risk-adjusted returns. However, sourcing and creating a portfolio of these strategies is not a trivial matter.

“Our team believes that specialists are in the best position to deliver superior results, so we look for managers who have experience and a demonstrated edge. That leads us to commodities traders. We’re agnostic about whether they take a systematic or discretionary approach, but commodities are narrow enough and specialized enough that they don’t attract as much talent and investment. A decade of depressed commodity prices have caused many commodities managers to shut down. Furthermore, we think it is much harder for traders to have an advantage in the financial sectors.”

“We look for specialists where we don’t have exposure” said Gladden. “Metals for example offer opportunities now, given the green economy transition and its effect on many commodities markets. There is a structural shift leading to a supply / demand imbalance in metals markets. The historical lack of capital expenditures has been exacerbated by ESG preventing renewed investment. We like that story a lot, so we sourced a trading group well positioned to take advantage of these dislocations. We’re always looking for strong risk adjusted returns from trading strategies with exposure in futures markets where we don’t have enough exposure in our portfolio.”

Another commonly held belief amongst investors is that risk is too high with managed futures and returns aren’t worth that risk. But the drawdowns in managed futures tend to be much shallower than those in equities. Since the beginning of 2019, the CTA indices have had a peak to trough drawdown of around 10%, while stocks had two drawdowns of 20% during the same period, although CTA drawdowns sometimes last longer.

“CTAs are complementary to equities in a portfolio," Gladden says. “Managed futures should be viewed as a diversifier; they’re not supposed to be highly correlated to equities. However, it must be noted that single strategy risk in futures is like buying just one stock in creating an equity portfolio. The same level of research and focus on diversification and portfolio design that occurs when creating a portfolio of equities should apply when creating a portfolio of futures trading strategies."

Whether Gladden is right about the next several years of course remains to be seen. But his message to investors is clear.

“Managed futures has a special role to play in a properly diversified portfolio, but the best way to get access is not to pick one or two of the largest managers but implement an allocation that has broad exposure to different markets, strategies and sources of returns. Investors should have a long term commitment to managed futures strategies because they are the most liquid, transparent and uncorrelated of the alternative investments.”

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