FYI: Copy & Paste 7/26/14: Lawrence C. Strauss; Barron's
Tiny gain in first half follows
years of annual losses for hedge funds and mutual funds in this sector.
Regards,
Ted
Many hedge funds specializing in managed futures have struggled with poor performance, to put it mildly.
After shining during the financial meltdown of 2008 -- the HFR index tracking these funds returned an impressive 18.06%, versus a 37% loss for the Standard & Poor's 500 that year -- these funds have fallen on hard times. On average, they lost 3.54% in 2011, followed by negative performances of 2.51% and 0.87% in 2012 and 2013, respectively.
As a result of this persistent underperformance, net outflows surged to nearly $6 billion in the first half of 2014, according to HFR. "Financial advisors are having a hard time persuading their clients to stay with it," says the manager of a large fund of funds.
MANAGED-FUTURES FUNDS' ASSETS total about $230 billion, or roughly 8% of the $2.8 trillion invested in hedge funds, according to HFR. The good news is that there are small signs of an improving environment for these funds, which tend to be helped by more volatility and a macro environment in which there's a lot of divergence among asset prices. The unwinding of the Federal Reserve's quantitative-easing program should help. In the first half, the average return for managed-futures funds was 0.37%. That's not great, but it's better than it has been in the recent past.
These funds rely heavily on futures contracts, usually to make calls on the direction of stocks, bonds, currencies, or commodities. Often with the help of computer algorithms, managers try to identify trends -- whether it's rising interest rates or declining gold prices. AQR Funds describes it in a recent shareholder letter as going long markets whose prices are rising and shorting those with falling prices.
For managers who can correctly identify trends ahead of the pack, so much the better when it comes to performance. Especially good scenarios are when markets are going from good to very good or from bad to worse, as was the case in 2008. Later that year, stocks and commodities tanked, while gold and Treasuries rallied. All of which led to a stellar performance that these funds haven't come close to repeating.
One of the trend-following strategy's selling points is that it's a good way to diversify a portfolio, thanks in part to low correlations to traditional assets like stocks and bonds. But with equities doing so well in recent
years, many of these funds have been passed by. However, Pat Welton, co-founder of Welton Investment, which runs managed-futures strategies, points out that many of these managers don't take large positions in equities because "it's exactly what you've been hired to diversify away from." In addition, when markets flatten out -- as has been the case with interest rates, for example -- it's harder for managers to find trends and exploit them.
Yao Hua Ooi, a portfolio manager of the $6.2 billion AQR Managed Futures Strategy fund (ticker: AQMNX), points to "how far you look back to determine whether a market is trending up or down" as a key factor. In the past few
years, managers who use longer time horizons -- say at least a year -- have fared better than those who use a shorter window, typically one to three months, he observes. The AQR fund's managers blend shorter and longer time horizons to gauge trends, he adds.
As if to illustrate how challenged performance has been for these funds, AQR Managed Futures Strategy has a three-year annual return of 1.2%, placing it near the top of its Morningstar category. It's a mutual fund, not a hedge fund, with an expense ratio of 1.50% -- pricey for a mutual fund but considerably cheaper than a typical hedge fund.
Welton attributes these funds' performance difficulties to the flood of liquidity by central banks around the world, more or less in unison for many
years. Low interest rates have been accompanied by lower spreads, making it hard to find good trends to follow, he adds.
AN 18.73% RETURN in 2010 for the Welton Global Directional Portfolio was followed by three straight
years of negative results, triggering outflows. In this year's first half, however, the fund was up 17.41%, having made money in equities, commodities, interest rates, and currencies. The portfolio also had success with so-called relative value strategies, an example of which would be going short one basket of stocks, while being long another.
Several firms have studied the dismal performance of managed futures. Ooi, of AQR, contributed to a paper on that topic. With the help of financial simulations -- these funds weren't around in, say, the 1920s -- the paper concluded that "trend-following has delivered strong positive returns and realized a low correlation to traditional asset classes each decade for more than a century." Adds Ooi: "Just like any investment strategy, it has had underperformance, but that isn't predictive that the strategy will no longer generate returns going forward."
Most of managed-futures funds, however, are in crying need of a sustained stretch of good performance -- and sooner rather than later.
M* Snapshot Of Managed Futures Fund Returns:
http://news.morningstar.com/fund-category-returns/managed-futures/$FOCA$13.aspx
