Saturday, 30 April 2016
Last updated 16 hours ago
Jun 13 2011 | 12:54pm ET
Rich Bornhoft is the founder of Denver, Colorado-based Equinox Fund Management, a multi-CTA manager with AUM of $1.2 billion. His firm tracks hundreds of CTA programs and allocates capital to a variety commodity shops, including Cantab Capital Partners, Winton Capital Management, Tiverton Trading and Beach Horizon.
Bornhoft, who has 30 years’ experience in the managed futures industry, created one of the first multi-manager futures funds for investment by large institutions and pensions. He believes managed futures is the most globally diversified investment strategy going, and he explained why during a recent phone interview with FINalternatives’ Senior Reporter Mary Campbell.
What are the advantages of managed futures?
First of all, they have a good absolute rate of return, regardless of the time period. Depending upon which time-window you look at, you’re going to see average annual returns that range from approximately 8% to 12%. So, managed futures do bring value on a standalone basis as it relates to rates of return.
The second advantage is that managed futures provide great diversification to a portfolio of traditional and alternative investments. The latter part of this comment surprises many people...You see non-to-negative correlation to stocks and bonds—this fact is well known—but what a lot of investors don’t realize is managed futures are also non-to-negatively correlated to the majority of hedge fund strategies and other alternative investments.
Can you tell me more about managed futures as a source of diversification?
We state that managed futures are the most globally diversified investment strategy a person could place in his portfolio. Managed futures participate in six sectors: three financial sectors—interest rates, currencies and stock indices—and three non-financials—energies, metals and agriculturals. That encompasses over 150 to 200 different markets on regulated exchanges. So, global diversification is a substantial attribute. Diversification also stems from the fact that CTAs are looking for profits from either up or down trends, therefore they go long or short or to cash. As a result, they may profit in either up or down markets. These two attributes are the reasons for favorable absolute returns, as well as the non-to-negative correlation with other asset classes.
How would you characterize the current environment for managed futures?
Periodically, dominant trends, up or down, in specific sectors or specific markets help explain current returns in managed futures. But the majority of the time, returns cannot be explained by identifying isolated market movements because managed futures are so diverse.
In recent years, an example of dominant trends that explained positive performance occurred in the commodity sectors. There have been overall uptrends in energy and agricultural markets. CTAs have been able to profit from these trends.
Over the past few years, market movement has been very favorable for managed futures. Looking to the future, many of the conditions that created meaningful up or down trends still exist. In fact, there are more issues in the marketplace today than over the past few years. Currently, we’re looking at the end of QE2. Quantitative easing may have created a new bubble in the dollar-based financial assets—all the way from stocks to gold. In addition, the end of QE2 may create other adjustments to the markets. Recent reversals in a number of strong up trends may be partially explained by this factor.
Another issue is the unprecedented debt that exists in the U.S., including the S&P threatening to downgrade the U.S. credit rating. It believes there is a material risk the U.S. is not going to be able to manage the budget challenges before it.
A third factor domestically is the number of states that are in financial trouble. A fourth factor is public pension plans—their defined benefits plans are in trouble. It does not look like they’re going to be able to meet the substantial entitlements they’ve given to their plan participants. Lastly, inflation continues to be a factor in many markets.
What about foreign markets?
Outside of the United States, the Eurozone has been at the forefront of the news for some time now. It appears most economists and forecasters believe Greece is moving towards total failure, with the strong possibility of other European countries following. While I do not like tactics that create fear in investors to promote their products, I have been involved in the financial industry for over 30 years, and the situations that exist in the marketplace today have to be dealt with.
When examining market conditions, the key factor to remember with CTAs, is they are adaptive, not predictive. Most CTAs adapt to changing market conditions; they do not try to predict or forecast specific trends, specific market conditions. Regardless of whether we’re in up markets, down markets, inflation, deflation, critical economic or geo-political situations, if CTAs find themselves on the wrong side of the market trend, within a short time they’re able to adapt to the new market trends and profit thereafter.
How many CTAs do you track?
We currently track over 1,600 CTA programs on a frequent basis. We track a large number of other CTA programs on a less frequent basis. We started compiling our database in 1983. Our objective is to track and evaluate every CTA program that exists in the world so our universe of CTA programs is very important.
That sounds ambitious—what criteria do you use when choosing which of these 1,600 programs you’ll allocate to? Do you decide simply on the basis of return?
There are several considerations. Return is one of them. The reward/risk attributes of the CTAs are very important. Once we’ve narrowed the large universe of CTA programs down to our top tier, then we go through both a qualitative and quantitative review process. We execute expanded due diligence on our top tier of CTAs. We select CTAs that demonstrate good performance, good risk-adjusted rates of return, scattered across a diversity of trading approaches.
We want to employ CTAs that complement each other; CTAs that are non-to-negatively correlated to each other. This provides a well-balanced multiple-CTA portfolio. We accompany our quantitative analysis with a qualitative review. We want to understand their trading approaches.
How many CTAs are in your average multi-CTA portfolio?
The Frontier Fund and Mutual Hedge are the two main product lines of Equinox Fund Management. Our core CTAs currently range from five to seven CTAs. Beyond the core advisors, depending upon the fund, another five to six satellite CTA programs are also incorporated into the portfolio. So in total, a well-diversified CTA program will be range from 12 to 14 CTAs.
Are pension funds and institutions showing more interest in managed futures these days? If so, does that indicate a higher risk tolerance on their part?
Historically institutions started investing in managed futures and CTAs in the late ‘80s and early ‘90s. In the 1990s, our research team spent literally 100% of our time working with large pension plans that were allocating to managed futures. Participation by institutions is increasing to a level that we’ve not seen in the last 15-20 years.
Many think that institutions are looking to higher return, higher risk investments. If you look at the risk profile of managed futures, they are historically less risky than most other investments in institutional portfolios. I think institutions are just coming to realize the standalone benefits of managed futures. They are a great diversifier against the other holdings they have in their portfolios. The traditional investments that all pension plans have relied on so heavily have substantially underperformed for over a decade. I think it’s a combination of these factors coming together that has increased the participation from institutions.
I would add one additional factor that has influenced many institutions: if you look at the highest AUM across the different hedge fund strategies versus CTAs, CTAs have consistently been in the top three or four, but they’ve moved to number one. This occurred in 2010. This documents the substantial interest in managed futures. [BarclayHedge reported that managed futures surpassed all other alternative investment strategies at the end of the Q2 2010, accounting for $223.4 billion of the total $1.78 trillion invested in all types of hedge fund strategies.]
Why do you think managed futures have surpassed other hedge fund strategies?
I think managed futures are finally becoming recognized as an alternative investment strategy with meaningful investment attributes, that should be placed in most portfolios, whether an individual investor or an institution.
In addition, I think 2008 was the year the attributes of managed futures really came to the surface. If you look at the bear market that occurred in stocks in the later part of 2000, 2001 into early 2002, a number of the hedge fund strategies and managed futures did well. When you fast forward to the bear market in equities in 2007 and 2008, both traditional investments and most hedge fund strategies had a difficult time. Managed futures were the only investment strategy that did well in 2008.
As time goes on, as markets become more volatile, as the geo-political and the economic environments become more unstable, managed futures should continue to provide value to most portfolios.