The Ins & Outs of Using Managed Futures

Diversification remains the Holy Grail when it comes to managing client portfolios. An ideal diversifier would provide low-volatility, largely positive returns and low or negative correlations with clients’ existing assets, since the goal is to achieve an improvement in the portfolio’s risk-adjusted returns.

A recent white paper from San Francisco-based Forward Management makes the case that managed futures can accomplish those goals. Their argument: the Barclay Commodity Trading Advisor (CTA) Index has produced long-term returns that match the S&P 500 Index and outperformed the Barclays Capital U.S. Aggregate Bond Index.

During the 1980-2011 period, the CTA Index was slightly less volatile than the S&P 500. Plus, it has also significantly lower one-month maximum losses, as shown in the following table:

Comparison of Monthly Returns by Asset Class: 1/1/1980 – 12/31/2011

	Annualized Return	Standard Deviation	Maximum Monthly Decline	Correlation to the S&P 500
Barclay CTA Index	11.16%	15.07%	-9.81%	0.01
S&P 500 Total Return Index	11.06%	15.62%	-21.54%	1.00
Barclays Capital S.S. Aggregate Bond Index	8.69%	5.69%	-5.92%	0.20

Source: Forward Investing

These results have attracted the attention of both investors and funds. Forward Investing notes that assets under management by CTAs grew from $10.9 billion at year-end 1990 to $37.9 billion by year-end 2000; that figure grew to $314 billion by year-end 2011.

Caveats are in order, of course. Unlike stock and bond indexes, the CTA Index is based on the results of a peer group of managers, not price changes in a set of securities. That means your clients can’t simply buy the CTA Index as they can a traditional securities index.

The white paper notes, “As a peer group index, the CTA Index reflects the results of a representative group of investment managers who employ diverse strategies within the managed futures category—not the performance of a certain group of securities. Thus, results vary widely among strategies, and investment managers’ degree of success is dependent on their individual strategies as well as on market conditions. Futures prices can be highly volatile, and individual strategies are likely to be substantially more volatile than the CTA Index as a whole.”

If you’re unfamiliar with managed futures funds’ strategies, the paper provides details on the main fundamental and systematic approaches to trading. 

Another challenge: Most CTAs are structured as limited partnerships, and investors must be accredited or Qualified Eligible Participants.

The emergence of managed futures mutual funds is improving access and reducing the cost of investors’ fees, as well. The white paper reports that as of May 31, 2012, 31 mutual funds had attracted $9 billion of assets under management.

Forward launched its own fund earlier this year, the Forward Managed Futures Strategy Fund (FUTRX).

According to the firm’s press release, the fund “is designed to generate positive returns in varied market environments while maintaining low correlations to major stock, bond and commodity indexes. The fund employs a systematic, trend-following approach that provides both long and short exposure to liquid futures contracts in four global asset classes-commodities, equities, bonds and currencies.”

The fund’s June 30, 2012 fact sheet states that the fund had $9.52 million of assets and a -6.32% return on investor-class shares.

Equities, Growth Assets Pull Back in Short Term

After Federal Reserve Chairman Ben Bernanke pledged to provide ongoing cheap money to financial markets, equities and growth assets surged upwards.  But with markets anticipating some sort of injection of liquidity, much of the move may have already been priced-in, pointing to the potential for a pullback in the short term.  Two charts highlight this quite well: the broad S&P500 Index and the course of the Canadian dollar. 

1. S&P500: Below we can see a potential reversal pattern two days ago. This chart shows that the market shot up to multi-year highs in early trade, but couldn't maintain its path, was met with selling interest, and then closed at the low of the day's trading range. This type of trading can indicate that demand in the short term has been met.

Source: SunGard MarketMap 2012

 

2. Canadian Dollar: On the same day, the Loonie exhibited almost identical trading action.  CADUSD shot up in early trade, almost hitting 1.0400 against the USD, only to meet with selling interest and finish at or near the day's lows, indicating that demand for CAD may have been met for the short term. 

Source: SunGard MarketMap 2012

 

Watch these two assets closely going forward, as they are both fair thermometers for the health of the global economy, and seem to suggest that we may have gotten a bit ahead of ourselves at this stage. 

 

 

 

 

 

Markets Stalled after Recent Run

Equity markets in Asia and Europe posted losses again this morning. Last week’s rally across equity and commodity markets seems to be taking a bit of a  breather at the moment as the focus of markets returns to structural problems in Europe, fiscal problems in the US, and waning global aggregate demand.

The ZEW  survey of German investor sentiment was the highlight of data from Europe this morning. In the short term, sentiment is at a two-year low; but looking forward, six-month sentiment actually rose from last month, coming in at -18.2. 

This morning the market saw more dark details of just how much more pain potentially remains before the debt crisis in Europe finds any sort of lasting solution. First, German Chancellor Angela Merkel commented that the long-term European Stability Mechanism (ESM) cannot be used to recapitalize banks without the establishment of a formal banking oversight committee, which would take at least another year to complete, and create delays in responding to requests for aid.

Second, a report was released stating that euro zone banks have not reduced the size of their of balance sheets as they had pledged to do last year. In fact, their balance sheets have grown by 7%, due in part to the cheap financing being offered by the European Central Bank.  The pledge to reduce the amount of assets held and increase capital was in response to fears over short-term funding requirements. That the central bank stepped up to meet that concern via unorthodox policies, rather than banks following through themselves, may be a cause for concern going forward.

North American data was light today, with the US releasing its current account reading for Q2, which came in at a deficit of $117 billion, a decrease from Q1's deficit of $136 billion.  Exports of goods, services, and investment income to foreigners outpaced the amounts imported. 

Alongside the current account, the US Treasury released July data for long-term securities purchases, which showed a net inflow of $67 billion into US capital markets for the month. This data did little to move markets, however, and equities remained lower while the USD stayed slightly stronger.

Thursday will bring a snapshot of global aggregate demand with the release of a slew of purchasing manufacturing indices from a number of major economies. Those from Europe are expected to indicate a contraction, while the US is expected to expand (ever so slightly).   

September 18, 2012: Overview

The USD is stronger this morning as markets digest the long-term implications of ongoing central bank support for the US and euro zone economies. Equities posted losses in Asian and European trade, and have opened lower in North America.

The EUR has weakened from its four-month highs but is holding above the 1.3000 mark against the USD. Oil is lower again today, sitting below $96.00 a barrel, and gold is up, testing the $1770-per-ounce level.  The Canadian dollar is flat from yesterday against its American counterpart, with USDCAD sitting in the mid-0.9700 area.

What's a Trade Gap? Loonie Keeps on Flying

This morning’s Trade Balance reports from both the US and Canada should be a reason for caution among CAD bulls.  The reports highlighted that two-way trade in both countries (imports and exports) slowed for the month of July, suggesting waning activity at home and abroad.

In Canada, the trade deficit came in wider than expected at CAD 2.3 billion for the month, the fourth consecutive reading in which imports have surpassed exports.  July’s data was particularly troubling, as both exports and imports fell, similarly driven by a drop in the volume of energy products traded.  Overall, exports fell 3.4% for the month, and imports fell 2.2%.

One would expect that an ongoing decline in demand for a country’s exports, especially energy products, would perhaps knock its currency down a few notches.  Not so the Canadian dollar: following the release it posted gains to a new 13-month high, hitting a low of 0.9710 so far this morning. 

It is becoming increasingly difficult to justify ongoing CAD strength.  Jobs growth is up just 1% on an annualized basis, and GDP has stalled at 1.8%, with inflation likewise nowhere to be seen.  This suggests that the CAD should be trading closer to par with the USD. But given that markets are driven by expectations of ongoing Fed easing, in contrast to a seemingly untenable tightening bias from the BoC, the market is happy to keep chasing the Loonie higher and higher. 

Markets Await Fed Announcement

With fundamental data pointing to waning global aggregate demand, markets are betting that central banks will provide the impetus to keep the recent rally in growth assets alive.  This line of thinking has proven sound over the past few months, as investors have cheered the decision taken by the European Central Bank to extend its bond-buying programmes, and fully expect the Fed to follow suit with additional stimulus this Thursday.  

Contributing to the positive mood today are reports that Wednesday’s ruling on the ESM by Germany’s Constitutional Court will not be delayed by recent lawsuits filed by regional German politicians.  The ruling is expected to be in favour of approving the ESM. However, the risk remains that approval will come with strict conditions aimed at ensuring that Germany’s balance sheet isn’t torn to shreds as it acts as guarantor for the weaker euro zone countries.  Such conditions threaten the current optimistic view of the European debt crisis. 

Elsewhere, Thursday’s Fed announcement is proving increasingly difficult to predict.  On the one hand, the Fed is not meeting its dual mandate of achieving full employment and containing inflation, which suggests that further stimulus may be warranted.  On the other hand, we can easily make the case that the lacklustre recovery in employment is not a cyclical problem that can be fixed by low interest rates; rather, it is a structural problem resulting from a disparity between skills and demand in the labour force.  Record low interest rates alone may not be enough to fix such a problem, and therefore the addition of further simulative measures may prove futile and actually hinder a sound resolution by sparking inflationary pressures in the future. 

But the market remains convinced otherwise at the moment, and is looking for more cheap money to keep the rally going, having fully priced-in such an outcome.  That said, Bernanke has proven that he is the most unconventional chairman in the Fed’s history yet, so even in the face of a looming presidential election and the diminishing returns of further stimulus, the market is expecting him to announce--at the very least--an extension of current policies. 

 

 

 

 

 

 

September 11, 2012: Overview

Equity markets are flat across the board this morning in anticipation of this week's highlights:  Wednesday’s German ruling on the European Stability Mechanism (ESM) and Thursday’s Fed announcement.  The USD is weaker against most of its counterparts this morning, and the Canadian dollar is once again outperforming across the board, hitting a 13-month high against its southern rival.  Oil is slightly higher in New York trade, currently sitting at 97.00/barrel.