Despite returns, advisers bullish on managed futures

The performance of managed futures is languishing, but that hasn't diminished their appeal among financial advisers. Assets in managed futures totaled $184.8 billion Sept. 30, up from $170 billion at the end of 2006 and $130 billion at the end of 2005, according to Barclay Hedge Ltd. of Fairfield, Iowa. The stock market's recent bout of volatility may be helping commodity-trading advisers make money, several industry observers said. Managed futures are investment pools run by commodity-trading advisers who can go both long and short in a variety of futures contracts. Studies have shown that commodity futures are not correlated to financial assets, yet they have similar risk-return characteristics, making them good complements for stock and bond portfolios.
Sure enough, while the stock market has charged higher in the past few years, overall returns in the managed-futures space have been "pretty lackluster," said Sol Waksman, founder of Barclay Hedge, which tracks alternative investments. In 2004 and 2005, Mr. Waksman's index of the largest commodity-trading advisers was basically flat. Last year, the index began making some headway, and through November of this year, it was up about 6.5%. Many CTAs tend to focus on financial futures covering stocks, bonds and currencies. But these strategies have not done well in the past few years, said Walter Davis, director of managed futures at Morgan Stanley in New York. That's because commodity- trading advisers need volatility to make money, and stock market volatility at least — as measured by the CBOE Volatility Index (VIX) — has been falling since 2003 while the market has been running up. Mr. Davis said the better-performing commodity-trading advisers have had greater exposure to commodity markets, have used multiple trading systems and have taken a shorter-term-trend-following approach. "The majority of CTAs are medium- to long-term-trend followers," said Ed Egilinsky, managing director of alternative investments at Rydex Investments of Rockville, Md. Furthermore, because there are position limits on physical-commodity contracts, larger commodity-trading advisers are forced into financial futures. "A lot of CTAs have 60% to 80% of their assets in currencies, fixed income and equity indices," Mr. Davis said. Those areas have not done well in the past few years, observers said. Despite the spotty results, advisers haven't forgotten that allocating some client money to futures during the bear markets of 2000 to 2002 worked well. "A lot [of futures funds] did extremely well while the market was going to hell in handbasket," said an A.G. Edwards rep, who asked not to be identified.

VOLATILITY RETURNS

Volatility returned to the stock market with a vengeance in September and October, with the VIX breaking out of a five-year slide. "We track [with] the VIX. There's a clear correlation," said Paul Wigdor, chief operating officer at Superfund Asset Management Inc. in New York and a commodity-trading adviser. "Our best trading month ever was September 2001," when stock markets fell following 9/11, said Aaron Smith, managing director at Superfund. As the uptrend in global equities weakens, commodity-trading advisers will be able to reduce their concentration in equity indexes and move into "broader areas with long-term secular moves," such as commodities and currencies, said Jerry Pascucci, who runs the managed-futures program at Citi Alternative Investments of New York. "We could be at the beginning of a very robust period" for managed futures, Mr. Pascucci said. "Historically, managed futures have done very well during periods of dislocations and sustained equity weakness," Mr. Davis said. Advisers do have other ways to play commodities, such as exchange traded notes and mutual funds that track commodity indexes. But those products are "long only ... so you only make money when [commodities] go up," Mr. Egilinsky said. Returns from commodity futures from 1959 through 2004 "far exceeded" the returns from spot commodities, according to a study published in 2005 by finance professors Gary Gorton of The Wharton School at the University of Pennsylvania in Philadelphia and K. Geert Rouwenhorst of Yale School of Management at Yale University in New Haven, Conn. The difference was due to interest from Treasury bills that were used as collateral and the average 5%-per-year futures provided above the risk-free rate of return. Rydex this year launched an open-end mutual fund with a new wrinkle. The Rydex Managed Futures Strategy Fund tracks the Standard & Poor's Diversified Trends Indicator, an index split evenly between financial and commodity contracts, with both long and short positions based on price momentum. Rydex hopes the $220 million fund, which comes with a $2,500 minimum investment, will encourage more average investors to consider managed futures. The regulatory environment has affected some of the public managed-futures programs, some of which come with minimums as low as $5,000. Fewer public funds are available than in years past, observers said. Gaining approval from multiple regulators is part of the problem, said Jack Gaine, president of the Managed Funds Association of Washington. In response, the industry is moving to private placements and a more upscale clientele, Mr. Davis said. But Superfund's Mr. Smith said public programs offer more regulatory oversight and transparency. "We want to make [managed futures] available to the mass affluent," Superfund's Mr. Wigdor added. Dan Jamieson can be reached at djamieson@crain.com.