Managed Futures: The Latest Trend in Liquid Alternatives

The second day of the 2012 Morningstar Investment Conference opened with a discussion of managed futures, one of the fastest-growing areas of the liquid alternatives space. Just five years ago, managed-futures strategies were accessible only to institutions and wealthy individuals in separate accounts or hedge funds. However, in 2007 Rydex|SGI, which was recently acquired by Guggenheim, launched the first managed-futures mutual fund, and now there are over 30 funds running these systematic trading strategies.

Panelists for the session included Ryan Harder, portfolio manager at Guggenheim; Brian Hurst, a principal of AQR Capital Management; and Matthew Osborne, co-founder and managing director at Altegris Advisors. These portfolio managers represent the three largest managed-futures mutual funds, with more than 50% of the category's $9 billion assets. Morningstar's director of alternative research, Nadia Papagiannis, moderated the panel.

Three Flavors of Managed Futures
As the managed-futures space has evolved, three basic types of funds have emerged: index-tracking products, active single managers, and funds of commodity trading advisors, or CTAs. All three approaches were represented on the panel. Harder has managed the Guggenheim Managed Futures Strategy RYMTX, which uses a similar methodology as the S&P Diversified Trends Indicator Index, since early 2008. Hurst runs the AQR Managed Futures AQMIX, an actively managed strategy that identifies upward and downward price trends in different futures asset classes. Last but not least, Osborne oversees the Altegris Managed Futures Strategy MFTAX, a fund of CTAs.

As Harder explained, there are "lots of different approaches and choice is really crucial here." Comfort levels with managed-futures strategies will vary from investor to investor. Some require a fully transparent investment process, such as Guggenheim's, to invest. Others are willing to sacrifice some transparency for the potential of enhanced returns in a multimanager structure (not to mention fork over significantly higher fees--funds of CTAs pass through the incentive fees of the portfolio's underlying managers, which can exceed 20%.)

Although an allocation to managed futures can add value, not all investors will be comfortable with this strategy, in any of the three formats, as it is still relatively new to the mutual fund space. As Hurst pointed out, for those investors, the best size allocation is 0%.

Theory Behind the Strategy
AQR has an academic bent and has done extensive research on trend-following strategies. Hurst laid out the science of market trends, explaining that they occur primarily because of investor behavioral biases and the presence of market participants that are not profit seeking (hedgers, for example). Psychological impulses such as herding, crowding, and performance-chasing all drive investors to jump on trends at the wrong times. This behavior overextends the trend until the market realizes it has overshot, at which point it will abruptly collapse.

Managed-futures strategies seek to profit from these market trends. To build a more diversified portfolio, these managers can invest in trends across various futures contracts (equities, commodities, currencies, and interest rates) and time frames (short term, intermediate, and longer term). Quantitative technical models are used to time exit and entry points.

Although the longer-term track record for managed futures is strong, their debut in mutual fund form has been disappointing. In fact, the strategy experienced its worst year ever in 2011: Because of several sharp equity-market reversals, the Morningstar managed-futures category sank 6.9% on average.