There are several hurdles to managing client expectations. First, managed futures clearly are more difficult to explain than, say, investing in U.S. equities. Second, performance chasing with individual funds leads to unrealistic expectations. Third, when managed futures underperform, advisors need a clear explanation of why this happened and why the strategy is not “broken.”
The following roadmap could help in those discussions:
• Managed futures are a long-term diversifier and should be included in portfolios over a 10- or 20-year period—just like stocks and bonds. They are best viewed as a complement to traditional assets, not a standalone investment.
• Managed futures strategies make money from trends in asset classes—both up and down. They perform best during long, sustained moves in markets and underperform during sharp reversals (frequent in the past few years).
• The risk of the asset class (approximately 10 percent volatility) is between equities and bonds. This means clients should not expect managed futures to rise every year.
• Managed futures tend to perform best during the worst equity markets: up 15-20 percent in 2008. The simple explanation is that when markets get really bad, “trends” are strongest as most asset classes experience significant re-pricing.
A key point is that clients should not expect managed futures to catch short, sharp downward moves equities. In the fourth quarter of last year, the strategy did what it was supposed to do: as equities declined, equity risk was cut, exposure shifted to other markets (bonds and currencies, primarily) and the strategy was well positioned to profit if markets deteriorated further.
Conclusion
Investing is a long-term endeavor, and managed futures have a clear role. Frustration with individual funds—many with excessive fees—and comparison to rising equities have caused too many allocators to overlook the long-term, proven benefits of the strategy. Today, with stretched equity valuations and many economists forecasting an economic downturn in the next year or two, advisors and allocators should seriously consider an increase in exposure to the space. No investment is guaranteed to make money—in fact, since 2000 equities have underperformed cash in nearly one third of rolling five-year periods. That said, managed futures are one of the few strategies that can perform strongly during the worst market conditions—something institutional investors call “crisis alpha.” Like any strategy, it is important to select the most efficient way to access the strategy over the long term, and we and other asset managers hope to provide attractive investment solutions in coming years that enable investors to benefit from the asset class with minimal single manager risk in a fee efficient structure.
Andrew Beer serves as the managing member at Dynamic Beta Investments LLC and is co-portfolio manager of the firm's investment strategies.