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Managed-Futures Funds: A Mess

Bad timing, a limited investment strategy, and high costs.

John Rekenthaler, 11/01/2013

Three Strikes
Managed-futures funds have done it all wrong. 

Fortunately, such funds don't have many assets, but what monies they do possess have come in the past five years. As is so often the case, investors extrapolated from a sample size of one: Managed-futures funds profited in 2008; nothing else save for long Treasuries made money that year; thus, managed-futures funds were good to own.

You know how that story played out. Stocks rebounded such that every U.S. stock-fund category has more than doubled in value over the trailing five years (through Oct. 31, 2013). Every bond-fund category has also profited nicely, with staid intermediate-bond funds up about 60% in aggregate and the aggressive bond categories of high yield, emerging markets, and general corporate bond (which often owns a number of lower-quality credits) faring even better. Managed-futures funds? Down for the period.

Part of the problem for the investment category has been the lack of a stock bear market: These funds look their best when other assets are struggling. Another part has been the behavior of commodity prices. Most managed-futures funds use trend-following strategies that have them hopping aboard rising commodities and then getting out when the price starts to decline. That tactic worked spectacularly well in 2008, when commodities rose en masse in the first half of the year, and then fell in the second half. Since then, though, commodities have bounced to and fro, leaving managed-futures funds chasing their tails.

So far, one could blame the category's results on bad fortune. That would be generous, as managed-futures funds were marketed heavily after the bear market, not before. Also, if managed-futures funds depend so heavily on the single tactic of trend-following, that calls into question the robustness of their investment approach. The third strike, however, settles the matter. The category has extremely high costs.

In a recent article, Fleeced by Fees: How Investors Lose 89% of Gains from Futures Funds, Bloomberg showed just how high those costs can be. For the decade ended 2012, a managed-futures limited partnership (that is, hedge fund) named Morgan Stanley Smith Barney Technical LP made $490 million in pre-expense gains for its investors, from a combination of trading profits and money market income. The fund's all-in expenses were $499 million. Thus, those who created, packaged, managed, and sold the limited partnership took in just under $500 million for the decade, while those who owned the fund lost $8 million.

In all, the author, David Evans, gathered the data for 63 managed-futures hedge funds and found that of the $11.5 billion in aggregate gross profits generated by those funds over the previous decade, $10.3 billion--the 89% of the article's headline--went to those who made and sold the funds, with only $1.2 billion left for the fund's owners.*

*As the article did not mention, but probably should have, these figures are affected by the pattern of the time period. They held relatively few assets early in the period, when the funds did indeed give their investors profits after expense, and were relatively large later on, when the funds continued to charge their annual expenses but did not generate profits because of a weaker performance environment. As written earlier, the category has been unlucky as well as undeserving.

is vice president of research for Morningstar.

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