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A Primer on Managed Futures

Josh Charney, CFA

Josh Charney: Hi, my name is Josh Charney, and I am alternatives analyst here at Morningstar. I'm here at the Morningstar Investment Conference, and joining with me today is Matt Osborne and he a portfolio manager at Altegris. Thank you for joining me today, Matt.

Matt Osborne: Thanks, Josh.

Charney: So managed futures have definitely seen record inflows of $3.6 billion in 2011, and can you just quickly explain to some of our viewers at home what exactly is a managed-futures fund?

Osborne: Sure, Josh. A managed futures investment strategy is primarily a momentum or trend-following-based investment strategy. Professional money managers that trade managed-futures portfolios are typically running very diverse portfolios of global futures contracts and invest in those contracts both long and short across the world's four major asset classes. So the portfolios are typically diverse and include futures contracts that are based on global currencies, commodity markets, global equity indexes, and global fixed-income markets. Primarily a managed-futures fund will have the predominance of its exposure in the financial futures with about 25% or 30% in commodity futures typically.

Charney: We all know that managed futures did terrific in 2008, but since then, the showing has been relatively sloppy in terms of performance figures. Can you kind of explain why we've seen sloppy performance from managed-futures funds?

Osborne: Sure, Josh. First of all I'd like to contextualize the long-term performance in managed futures, which over 20-plus years the index that Altegris runs, Altegris 40 Index, has annualized at about 9% per annum, which is very similar, slightly above actually the S&P 500 with dividends reinvested, but managed futures has achieved that absolutely rate of return with lower standard deviation than a stock market, a standard deviation of about 11% compared with the S&P's 15%. And of course it's also done so with a much lower worst drawdown statistic. Managed futures' worst losing period was about 15% versus the S&P's 50% drawdown of course in 2008 and 2009.

The recent performance over the last three years has indeed been relatively flat. The main reason for that has been the continual risk-on, risk-off environment that we've seen, and as I mentioned, managed-futures managers are typically trend-following in nature. We simply have seen rapid trend reversals during the last two or three years.

Charney: Morningstar did a survey with Barron's in 2011, and it showed that advisors overwhelmingly are very interested in investing in managed futures. Can you kind of explain what you think the motivation is driving this interest?

Osborne: Yes, there's really two main facets to that, Josh. The first is that absolute rate of return that has historically been a good rate of return in managed futures, the last couple of years notwithstanding. But the primary benefit of managed-futures investing is simply the noncorrelation. Managed-futures investing is uncorrelated with the stock market; it really has about a zero long-term correlation. And in the context of a diverse portfolio of asset allocations, managed futures has a provided really great diversification benefit in investor portfolios.

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Charney: And there's definitely more than one approach to investing in managed futures. There's the active approach, and then there's the passive approach. Altegris kind of has this unique approach, which is on the fund-of-funds side. So can you explain how Altegris chooses strategies as well as managers for its managed-futures fund?

Osborne: Sure. Well as you mentioned, Josh, about $3.6 billion have come into managed-futures mutual funds recently, but this is about $300 billion asset class spread across probably 700 professional money managers worldwide. Altegris' approach is a multimanager, multiadvisor mutual fund where we allocate assets to underlying managers from that database or universe, of managers. And what Altegris likes to do is focus on the largest managers with, in our opinion, the very best long-term track records.

Charney: With this fund-of-funds approach, presumably the fees are going to be slightly higher than in the passive approach. So how can investors overcome this hurdle rate?

Osborne: Those historical performance numbers for the managed-futures index that I quoted you, Josh, are net of all fees, and those fees do include management fees and performance-incentive fees. The Altegris view is that the best-quality typically does cost more, like many things in life. So our view is that by allocating the very best managers with proven long-term track records, we give investors the best access to this asset class.

Charney: So what investors would be suitable for managed futures, and what kind of allocation do you recommend for their portfolios?

Osborne: Institutional investors, like pension plans and some endowments, have been allocating to the managed-futures space for several decades now. The opportunity to access managed futures in a mutual fund provides the asset class to a much broader array of investors. Investors should talk carefully with their advisor, and they should understand what it is that they're buying. And if they don't understand, their allocation should be zero. Assuming that they are able to understand what is it they are allocating to with the help of their investment advisor, an allocation of a minimum of 10% to managed futures we believe can provide the adequate diversification benefits, especially in times of crisis like we saw in 2008.

Charney: Well Matt, thank you for answers to my questions and enjoy the rest of the conference.

Osborne: Thanks, Josh