Investors chasing the hot performance of alternative investment strategies instead of thinking about them as diversifiers will likely end up disappointed, says Aston/Lake Parners' Rick Lake.
Nadia Papagiannis: Hello, my name is Nadia Papagiannis. I am the Alternative Investment Strategist here at Morningstar.
And today, I have with me Rick Lake. Rick Lake is the manager of the Aston/Lake Partners LASSO Alternatives Fund. Thanks for being with us today.
Rick Lake: Thanks for inviting me.
Papagiannis: So, we're going to talk about managed futures today, but first we're going to take a step back and talk about how the landscape of alternatives funds have changed. So in the beginning, we had long/short equity managers, and how have alternatives changed since then, since you've been in this industry since the beginning, 13 years ago?
Lake: I sound like Methuselah, but the beginning of alternative mutual funds was 1997 when Congress repealed that old tax reg, that was a bit horse and buggy, and it open the door for mutual funds to use alternative strategies as an integral part of their mandate.
And the first funds back in '97 and '98 we long/short equity funds, some option hedging funds, market mutual funds and one convertible arb mutual fund.
Papagiannis: And so how has that changed in recent years?
Lake: Well, over the years the number of alternative mutual funds has grown and there was a wave of innovation over the past two or three years that brought a wide variety of long/short bond fund strategies into the mutual fund world.
So today we now have long/short global sovereign bond funds, we have long/short credit funds, we have long/short currency funds, and the managers can take advantage of all the trends and events happening in the world long or short. It's interesting one of the long/short global bond fund managers had been short Greece for the past five years, assuming that…
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Papagiannis: Before it even happened?
Lake: Before it even happened. Their analysis showed things were brewing and their analysis paid off.
Papagiannis: And they were able to take advantage of Greece on the downside?
Lake: On the downside.
Papagiannis: So another strategy that can take advantage of markets that are turning upwards or downwards is managed futures. Rick, can you basically explain what managed futures is?
Lake: Sure managed futures managers utilize futures contracts of all type. It could be commodity futures contracts, covering things like agricultural commodities or metals such as gold, or they could be using financial futures contracts, which cover currencies, stock markets or bond markets, and they can use those futures contracts to bet that any given market is going up or down.
Papagiannis: And this managed futures funds tend to fall into two types of camps in terms of their strategy?
Lake: Yeah, historically there has been two types of managed futures funds. Group A are the discretionary managers, who make informed judgments about which markets are going up and down. And then Group B are the systematic traders, who use quantitative models, quantitative systems to determine, which futures contracts they should be on, long or short and how to optimize mathematically that mix.
Papagiannis: And the systematic traders, they tend to trade trends, price trends in futures?
Lake: Yeah, they tend to be trend-following strategies, though identify trends in each of the futures markets and then make a decision to be long or short, and those trends could be short term in nature. They could be intermediate term in nature or long term in nature.
Papagiannis: So, can we talk about how our managed futures strategy could benefit an individual investor?
Lake: Sure, managed futures strategies tend to move independently of traditional strategies, so stock markets might be going in one direction. Fixed income investors might be enjoying another type of return, and the managed futures strategies are marching to their own drummer, providing returns, hopefully independent of the traditional markets. So they can be great diversifiers for a portfolio.
Papagiannis: And how has that played out in the recent bear market?
Lake: Well, in recent years, for example, in 2008, in the bear market of 2008, managed futures funds had a very profitable year. They are able to capture the power of those downtrends and turned them into profits. In 2009, commodities and futures markets became choppy. Trends weren't clear and…
Papagiannis: And they kind of moved in a range…?
Lake: They would move in a channel or they would go in a trading range or they would move in one direction and then the other.
Papagiannis: As opposed to straight up or straight down.
Lake: As opposed to straight up for a long period of time or straight down for a long period of time which is a great pattern for trend followers to make off of. But in a choppy trend-less or channel-type trading environment, it becomes more challenging for many managed futures managers to make money and some of them have showed negative returns or choppy sideways results, while other markets have rallied.
Papagiannis: But over the, let's say over the two-year period, 2008 and 2009, have there been some managers that because they didn't lose so much in 2008 and even made money, even though they didn't make any money in 2009, are still better off than being …?
Lake: Exactly. If you had a manager that made a lot of money in 2008 and held their own in 2009, while other markets rallied that would be a great diversifier for a traditional portfolio.
Investors needs to be aware that managed futures performance is very different than the rest of the markets. And one of the pitfalls is investors using the rear view mirror could say, gosh, these funds were up in 2008, I'm going to invest in 2009. So they miss the upside in 2008, invest during a very choppy period and find themselves frustrated.
Papagiannis: Whole performance chasing problem?
Lake: Performance chasing exists across all asset classes and all strategies and investors will have to educate themselves once again, how to use the strategy correctly.
Papagiannis: So this is not a performance-chasing strategy. This is more a core part of your diversification strategy.
Lake: It's a diversification strategy as opposed to a performance-chasing strategy.
Papagiannis: Thanks, Rick. Thanks for joining us.
Lake: Great to be here.
