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The Case for Managed Futures

Josh Charney, CFA

Josh Charney: Hi, my name is Josh Charney. I'm an alternatives analyst here at Morningstar.

Joining me today I have Brian Hurst and Yao Hua Ooi from AQR Managed Futures; they are the winners of the Alternatives Fund Manager of the Year award for 2013.

Thank you guys for joining me today.

Brian Hurst: Thanks, Josh.

Yao Hua Ooi: Thanks.

Charney: Brian, for those at home, what exactly are managed futures and what exactly is a managed futures fund?

Hurst: Managed futures is a trend-following strategy. It invests both long and short in global equity, fixed income, commodities, and currency markets around the world. By being able to go long and short based on trends, meaning, go long markets that have been moving up in price, going short in markets that have been falling, it's able to profit in both up and down markets.

Charney: For those listening at home that are thinking of investing in managed futures, what is the case to be made to invest in managed futures funds, like the AQR Fund?

Hurst: What we found historically is that trend funds strategies tend to do pretty well when there is a big equity drawdown. So when you combine it with people's typical portfolios, which will hold 50% or more in equities, that helps smooth the ride out.

Charney: Brian, why does trend following work?

Hurst: What we find is--and what we believe--it's mostly behavioral biases: the fear and greed cycle. People tend to under-react to news and information, allowing managed futures funds to get in trends early on, and then profit when people ultimately overact and do performance-chasing and things like that.

Charney: Yao Hua, these funds did fairly well in 2008. Can you give the people at home [a sense of] why that might have been the case.

Ooi: 2008 was a great environment for trend-following strategies. Trend-following strategies in general tend to do best when things either go from good to great or from bad to worse. And as we all remember, 2008 was definitely a case when the economy and global financial system went from a bad situation to a very severe situation, especially in the last half of the year.

A trend-following strategy was able to profit from the sustained trend by going short in the majority of risky markets, such as commodities and equities, and going long in the safe haven assets that did well that year, like Treasury markets and gold markets.

Charney: So, you are saying there was a bull market in negative trends when the stock market was going down, and that's how managed futures funds were able to profit?

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Ooi: What made 2008 especially a good year for managed futures, was not just the fact that some of these markets trended, but really that across the board, we saw very strong and persistent trends in all four major asset classes that the strategy invests in, and because all four of these asset classes were so profitable, the category as a whole was able to benefit greatly.

Charney: But subsequently, since 2008 the category has definitely taken a shellacking. So why has trend following as a broad asset class not worked as well since the recession?

Ooi: Since 2008 it has been a tougher environment for trend-following strategies. As we all know, markets have been overall more choppy. There have been fewer clear and obvious trends in the last five years.

That being said, there have been certain segments and certain longer-standing trends that have actually done quite well within the marketplace. What we found is that shorter-term trend signals, or shorter-term trend models, have actually gotten hurt more in last few years as markets have shown a lot of whipsawing behavior, but some of the longer-term trend models particularly those in currencies and fixed-income markets have actually paid off quite well since 2008.

Charney: And in 2013, what were some of the trends that really paid off?

Ooi: What we saw in 2013 was being long from the long-standing trends really helped the fund. For example, we saw that in the majority of global developed equity markets, continuous stimulus from central banks led to a continued rally in equity prices, and the fund was positioned long and benefited from that move.

Outside of equities we also saw some very large trends, particularly in gold and silver markets, where they had continued to fall since 2012, and they fell very sharply in 2013 as well. That also proved to be a bright spot for the fund.

And lastly we all know that in Japan, the central bank has been very aggressive in trying to stimulate the economy, leading to a very big rally in Japanese equities, and a sharp drop in the yen. Again, the fund was able to benefit from following the trends in both of these markets.

Charney: So what I'm hearing is that, there are trends everywhere. It's pretty hard, it seems, to predict which trends are going to be the next big win. So, Brian how does AQR capitalize on all of these different trends.

Hurst: Our research historically has shown that trends happen, markets trend on average. But you are right; it's very difficult each year to predict which particular markets are going to trend and over what time horizon. Because of that, we designed the fund with a very diversified approach--diversified across markets, within markets and across trend horizons. In years like 2013, our exposure to these long-term trends really helped to pay-off.

Charney: Each year different trends pay off. So what you are saying is the diversified approach has definitely kept your fund above water and above the category?

Hurst: Absolutely. We believe the diversification, the construction of the fund, has been one of the main drivers for our outperformance versus the industry.

Charney: Yao Hua, how could the folks at home use this in a portfolio? What roles do managed futures play in a stock/bond allocation?

Ooi: We know the majority of investors out there have 50% or more of their portfolios invested in equities typically. That's a lot of dominated equity risk within their portfolios. In years like 2000 or 2008, that can be very difficult when equities are not doing well.

What managed futures allows an investor to do is diversify away some of the risk in those tough years, and provide a return source that can do well in both rising and falling markets. And overall, when put together in a portfolio, it can help an investor have a smoother ride in the markets.

Charney: Congratulations again for winning Alternatives Fund Manager of the Year, and thank you for joining me today.

Hurst: Thank you, Josh.

Ooi: Thank you.