By Josh Vail, National Investment Specialist
Preface by Brian Cunningham, CFA, President & Chief Investment Officer
June 2013
Preface by Brian Cunningham
value. By comparison, the initial margin required for an
investor purchasing an S&P 500 exchange traded fund (ETF)
such as the SPDR S&P 500 Trust, (SPY), is 50% of the current
security value. In addition, the investor buying the ETF must
pay interest on the amount borrowed, in this case also 50%.
The end result is that participants in the futures markets have
significantly higher amounts of cash in excess of the initial
and ongoing margin requirements.
Although investors have been disappointed with managed
futures strategies since the last bear market ended, the
drawdown over the last two years has been even more
troubling as well as somewhat perplexing. By late 2012,
the Dow Jones/Credit Suisse Managed Futures Index had
declined over 12% from its prior peak. Although there have
been a number of opportunities for various managed futures
This leads us to another reason why managed futures
strategies, the drawdown that began in May 2011 has yet
strategies have struggled. A significant result of the financial
to get back to even. During the same period, the domestic
crisis in 2008 was the massive negative affect it had on the
equity markets experienced significant positive returns with
economy. Asset prices declined rapidly and consumers
the S&P 500 gaining over 22%. Two years is a long period for
suddenly found themselves much
investors to wait for any strategy or
poorer than they were just a short
manager, and as we discuss in this
period before. The combination of
article many advisors are debating
declining asset prices and slower
whether managed futures even
CTA Index
economic growth prompted the
belong in their portfolios.
Annualized compound
Federal Reserve to reduce short
However, as with any investment
term interest rates in an attempt
strategy, it is important to Average monthly
to revive the struggling economy.
understand all potential sources of Annualized volatility
What has become known as ZIRP or
return and risk. With that in mind, Maximum drawdown
zero interest rate policy decimated
it is worthwhile to briefly discuss a Risk-adjusted returns
the return that investors could
source of managed futures returns Source: BarclayHedge, Newedge Alternative Investment Solutions
get from money markets and
that for whatever reason, is rarely
other short-term fixed income
mentioned. To do so requires a bit
investments. Managers of futures
of background information and context, which we will provide
strategies were accustomed to getting a good portion of their
before discussing the source of return that is oft overlooked.
return from the excess margin that was often kept in money
Futures contracts do not represent direct ownership in
markets, U.S. Treasury Bills, commercial paper, or other low
anything per se and therefore are not considered an asset
risk short-term securities. Furthermore, a good portion of
or asset class. Rather they represent a standardized contract
investments made with excess margin were kept in highly
between two parties to buy or sell an asset at a price today
liquid securities in case the manager had to post additional
with delivery and payment occurring in the future. As a
margin if a position moved against them resulting in mark to
result, the term “margin” has a different meaning for futures
market losses.
contracts then it does for a typical financial asset or security.
The question is exactly how much has ZIRP cost managed
When one puts up margin for a security, they are in essence
futures strategies. A recent analysis performed by Newedge1
borrowing money from a broker for a portion of the value of
focused specifically on the role of cash in managed futures
the security. When talking about margin for futures contracts,
investments and produced some very interesting results.
the term refers to a “good faith” deposit. It is from this good
Newedge analyzed data starting in January 1990 through
faith deposit that any losses are deducted on a day to day
December 2012. They assumed that 20% of a manager’s cash
would be posted as collateral and 80% would be invested at
Discussion of margin is relevant as the amount of money
the risk-free rate. This allowed them to approximate the excess
required to trade futures contracts is substantially less than
net of fees return that was earned above the return earned
the margin required to trade a security. For example, the
from the cash over and above the 20% collateral requirement.
current initial margin required from a speculator to trade S&P
They concluded that over the 23 year period studied, the
500 contracts is less than 5% of the notional, or total contract
“Well, it’s much better than it looks”, Newedge AlternativeEdge Snapshot, January 23, 2013
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3 Reasons
excess return (CTA Index return less the risk-free rate) was
3.08% per year with volatility of 9.14% and a maximum
drawdown of 15.54%. The total return including interest
income on excess cash was 6.02% with annualized volatility
of 9.16% and a maximum drawdown of 10.30%, so clearly
interest income has been a material contributor to total
return. It’s important to note that these figures are averages
over 23 years and there have certainly been years where
managed futures strategies produced good returns in spite
of low interest rates. For example, the Dow Jones/Credit
Suisse Managed Futures Index was up over 12% in 2010.
Nevertheless, earning little to nothing on excess margin
has resulted in a powerful headwind for managed futures
As with any investment or strategy, there are always
opportunities and exceptions to the rule. This is why it is
so important for investors to cast a broad net and look
for managers that have been very consistent over a long
period of time, as well as over various market environments.
Finally, as contrarian investors, we believe strongly that
prices, performance, managers, and strategies all tend to
mean revert. Therefore, recent struggles in managed futures
strategies may provide a great opportunity to “buy low” and
produce outsized returns going forward. We do know that no
investment moves in the same direction forever and recent
enthusiasm for equity markets that have doubled or more
over the past few years is one indication that the tide may
soon turn.
361 Capital believes strongly in the advantages of exposure to
managed futures strategies. Managed futures strategies have
played an important role in portfolios for many years, and after
the dust settled on March 9, 2009, the benefit of managed
futures in a portfolio during the 2008 crisis was undeniable.
For example, from September 2008 through March 2009 the
HFRX Systematic Diversified CTA Index (a benchmark for
managed futures strategies) was up 14.14% while the S&P
500 was down -36.71%. In response to such dramatic returns,
many advisors re-evaluated their asset allocation mixes and
determined that the correlation and performance benefits
from allocating to the managed futures category was worth
serious consideration. Many took it a step further and actually
implemented the strategy. To put this into perspective, $232
million flowed into managed futures in 2007; this space grew
to approximately $7.5 billion between 2008 and 2011. There
was only one problem…THEY WERE NOT PERFORMING! At
least not from 2009 through 2012. Since then, advisors and
clients have grown tired of waiting for the performance of
2008 to return. Which is understandable because the average
performance of managed futures strategies were down an
average of -3.23%, according to the HFRX Diversified CTA
Index. This number only gets worse if you examine the small
universe of managed futures mutual funds that were available
over the same period.
Reason #1 – Trend Following
Lackluster performance is only one of the problems. The other
is that the investment strategy of managed futures funds is
often complex, quantitative, and somewhat opaque. Clients
and advisors have difficulty wrapping their heads around
the why behind the performance. After all, if something is
behaving the way it should, most advisors are sophisticated
enough to diagnose the intent, goal, and outcome of a
strategy regardless of the results. Because there has been so
much mystery surrounding the cause of this strategy’s recent
struggle, this paper will explore:
“The trend is your friend”…unless of course your friend is
nowhere to be seen when they are needed the most. If a
friend does this too often, they quickly cease being a friend.
This not so pleasant quality seems to be ever so present when
discussing our ex-friend…the elusive trend.
Trend following is the most common trading system
employed by managed futures funds. In general, a trend
following system aims to invest in the direction of the longterm trend of commodities, interest rates, exchange rates,
or equities. Trends, also known as momentum strategies,
are identified using a price-based system such as a moving
average crossover. If a market’s trend is up (market’s price is
above its moving average) then a trend following system will
be long that market. Conversely, if the trend is down (price
is below its moving average) the trend following system
will be short that market. Systematic trading models such
as trend following are reactionary systems, meaning they
do not make explicit forecasts about future prices and they
do not try to call market tops and bottoms. Instead, these
models are designed to react to recent price movements.
For example, when trading the S&P 500 using a 30-day/120day moving average price crossover, the rules are as follows:
(1) determine the 120-day moving average of the S&P 500’s
prices, (2) determine the 30-day moving average, (3) if the
30-day moving average becomes greater than the 120-day
moving average, this simple model would suggest the market
is trending upward thereby suggesting a long trade, and vice
versa. Figure 1 graphically shows this example.
Figure 1: S&P 500 30 Day and 120 Day Average Price
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The example on the previous page may be elementary, but it
does provide a good context to discuss the reasons managed
futures strategies, in general, have struggled over the recent
years. Trend strategies often produce positive returns
during times of sustained trends, such as the 2008 - 2009
timeframe. However, as shown by the graph, the identified
trends following 2008 - 2009 were much shorter, potentially
causing trend following strategies to be on the wrong side of
the trade. This is most evident in 2010. Recalling that the S&P
500 was up in 2010, having gained 15.08% for the year, the
inability of the model to identify the correct trend resulted in
the example trend following strategy to be down -8.6% that
year. The trend performance proved to be elusive and the
strategy worked against the investor.
Interestingly, though struggling in 2010, this simple strategy
garnered a great 2009 performance (up more than 24%) and
a solid 2011 performance (gaining more than 11%). These
results are intriguing because many trend following strategies
struggled in those years. For instance, the HFRX Diversified
CTA Index had the following returns for 2009, 2010, and
2011, respectively: -9.04%, +6.02%, and -1.79%. So what
happened? The answer lies in the very name of the index
cited – diversified.
Reason #2 – Over-Diversification
In addition to deploying trend following strategies, the vast
majority of managed futures funds are multi-manager in
nature. On the surface, this approach would seemingly
allow investors the benefit of diversification; however,
diversification does not always drive returns. We have all
been told that diversification is the “holy grail” of effective
portfolio management and, which in turn, is the very reason
to even consider managed futures in the first place. To be
clear, the intent of this section is not to denounce the idea
of diversification, but rather to identify one of the top three
reasons managed futures funds have struggled as a category
since the financial crisis. Diversification is one of those reasons.
For this explanation we again use the simple trend following
model based off the moving average crossover of the 30-day
and 120-day moving averages. Rather than being constrained
to one futures market, the following illustration examines
three types of futures strategies and eight sub-strategies,
o S&P 500
o Yen V. Dollar
o Gold
o Russell 2000
o Euro V. Dollar
o Oil
o NASDAQ 100
o Corn
Acknowledging these selections are riddled with hindsight
bias, the purpose is not to advocate a portfolio, but rather
simply to explore the lackluster performance of a strategy.
The sub-strategies were chosen because they represent some
of the most heavily traded futures markets.
By examining the table below, one can see that “lack of a trend”
is not the whole story. In fact, there are many times where the
simple model performed well across multiple markets.
However, by equally allocating between each futures market
and applying the same trend strategy, the annualized return
from the beginning of 2010 through 2012 would be a meager
-1.75% compared to an annualized 8.55% of the S&P 500.
Upon reflection, this makes perfect sense. Managers who
employ trend following strategies understand the difficulty of
knowing which markets will stay with a trend for a meaningful
amount of time. Managers are forced to diversify and in
periods of great stress, like the 2008 financial crisis, it works in
their favor. When the majority of the market moves together
it results in the majority of market trends aligning. Markets
have normalized since the 2008 crisis, resulting in lower
correlations between different assets. As a result, managers’
bad performing strategies have cannibalized their good ones.
Therefore, over-diversification, in fact, did work against this
The chart above displays the simple trend following model based off the moving average crossover of the 30-day and 120-day moving averages.
Past performance is no guarantee of future results.
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3 Reasons
Though lagging the S&P 500 and negative, the annualized
return of -1.75% by this simple trend following strategy
would have outperformed most managed futures strategies
available.* Given that many of the managed futures strategies
theoretically have superior investment methodologies, what
was the main cause for the mutual fund universe lagging?
The answer is easy – the simple model was calculated gross
of fees.
Reason #3 – Fees/Structure
The average net expense ratio of mutual funds in the
managed futures space is 2.61%*. This fee seems high relative
to most long only mutual funds, but certainly not outrageous
compared to other complex alternative strategy structures.
But there is more to this story…structure. Because many
funds use commodity futures, mutual fund companies must
become creative with the structure of their funds. Commodity
futures cannot be traded inside a ‘40 Act mutual fund without
causing “bad income.” Because dissecting U.S. tax law is not
the point of this paper, we will move on with the knowledge
that a mutual fund cannot trade commodity futures because
of tax reasons. Clearly, many managed futures funds provide
access to these markets, so how do they do it?
The answer lies 432 miles south of Miami in the Cayman
Islands. Mutual funds can buy into Cayman legal structures
(known as Cayman Blockers), and those entities in turn
trade commodity futures. There is nothing inherently wrong
about this structure – it is perfectly legal and ethical. There is,
however, something less than transparent about how the fees
are paid and disclosed. The Cayman entities in which the fund
invests hire Commodity Trading Advisors (CTA’s or futures
managers) to implement various strategies. Those CTA’s
charge a fee and the Cayman entity pays this fee which can
typically resemble a CTA management fee of 1.5% - 2% plus
participation in investment performance (i.e. 20% of profits).
Assuming the CTAs do perform, the fee can easily be 3-4%
in addition to the stated mutual fund expense ratio. Using
mutual fund industry expense ratio averages of 2.61%, it is
reasonable to assume a 5-6% annual fee which clearly reduces
the returns of the already struggling sample model.
Does all this mean that advisors should not allocate to
managed futures funds? Absolutely not. Remember the title
of this paper is Why Most Managed Futures Funds Have
Struggled Since 2008, not Why Managed Futures Funds
are Bad. In fact, multi-manager trend following strategies
will likely have periods of strong performance in the future
unlike the time period examined by this paper. As stated at
the outset of this paper, 361 Capital believes strongly in the
advantages of exposure to managed futures strategies. In
general, managed futures strategies are excellent diversifiers,
as proved during the financial crisis. Quite simply, managed
futures strategies, and more specifically managed futures
mutual funds, have struggled since 2008 because:
1. Systematic trend following models have struggled
due to the directionless market environment
2. Diversification within the funds has watered down
3. Fees being charged, in part through Cayman entities,
have degraded returns
As such, advisors that are concerned that the current
investment environment may persist, but wish to allocate to
managed futures strategies, can take the following approach:
Tip #1 - Find strategies that do not require a longterm trend
The examples regarding trend following were generic in
nature and like anything, the devil is in the details. There are
a number of strategies that offer a wide array of differences
which include everything from short-term trends that tend
to perform well in directionless markets, to counter-trend
models which look to sell short-term overbought levels
and buy short-term oversold levels. Many of these models
have ample ability to provide attractive returns with low
correlations to broad markets and can be more consistent
across various market environments.
Tip #2 – Look to funds that employ a single strategy
Diversification is a proven investment methodology that
clearly has undeniable benefits. With that said, it is possible
that diversification can water down returns. Again, although
most managed futures models utilize a multi-manager
structure, not all do. Looking at single strategies certainly
puts extra importance on the advisor understanding the
model and investment thesis, but this is a necessary step in
avoiding poor performance in directionless environments. On
the other hand, understanding the potential outcomes from
a single strategy is much easier than trying to understand
the numerous potential outcomes from a multi-manager
portfolio. Advisors should not necessarily look for a diversified
managed futures strategy, but rather use a managed futures
strategy to diversify their overall portfolio. Blending the
methodologies of trend following and counter-trend may
also be a consideration.
Tip #3 – Be conscious of fees and structure
Advisors should certainly focus on net performance, but
when performance suffers, the question of fees must be
explored. Unfortunately, a handful of advisors are concerned
about the optics of a fee, rather than the actual cost. In the
case of managed futures funds, the costs and fees paid by and
through a Cayman entity are potentially extremely high, and,
due to current disclosure requirements, have not always been
historically easy to ascertain. In addition, they do not always
show up under the funds’ stated expense ratio. Having a clear
understanding of all fees incurred is integral in understanding
*Based on data from Morningstar
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performance, especially during times of unattractive returns.
While the drawbacks to the managed futures category have
recently been points of confusion and contention, much of
these problems can be traced to the previously mentioned
issues: trend following, over-diversification, and hidden fees/
structuring. When searching for a managed futures fund in
which to invest, advisors would be wise to research these
concerns and seek out a strategy that aligns with their overall
About the Authors
Brian Cunningham is President, CIO, and an owner of 361
Capital. He is responsible for managing the investment group,
including oversight of macro-economic research, portfolio
construction and portfolio management.
He has over 28 years of experience in investment management
and has personally provided investment advisory services
to numerous institutions and high-net-worth individuals. In
1996, Mr. Cunningham co-founded a regional investment
advisor, where he served on the Board of Managers and acted
as Chief Investment Strategist. In addition to his experience
evaluating hedge funds, Mr. Cunningham also has direct
hedge fund expertise, which he developed while serving
as managing member for a quantitative market neutral
management company.
Mr. Cunningham has earned the designations Chartered
Financial Analyst (CFA) and Certified Investment Management
Consultant (CIMC). He is a member of the Association of
Investment Management and Research, and the Denver
Society of Security Analysts. In addition, he was a charter
member and served on the Board of the Institute for
Investment Management Consultants (IIMC). Mr. Cunningham
has served on numerous boards in the community including
The Eleanor Roosevelt Institute and the Caring for Colorado
Foundation where he also served as interim President. He
earned his degree in Business Administration from Colorado
State University and currently serves on the Finance Advisory
Board for the College of Business.
Josh Vail serves as National Investment Specialist at 361
Capital. He is responsible for investment marketing and
distribution management.
Mr. Vail joined 361 Capital in late 2010 prior to the launch of
the firm’s first mutual fund. He brings more than 10 years of
experience working with alternative investments and product
development. Throughout his career, Mr. Vail has worked in
this capacity with numerous investment structures, including:
Private Offerings, Non-Traded REITs, Hedge Funds, and
Mutual Funds, as well as various alternative asset classes and
strategies, including: Private Real Estate Equity, Collateralized
Debt Obligations, Mezzanine Financing, Long/Short Equity,
Equity Market Neutral, and Managed Futures.
Prior to joining 361 Capital, Mr. Vail was the Director of
Capital Markets and Regional Vice President for Welton Street
Investments and focused on alternative product development
and distribution.
Mr. Vail graduated from the Colorado State University with
a Bachelor of Science degree in Finance and Real Estate. He
currently holds FINRA Series 7, 24, and 63 registrations.
About 361 Capital
361 Capital is an investment firm that manages liquid
alternative investment strategies consisting of managed
futures, long-short equity, and multi-alternative in various
structures including mutual funds, Separately Managed
Accounts (SMAs), and limited partnerships.
For more information about managed futures and other
alternative strategies, including strategies 361 Capital manages,
please visit our website at www.361capital.com.
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3 Reasons
The views expressed are those of the authors at the time
created. These views are subject to change at any time based
on market and other conditions, and 361 Capital disclaims
any responsibility to update such views. No forecasts can be
guaranteed. These views may not be relied upon as investment
advice or as an indication of trading intent on behalf of any
361 Capital portfolio.
The 361 Capital website is not intended to provide investment
advice. This paper should not be construed as an offer to
sell, a solicitation of an offer to buy, or a recommendation
for any security by 361 Capital or any third-party. You are
solely responsible for determining whether any investment,
investment strategy, security or related transaction is
appropriate for you based on your personal investment
objectives, financial circumstances and risk tolerance. You
should consult your legal or tax professional regarding your
specific situation.
Data and other materials appearing that are provided by
third-parties are believed by 361 Capital to be obtained from
reliable sources, but 361 Capital cannot guarantee and is not
responsible for their accuracy, timeliness, completeness, or
suitability for use.
It is not possible to invest directly in an index. Past
performance does not guarantee future results.
S&P 500® Index is a commonly recognized, market
capitalization weighted index of 500 widely held equity
securities, designed to measure broad U.S. equity performance.
The NASDAQ 100 Index is a modified capitalization-weighted
index of the 100 largest and most active non-financial
domestic and international issues listed on the NASDAQ.
Russell 2000® Index is an index that measures the
performance of the 2,000 smallest companies in the Russell
3000® Index. Russell 3000® Index measures the performance of
the largest 3000 U.S. companies representing approximately
98% of the investable U.S. equity market.
Systematic Diversified CTA Index, calculated by Hedge Fund
Research, Inc., tracks the performance of systematic macro
strategies. Macro strategy managers trade a broad range of
strategies in which the investment process is predicated on
movements in underlying economic variables and the impact
these have on equity, fixed income, hard currency, and
commodity markets. Systematic diversified strategies have
investment processes typically as a function of mathematical,
algorithmic, and technical models, with little or no influence
of individuals over the portfolio positioning.
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