Diversification Benefits
Once Equinox has a selling agreement with a broker-dealer in place, Enck says, an Equinox wholesaler meets with the financial advisors associated with the broker-dealer or RIA to provide education on managed futures. Education is critical because managed futures comprise a relatively obscure asset class, he says. "It's different from stocks, bonds and cash, the typical diversification strategy most people utilize," says Enck. "The more investors and RIAs and financial advisors learn about this category, typically the more they utilize the category."
From 1980 to March 2010, managed futures, as measured by the CASAM CISDM CTA Equal Weighted Index, had a compound average annual return of 14.52%, while U.S. stocks in the S&P 500 index returned 7.04%.
Managed futures are offered by CTAs, who are regulated by the U.S. Commodity Futures Trading Commission and the National Futures Association. CTAs use proprietary trading systems to manage their clients' assets and generally take long or short positions in global financial and commodity futures contracts. Strategies vary widely. Many CTAs employ a trend-following strategy, where they try to capture and hold long-term market trends. Others try to take advantage of the reversals of such long-term trends.
Enck says Equinox's business thrived in 2008 when the financial crisis took hold, thanks to the peculiar nature of managed futures. He notes that over the last 25 to 30 years, when national or global catastrophic events have struck, managed futures have typically done very well.
Enck points out that because many CTA programs follow trends, they often get hit hard when trends reverse, losing money before the programs catch up with the change.
"After a very robust 2008, 2009 saw some directional changes throughout the year, both up and down, and managed futures were off a bit," he says. According to BarclayHedge, the CTA Index lost 0.1% in 2009. Year to date through July, the index was down about 1%.
Investment Process
The Frontier Funds and MutualHedge are managed in similar ways. The investment team, led by chief investment officer Bornhoft, starts with a universe of about 1,200 CTA programs. They analyze each one quantitatively, using a combination of third-party and proprietary data, and narrow the set down to the top 10% of "very star-performer" programs, Enck says.
To find the best in this elite group, the team applies qualitative metrics, considering such things as trading style (systematic vs. discretionary, for example) and the time horizon each program follows for trading (some programs are shorter term, some longer term). "We truly believe in diversification, so we'll put together a broad cross-section of CTAs in terms of time horizon," Enck says.
Then, the Equinox team looks at which markets the programs trade in order to find a balance between the six categories it tracks. Equinox's CTA programs trade more than 100 markets worldwide in three financial categories (currencies, equities and interest rates) and three physical commodities groups (metals, energy and agricultural products). The team also meets with the top CTAs to assess their risk management techniques.
Equinox currently allocates to a select group of a half dozen or so core CTA programs. Enck says that if it adds a new program, it will normally "dial down" allocations to other programs while introducing the new one.