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By Terry Tian | 11-28-2012 01:00 PM

Will Trends Reverse for Managed Futures?

AQR's Brian Hurst discusses why trend-following strategies have struggled recently and how his firm is positioning its managed futures portfolios to offer investors a smoother ride.

Terry Tian: Hi. My name is Terry Tian. I am alternatives investment analyst with Morningstar. Today, I have Brian Hurst, portfolio manager of AQR Managed Futures Strategy. Brian, thank you very much for joining me today.

Brian Hurst: Thank you very much.

Tian: Brian, you know a lot of investors are attracted to managed futures because of their spectacular performance in 2008, but since then the strategy has struggled. Could you offer some insights on the performance of trend-following strategies after 2008?

Hurst: Absolutely. So, I think we see this historically through time, strategies have good peer performance--and managed futures certainly had a very great 2008--a lot of people rushed into it expecting that same kind of performance going forward, and they are always invariably disappointed. What’s happened since 2008 has been an unusual environment certainly. It’s been, as people call, the risk-on and risk-off environment.

Effectively, you’ve seen a lot of choppy markets, which are tough for managed futures funds. Managed futures funds are betting on trend following, which means betting that trends will continue to keep going. They have tough periods of time when markets go one direction for a few months then turn around and go the other direction for few months. That choppy environment can cause losses for trend-following strategies. And we've seen that happen in episodes in both 2009 and 2011, and a little bit [in 2012]. So, it’s caused anemic or disappointing results for investors. So, at AQR what we’ve done is, we said, "Let’s look at the long horizon. Is this an unusual period of time? Is this an anomaly? Does this mean that the strategy is no longer working?" I think those are the kind of the questions that we’re getting.

We did a study where we took 110 years of data trading on trend-following strategies a little over the past century, and we can show that decade-by-decade the performance for trend following shows up and there is a reason for that. With trend following we’re taking advantage of investor behavioral biases. And the existence of market participants, they are trading in the markets but are trading not with profit as the goal, but trying to solve some other goal. An example of that would be like a central bank, where they’re trying to guide interest rates, or guide their currency from appreciating. They’re actively trading in the market to keep prices from going to true value. Those enable trends to exist, enable trend followers to buy and sell at prices they shouldn’t otherwise be able to, and that’s really that the premium that we’re taking advantage of.

Then you have things like corporate-hedging programs, when prices move up and producers or airlines or what not, they start losing money, they'll go out there and hedge. Those hedging trades tend to exacerbate the price direction of trends. This again enables trend-following managers to make money. But it's not a perfect strategy just like any. When there are choppy markets, trend-following strategies do lose money and that's happened many times in the past and the last few years are no different.

That said, the main reason we think investors should follow a trend-following strategy or invest in trend-following strategies is the diversification purposes. On average, over a long period of time it has produced good returns because of the differences in the markets that you're trying to take advantage of, but it's provided zero correlation to traditional markets. But behind that zero average correlation, there is positive correlation in up markets and negative correlation in down markets.

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