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By Mallory Horejs, CFA | 05-09-2012 10:00 AM

Taking Advantage of Managed Futures

Direxion's Ed Egilinsky discusses why liquid alternatives, particularly managed futures strategies, should be part of a diversified portfolio.

Mallory Horejs: My name is Mallory Horejs, and I am an alternative investments analyst here at Morningstar. Today with me I have Ed Egilinsky, head of alternative strategies at Direxion. Ed, thanks for joining us.

Ed Egilinsky: Thanks for having me, Mallory.

Horejs: So Ed, liquid alternatives is a very rapidly growing space, and overall these new mutual funds and ETFs have provided valuable downside protection for investors after the financial crisis. However, a lot of these young products have really struggled to capture the market's upside. What can investors expect from these liquid alternatives, should the market continue to trend upward during the next few years?

Egilinsky: I think you got to look at it from the standpoint that regardless of the market environment, you should include alternatives as part of the portfolio because of their historically low correlation to stocks and bonds. Certainly with any asset class there are going to be better periods of performance than others. But to have alternatives in the portfolio, I think, as a long-term investment is how people should look at it.

Horejs: And Direxion offers alternative ETFs and mutual funds. So, when investors are trying to incorporate these strategies into their portfolio, what factors should they consider when deciding what products to use?

Egilinsky: We're pretty agnostic when it comes to the structure. Whether it's ETF or mutual fund, the fact is these investments have daily liquidity. For the most part, our alternative mutual funds are structured as such because we feel the daily liquidity is sufficient. Clients don't need to trade those like stocks, like some of our ETFs that have that type of liquidity.

Horejs: Managed futures is one of the fastest-growing areas in this space. Looking at that category, it's expanded rapidly during the past years. There were 13 new funds launched last year; six in the first quarter this year, one of which was your new product, Direxion Indexed Managed Futures. Could you tell us a little bit more about it?

Egilinsky: Sure. The Managed Futures fund is index-based. The Auspice Managed Futures Index is the strategy we're replicating. It's a long/short managed futures index, and we feel it's unique because it behaves like a CTA. It can make changes intramonth as well as the fact it's looking at shorter-term trends. It has a smart roll yield within the index, which means it takes into account contango and backwardation, and it could dial down exposure to an individual component if volatility gets too high.

Horejs: How does that compare with some of the active strategies that we have on our database? Investors are always asking what's a difference between a passive index-tracking strategy and an active. What's the advantage or disadvantage of using a fund like this?

Egilinsky: When it's index-based, you don't have the underlying managers or the fees associated with them. You also have the fact that this is completely transparent an index. You know what's under the hood at all times. So, really with the low cost and complete transparency, it really has the advantages of an index structure relative to that of an active manager.

Horejs: Whether you're using an active manager or a passive strategy, what kind of allocation would be appropriate for an investor?

Egilinsky: I don't think it has to be an either/or scenario. I think you can have an indexed-based managed-futures strategy and complement it with a single manager or a multimanager. In terms of an allocation to alternatives, most investors should look at anywhere from a 10% to 30% allocation in total, and managed futures probably as a core holding to that of at least 10%.

Horejs: Lastly, I'd like to touch on the evolving regulatory landscape. On Feb. 9, the CFTC announced that futures-based mutual funds must register as a CPO by the end of the year. How is  that going to affect the sector? Does that mean anything for your fund?

Egilinsky: Well, in our case we're duly registered already with the CFTC and the SEC. So, it's nonevent for us, but it could prevent mutual fund companies that haven't entered into the alternatives space as of yet to be preventative for them.

Horejs: Ed, thanks so much for joining us today. We appreciate your insight.

Egilinsky: Thanks for having me.

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