Monday, 30 March 2015
Last updated 37 min ago
Aug 22 2014 | 12:52pm ET
By Susan Roberts
Director, Campbell & Company
For the past five years, the annualized performance of the S&P 500 Index has been +18.4% (through May 2014). If you believe that this level of performance from equities is likely to persist, there is little need for portfolio diversification. Looking back over a longer timeframe, however, suggests that the recent results may not be sustainable: over the last 20 years, the annualized return of the S&P was nearly half the five-year value. A look at consecutive five-year periods reveals an even greater disparity in results (see below).
During raging bull markets, like the one we’ve been in since 2009, it can be difficult to maintain allocations to protective strategies. While put options, for example, were quite useful during periods like 2000-2002 and during the financial crisis of 2007-2009, the last five years would have been extremely punitive due to the steady erosion of value incurred by put options during sustained rallies. Investors who relied on Managed Futures to provide portfolio diversification fared much better: the Barclay CTA Index was approximately flat for the last five years, while the S&P surged 130%. Though Managed Futures is not a ‘put’ on the stock market, and will not profit during every single stock decline, the strategy has historically done well during bear markets due to its ability to go short equity indices and dynamically adjust positions to capture trends that may develop in other sectors.
Comparing the performance of the CTA Index to that of a put option provides an interesting but limited perspective on recent strategy returns. The perspective is limited because, in addition to providing portfolio diversification, Managed Futures also seeks to provide attractive stand-alone risk-adjusted returns. From that perspective, the strategy has recently come up short.
There are several possible reasons why the environment has been difficult for the industry. The challenge in identifying these reasons stems from the fact that, unlike ‘Long-Short Equity’, which tends to have a consistent positive correlation to stocks, Managed Futures returns are not consistently correlated to any market or sector.
The dominant factor driving global market activity since the financial crisis has been the unwavering commitment by the Fed and other central banks to flood the system with liquidity. While it is difficult to determine causality, market conditions developing concurrently with the unprecedented level of interventionist policy include an increase in correlations across markets, an extreme decline in realized and implied volatility, and a marked uptick in headline-driven trend reversals. All of these effects may have contributed to the inhospitable environment for Managed Futures strategies. That being said, there have certainly been pockets of opportunities. In 2013, for example, the QE-driven surge in stocks provided an attractive target for trend-based strategies.
While many Managed Futures programs were profitable in the equity sector in 2013, overall industry returns were still negative: the Barclay CTA Index returned -1.4%. However, as tapering continues and monetary policy shifts back towards center, the environment for Managed Futures may improve, with more opportunities and fewer headwinds.
By some measures, the industry has already started to see a recovery, with gains for the CTA Index in 3 of the last 4 months (through May 2014). It will be interesting to see if this is the beginning of a broader shift in performance.
It is not just the S&P 500 which has historically exhibited cyclicality. Diversifying investments like Commodities, Real Estate and Managed Futures have also shown the same cyclical tendencies, at least over the last few 5-year periods.
In summary, the global diversification provided by Managed Futures may prove to be extremely valuable as we enter the next phase of the economic recovery. The next five years may look like the last five, in which U.S. Equities, Real Estate and Commodities all performed extremely well, or perhaps they will look like the prior five years, when all three strategies incurred significant losses, and Managed Futures strategies performed well. Regardless, at Campbell we believe in the ability of our portfolio to provide our investors with both attractive risk-adjusted returns and portfolio diversification. We are looking forward to the next few years.
Susan Roberts is a Director and Product Specialist at Campbell, where she works closely with both the Research and Business Development teams, focused on the development of investment-related content with a goal of providing technical insight into Campbell’s portfolio. Prior to joining Campbell in October 2012, Ms. Roberts was Senior Managing Director at R.G. Niederhoffer Capital Management, where she was responsible for strategic initiatives and business development. Ms. Roberts is a former actuary, and a frequent speaker and panelist on the subject of Managed Futures at industry events. Ms. Roberts holds a B.S. in Mathematics from the University of Notre Dame.
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