Managed futures is a fast-growing area in the alternative investment space, but the sector's negative returns last year reinforces the point that investors need to understand how these investments work.
And that's especially relevant given the growing number of mutual funds using managed futures strategies, an asset class that until fairly recently was available only for accredited investors. According to Morningstar, the amount of assets plowed into funds that employ managed futures strategies zoomed roughly 240% last year, to $3.4 billion. There are now 26 funds in this category, with half of them coming on board since the start of 2011.
Managed futures are programs run by commodity trading advisors (CTAs) who are registered with the Commodity Futures Trading Commission. They manage client assets in proprietary programs that trade an array of futures contracts in more than 150 global markets ranging from currencies and commodities to stock indexes and interest rates, and they can take both long and short positions.
Proponents of managed futures say the strategy provides diversification by investing in a broad range of assets that offer non-correlation to traditional long-only stocks and bonds. Many investors interpret "non-correlation" to mean that managed futures should shine when traditional assets stumble. But that's not always the case.
Managed futures, as measured by the Altegris 40 index, lost 3.14% last year. In comparison, the Nasdaq Composite dropped 1.8% the S&P 500 was flat and the Dow Jones Industrial Average gained 5.5%. And the 13 managed futures funds tracked by Morningstar that traded for the entire 12 months last year had an average negative return of 6.92%. (All seven alternative fund strategy categories tracked by Morningstar finished 2011 in the red.)
"We can lose money at any given day or month, but non-correlation holds up over time," David Kavanagh, portfolio manager of the Grant Park Managed Futures Strategy fund, told a press gathering on the topic of managed futures earlier this month in New York City.
That was a prevalent theme expressed at the meeting hosted by a handful of companies involved in the alternative investments industry. "My concern is that investors need to stay in it long enough to reap the long-term benefits of the [managed futures] strategy," said Greg Anderson, chief investment officer at Princeton Fund Advisors, which introduced the Princeton Futures Strategy fund in July 2010. "Clients have to understand that the diversity offered by managed futures is a long-term diversity."
Alpha When You Need It
The beauty of managed futures, the speakers said, is that they tend to be at their best when the markets take a massive header--a concept known as "crisis alpha." "Many investors have unreal expectations," said Jon Sundt, president and CEO of Altegris. "When they see it doesn't work [like in 2011], they bail. But when they want the benefit of crisis alpha, it's too late."
Sundt pointed to the financial meltdown of 2008, when U.S. stocks plunged 37% but the Altegris 40 index gained more than 15%. And when the S&P 500 lost about 45% during the tech bubble implosion from September 2000 through September 2002, the Altegris 40 index gained 43% during that period.
The Altegris 40 is a dollar-weighted index of 40 CTA programs (less than 5% of the total number of CTAs who report their performance) tracked by Altegris, an alternative investments shop in La Jolla, Calif. that provides alternative investment platforms for advisors and in 2010 launched its Altegris Managed Futures Strategy fund.
In the 12 years between 2000 and 2011, managed futures underperformed U.S. equities in seven of those years. But according to Altegris, during the 10-year period ending last December 31, the Altegris 40 returned 6.5% versus 2.92% for the S&P 500.
Low Correlation, High Cost
Correlation is a statistical measure showing how closely different types of investments move together over time. A correlation of 1 means they move in perfect unison, 0 means their movements are random, and minus 1 means they move in opposite directions. According to Altegris, during the 10-year period ending last year, managed futures had a correlation of minus 0.09 to U.S. stocks (S&P 500), 0.03 to international stocks (MSCI EAFE index), 0.16 to U.S. bonds (Barclays Capital US Aggregate index), and 0.21 to commodities (S&P GSCI Total Return index).
That type of non-correlation, say managed futures proponents, can help shield investors during down markets and provide solid long-term results. But it also comes at a cost. The Class A shares of the Grant Park Managed Futures Strategy fund carry net expenses of 1.95% and the Class C shares have net expenses of 2.70%. Net expenses on the Princeton Futures Strategy fund are 2.20% for the A shares and 2.95% for the C shares. And the Altegris Managed Futures Strategy fund has a net expense ratio of 3.86% on its A shares and 4.62% on its C shares.
"We have higher costs because we're going after best of breed managers who deliver the goods," says Sundt, whose fund picks the best managers in the Altegris 40 and combines them into one offering where each of them manages a portion of the fund. "It would cost $1 million to $25 million to engage them directly."
Kavanagh offered that fees needn't be too big of an issue with investors considering that managed futures should comprise no more than 5% to 15% of an overall allocation, and that the long-term performance of managed futures justify the cost. "Cost becomes an issue in the absence of value," Kavanagh said.