Alternatives of all stripes become a hard sell when equities and bonds are enjoying extended bull markets, but the high times for traditional asset classes might also be the right time for managed futures in client portfolios.
According to a panel discussion at the 2017 Inside Alternatives conference in Denver on Monday, managed futures have faced additional headwinds in gaining popularity as investors remain largely unaware and advisors are uninformed about the utility of the strategies.
Managed futures strategies use contracts like options, futures and swaps that are associated with markets or indicators. Managers access asset classes like equity indexes, commodities, currencies, fixed income and precious metals across various geographies to achieve a variety of goals.
The strategies are quite diverse, said Jerry Szilagyi, CEO of Catalyst Funds. “The asset class encompasses everything from a traditional commodities trading advisor, to quants, to a manager of managers, to a specialist who packages together single strategies and multiple strategies into mutual funds.”
Most managed futures strategies employ some sort of trend-following component to take advantage of bull market growth, said Szilagyi. Generally, managed futures strategies are intended to outperform during bear markets, and participate in some of the upside of bull markets.
Until recently, managed futures strategies were only accessible to institutions and a small sliver of the investing elite, but recent trends have opened them up to a larger cohort of investors and at lower prices.
The strategies tend to shine most when markets are down -- eight years of bull markets have not offered managed futures an opportunity to prove their value. Szilagyi noted that Monday marked an all-time record for the longest period of time since a 3 percent equity market decline.
“We haven’t had much of a crisis for managed futures to really perform and provide superior returns,” says Szilagyi. Prolonged low volatility has also worked against managed futures strategies, which typically try to provide a smoother ride to investors.
According to the panelists, monetary policy is the source of much of their pain, as accommodative central banks have provided support for equity valuations and created less volatile markets. Traditional asset classes and some alternatives became correlated, leaving managed futures strategies behind.
“It’s been an awful, terrible period for our asset class, which is flat and boring,” said Dr. Rufus Rankin, director of research of Equinox Institutional Asset Management. “Yet while we’ve been boring and frustrated, we’ve also been preserving capital and providing a return stream independent from anything else your clients are invested in.”
The panelists commented that the era of loose monetary policy is slowly coming to an end, and that the bull market is past its prime. Bergin argued that markets and asset classes were decoupling as correlations were breaking down.
Szilagyi said that advisors who use managed futures are struggling to keep their clients allocated to the strategies, as many investors push to liquidate their low performing allocations.
Marty Bergin, president at Dunn Capital Management, says the problems are compounded because the industry has done a poor job of educating advisors and investors about alternatives. While clients are comfortable with long-only mutual fund and index strategies and building asset allocations based on a target rate of return, they have more difficulty understanding strategies like managed futures, which target risk.
“The argument for managed futures is that you never perform as badly as the S&P 500,” said Bergin. “It’s an educational bottleneck, a completely different way of looking at allocation, and thus the return stream is different from anything (advisors and investors) may have seen.”
Historically, managed futures have delivered on their promise to perform well during bear markets. In 2008, amid the global financial crisis, managed futures strategies returned an average of 14.1 percent. In the same period, the S&P 500 lost 36.5 percent, its second worst year since the 1929 stock market crash.
Yet investors who wait for a bear market may miss out on the diversification benefits of a managed futures strategy, as it provides an additional, uncorrelated asset to rebalance to and from as the market fluctuates, said Larry Kissko, client portfolio manager for Man AHL.
“The idea of a managed futures strategy helping out and providing diversification is still there,” says Kissko. “It’s a bit surprising, we have seemed to grow a bit unwary. In the 2000s, there was a lost decade for equities; they were flat, but it was rare for someone to come up to me and say, ‘I don’t want any more S&P 500.’ Nobody gave managed futures that kind of break.”
Managed futures strategies may create alpha over a long enough time, as many significantly outperform down markets, said Kissko, but most markets are only down one in every three to four years on average.
Under typical market cycles, the strategies are best held for at least three to five years, said Bergin of Dunn Capital.
“Even when they’re not overperforming, it does at least reduce your standard deviation and increase your risk-adjusted returns,” said Bergin. “Keep in mind that when we talk about these strategies not performing well, we’re talking about not performing as well as the S&P 500. If you’re serious about allocating to managed futures, you put it in a portfolio and leave it there as you rebalance.”
Most of the panelists advocated allocating 5 percent to 15 percent to managed futures strategies, depending on advisor and investor preference.