What are managed futures?

One of the most difficult tasks in building a portfolio is finding asset classes that do not move in lockstep with stocks or bonds. Non-correlation—the tendency of an asset class to move independently of others—lowers a portfolios volatility, but it’s elusive.

Perhaps the most promising candidate is commodities: according to Larry Swedroe’s The Only Guide to Alternative Investments You’ll Ever Need, from 1973 through 2007 the S&P GCSI Commodities Index actually had negative correlation with U.S. stocks, international stocks, and U.S. Treasuries. That means they tended to zig when other asset classes zagged. Yet in 2008, commodities plunged along with all other risky assets.

However, a related asset class thrived during that crisis: managed futures. This term refers to strategies that trade commodity futures in an attempt to deliver positive returns in both up and down markets. (Many also include trading futures in currencies and interest rates.) Traditional commodity ETFs such as the iShares S&P GSCI Commodity-Indexed Trust (GSG) simply hold long positions in various crops, metals and energy products, and if commodity prices fall, so does the value of the fund. Managed futures strategies, on the other hand, attempt to follow price trends, and they can take both long and short positions. If they get the timing right, they can deliver positive returns even when prices fall. That’s just what they did in the bloodbath of 2008: the Credit Suisse/Tremont Managed Futures Index returned about 18%.

Managed futures strategies, which have been around for some 30 years, are carried out by professionals called Commodity Trading Advisors (CTAs). The strategies are popular with hedge funds and institutional investors around the world, although they are much less widely used in Canada. Their appeal is not only their non-correlation (or even negative correlation) with other parts of the portfolio, but their surprisingly low volatility: as a group, managed futures tend to have lower standard deviation and smaller drawdowns than both stocks and commodities.

Passively managed futures?

Because managed futures strategies require someone to make the trading decisions, they are in no way passive strategies—indeed, it’s a bit misleading to describe them as an asset class, since each individual strategy has its own risk and return characteristics. But this year, two managed futures ETFs have been launched in Canada: the iShares Managed Futures Index Fund (CMF) and the Horizons Auspice Managed Futures Index ETF (HMF). These join the two-year-old iShares Broad Commodity Index Fund (CBR), which uses a managed futures strategy without the short positions: the fund will either take a long position in a given commodity or none at all.

Note that all of these funds include “index” in their name. While they are certainly not traditional Couch Potato products, the ETFs make an attempt to execute a managed futures strategy based on quantitative rules rather than the whims of a fund manager. And unlike hedge funds—which often charge at least 2% plus 20% of returns above their benchmark—they are accessible to retail investors for a management fee of less than 1%.

Does it make sense for you to consider adding managed futures to your index portfolio in order to capture their diversification benefit? In a two-part series this week, I’ll share my recent interview with Tim Pickering, president of Auspice Capital Advisors, which manages both HMF and CBR. He will explain more about how the ETF strategies work and help you decide whether they make sense for you.