By Emanuel Balarie -- 2008 will likely be recognized as the breakout year for managed futures. Not necessarily because the industry was able to generate positive returns, but because the Managed Futures industry was able to generate these positive and non-correlated returns during volatile and changing market conditions. While the main benefits of managed futures have been prevalent for years, it took a year like 2008 to finally highlight the unique characteristics of this asset class.
Not surprisingly, there was an increase of media coverage regarding managed futures. Over the past several months I personally received calls from various reporters who were looking to write stories on a managed futures related topic. These conversations not only reaffirmed the growing interest, but also brought to light the misconceptions that continue to surround the Managed Futures industry. I will talk about some of these misconceptions a bit later on.
In terms of the media coverage, systematic trend followers seemed to garner most of the attention. I have listed some of these articles in MFQ’s news link at the bottom of this newsletter. Trend followers were mentioned most often in these articles, but non-trend following CTAs were also able to successfully navigate the markets (and thrive) in 2008. The Barclay Agriculture Index and The Barclay Discretionary Index were up 10.23% and 12.08%, respectively. You can view the performance below in the Barclays CTA Indices.
Another reason for the increase in coverage was the simple fact that CTA indices were positive, while other indices were not. According to a recent Credit Suisse report, CTAs were one of the only two positive performing sectors within the Credit Suisse Tremont Hedge Fund Index.
Clearly the question that many investors were asking was…Who is making money in these markets? This question will likely continue in 2009 as investors re-evaluate their asset allocation models.
It is important to point out, however, that even though the various CTA indices showed a positive performance for the sector, there were CTAs (such as some option sellers) that were unable to adapt to the changing market conditions. The result was a record drawdown for several managers and the subsequent closure of their programs. In addition, there were also a few systematic trend following managers that also incurred draw downs this year, showing that not all trend followers are alike. The discrepancy between CTA returns once again shows the value of having a CTA portfolio that is diversified across managers, sectors, trading strategies, time frames, and styles.
Institutional interest also increased in 2008. A recent article in Reuters highlighted the fact that many pension funds were going to reconsider their commodity asset allocation models. While the long-only index approach seemed to have worked previously, the quick and drastic sell-off has forced many of them to re-evaluate their allocation strategies. CalPERS, for instance, recently announced that they have hired a group of consultants to determine how they can generate commodity returns that are not aligned with long only indices, such as the S&P GSCI. Earlier this year, CALPERs also announced that they would allocate 100 million to Blue Crest Capital Management, a systematic commodity trend follower.
While this increased media coverage and investor interest confirms that managed futures is well on its way to becoming a legitimate part of investor portfolios, we continue to feel that the general lack of knowledge and misconceptions surrounding the industry continue to keep investors from allocating to this sector.
Even though some might argue that the Managed Futures industry has already experienced exponential growth in terms of money under management, this number ($225.5 Billion according to BarclayHedge) still pales in comparison to the amount of money under managed for hedge funds ($1718.4Billion according to BarclayHedge).
Part of the reason for why the Managed Futures industry is not growing at a faster pace has to do with the relatively newness of the Managed Futures industry itself. However, now that the Managed Futures industry has evolved over the last 30 plus years, there are sufficient amount of data points that appear to warrant a greater allocation towards this sector. What keep some investors from allocating to this sector are simply the common misconceptions that surround the industry. Misconceptions like…
- Managed Futures are Hedge Funds
- Commodity Trading Advisors only trade commodities
- CTA’s are only trend followers
- Managed Future are Futures and therefore they are too risky.
The above are some of the misconceptions that I have heard from both reporters and investors over the past several years. For those involved in the Managed Futures industry or knowledgeable about the Managed Futures industry, these are clearly misconceptions. For those outside of the Managed Futures industry, however, these statements are often taken for granted.
A year ago, I wrote about myths and misconceptions in my book, Commodities For Every Portfolio:
“As is the case with most myths, the source of misconceptions about commodities can be traced misinformation and lack of knowledge….Most people, however, still lack a basic understanding of the futures markets. Instead of picking up a book and educating themselves about the world’s hottest markets, they rely on misinformation that is passed along from other sources. A friend of a friend might have relayed a horror story about how he lost money investing in gold or oil. A financial advisor might have cautioned against investing in commodities. Perhaps a CNBC guest proclaimed that commodities were too risky for investors.
In all of these cases, a good number of assumptions were made along the way. Take for example, the seemingly common friend-of-a-friend story. Often the facts behind the story are left out. What trading strategy did he implement? Was he overly aggressive? Did he even know what he was doing? Instead, the focus is simply on the fact that he lost money trading commodities. Pretty soon the story is told over and over again, and the myth that you will definitely lose money trading commodities is created.”
While the above excerpt relates to trading commodity futures, it can still be applied to the managed futures industry. First, many investors will often group the Managed Futures industry in the “trading futures” camp. Once put in this group, many investors will immediately assume that it is too risky of an investment.
Similarly, the above noted myths can keep investors, who otherwise might invest, away from this sector. For example, some investors have incorrectly assumed that hedge funds and commodity trading advisors are the same. The recent performance of CTA’s clearly shows that this is not the case, as do several academic studies, like Harry Katz’s Managed Futures And Hedge Funds: A Match Made In Heaven
Additionally, many new investors in the industry are initially perplexed that the returns of Commodity Trading Advisors are not necessarily dependent on the whether or not we are in a commodity bull market. Rather, returns are a byproduct of the markets traded (ranging from commodities to financials to currencies), the strategy that the manager implements, and the actual skill of the manager trading the program.
But not all myths in this industry keep investors away. Some myths bring investors on board. For instance, some investors will look at a CTA index or buy into the concept of using managed futures to diversify their portfolios and falsely assume that an investment in a single strategy emerging CTA will add the same level of diversification to their portfolio. Clearly, this is not the case. There are additional risks with only investing in a single CTA, let alone an emerging CTA. Additionally, managed futures are not suitable for all investors.
While these misconceptions can be frustrating for both investors and advisors alike, it should be expected in an industry that is still relatively young. However, it is important that the Managed Futures industry as a whole capitalize on this positive news, continue with best practices, and collectively focus on educating the public on this industry.
Emanuel Balarie is a managing director at Balarie Capital Management. The firm works with high-net-worth investors, family offices, pensions, and endowment funds interested in adding managed futures to their investment portfolios. In addition, Balarie Capital Management offers clearing and execution services for CTAs, fund of funds and professional traders. Balarie is also the publisher of the online industry resource Commodity News Center.
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. THERE IS SIGNIFICANT RISK OF LOSS WHEN TRADING FUTURES AND OPTIONS. ALWAYS REVIEW A DISCLOSURE DOCUMENT BEFORE INVESTING IN ANY MANAGED FUTURES PROGRAM.