What Are Managed Futures?

One of the most difficult tasks in building a portfolio is finding asset classes that do not move in lockstep with stocks or bonds. Non-correlation—the tendency of an asset class to move independently of others—lowers a portfolios volatility, but it’s elusive.

Perhaps the most promising candidate is commodities: according to Larry Swedroe’s The Only Guide to Alternative Investments You’ll Ever Need, from 1973 through 2007 the S&P GCSI Commodities Index actually had negative correlation with US stocks, international stocks, and US Treasuries. That means they tended to zig when other asset classes zagged. Yet in 2008, commodities plunged along with all other risky assets.

However, a related asset class thrived during that crisis: managed futures. This term refers to strategies that trade commodity futures in an attempt to deliver positive returns in both up and down markets. (Many also include trading futures in currencies and interest rates.) Traditional commodity ETFs such as the iShares S&P GSCI Commodity-Indexed Trust (GSG) simply hold long positions in various crops, metals and energy products, and if commodity prices fall, so does the value of the fund. Managed futures strategies, on the other hand, attempt to follow price trends, and they can take both long and short positions. If they get the timing right, they can deliver positive returns even when prices fall. That’s just what they did in the bloodbath of 2008: the Credit Suisse/Tremont Managed Futures Index returned about 18%.

Managed futures strategies, which have been around for some 30 years, are carried out by professionals called Commodity Trading Advisors (CTAs). The strategies are popular with hedge funds and institutional investors around the world, although they are much less widely used in Canada. Their appeal is not only their non-correlation (or even negative correlation) with other parts of the portfolio, but their surprisingly low volatility: as a group, managed futures tend to have lower standard deviation and smaller drawdowns than both stocks and commodities.

Passively managed futures?

Because managed futures strategies require someone to make the trading decisions, they are in no way passive strategies—indeed, it’s a bit misleading to describe them as an asset class, since each individual strategy has its own risk and return characteristics. But this year, two managed futures ETFs have been launched in Canada: the iShares Managed Futures Index Fund (CMF) and the Horizons Auspice Managed Futures Index ETF (HMF). These join the two-year-old iShares Broad Commodity Index Fund (CBR), which uses a managed futures strategy without the short positions: the fund will either take a long position in a given commodity or none at all.

Note that all of these funds include “index” in their name. While they are certainly not traditional Couch Potato products, the ETFs make an attempt to execute a managed futures strategy based on quantitative rules rather than the whims of a fund manager. And unlike hedge funds—which often charge at least 2% plus 20% of returns above their benchmark—they are accessible to retail investors for a management fee of less than 1%.

Does it make sense for you to consider adding managed futures to your index portfolio in order to capture their diversification benefit? In a two-part series this week, I’ll share my recent interview with Tim Pickering, president of Auspice Capital Advisors, which manages both HMF and CBR. He will explain more about how the ETF strategies work and help you decide whether they make sense for you.

6 Responses to What Are Managed Futures?

  1. Andrew July 16, 2012 at 1:12 pm #

    I am looking forward to this interview.
    I have thought about the two ETFs mentioned. There is another strategy that can be mechanical that is lower correlation but do not know if there are ETF products for it – fixed income arbitrage.

  2. Andrew F July 16, 2012 at 3:31 pm #

    I, too, am interested in these interviews. I like the idea of managed futures on paper as an uncorrelated asset class that can be used to reduce portfolio volatility. The short historical performance of these two managed futures funds in Canada has not been that impressive.

  3. Michael February 1, 2014 at 8:00 am #

    Andrew F – “The short historical performance of these two managed futures funds in Canada has not been that impressive.”

    Compared to what?

  4. Rob T February 14, 2014 at 5:10 pm #

    Not only have commodities enjoyed a low correlation to both equities (-0.30) and bonds they have also produced a high return. The S&P GSCI had an annualized return of 10.9% over 25 years (1973-2007). This is just 0.1% short of the S&P 500 returns for the same period. Even omitting the high inflation 70’s the GSCI still returned 9% annualized for the 15 years 1992-2006.

    The GSCI not only gave high return, but so high it rivaled equities – and with a correlation to equities that was not just low, but so low it was negative! This is the holy grail of diversification. As the Canadian dollar is considered a ‘commodity currency’ then investing in commodities may have currency hedging benefits as well. Commodities are more volatile than stocks but, as Swedroe says in his book, “with a negative correlation to a [equity] portfolio, high [commodity] volatility can be a good thing”. Overall portfolio volatility actually goes down by adding a small allocation to commodities.

    The negative correlation did fail in 2008 when they went down along with everything else. And more recently commodities have performed poorly (though this is to be expected since stocks have done well). But based on their long term record the GSCI sounds like an asset class I should have in my portfolio.

    Gaining exposure to the S&P GSCI broad based commodity index (or the also popular DJ-AIGCI) can be done through CCFs (Collaterallized Commodity Futures) in the form of ETFs. Swedroe recommended ETFs that passively track a broad based index that are unleveraged, long only, and fully collateralized. On the other hand, he roundly condemned CTAs which are generally active, long/short, leveraged, unregulated, charge high fees and went on to give truly horrifying statistics concerning the performance of such funds. HMF and CBR seem to be better than most CTAs this but I would still like to here more about index tracking CCFs like GSG and others.

    @CCP Can you do an article on index tracking commodity ETFs? I’d look forward to your usual thorough analysis comparing various fund choices (choice of index, fund MERs, other costs, tracking errors, etc). What portion, excluding gold, of a portfolio should an investor consider allocating to commodity etfs?

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