More than five years after the financial crisis, many money managers are still wondering how they might have averted portfolio calamities they experienced in 2008 and early 2009.
Was there a way to have shorted equities as volatility rose, for instance, going long on Treasuries and gold? And, perhaps more important: Were there signals suggesting that the time was right for these actions?
Managed futures are designed to have little correlation with other asset classes, hoping to provide a zig to the broader equity market's zag. In 2008, the Altegris 40 index, which tracks 40 programs using a managed futures strategy, rose 15%, while the S&P shed 38%.
"Most investment strategies are long biased," says Brian Hurst, a principal and one of the managers of the $4.6 billion AQR Managed Futures Strategy fund. "But in our fund, we are equally likely to go short as we are to go long."
In the aftermath of the financial crisis, money managers were clamoring - albeit belatedly -for alternatives to the standard portfolio staples of stocks, bonds and cash. The managed futures fund category has grown from $814 million in August 2008, when there was only one such fund, to $10 billion and 52 funds as of the end of July, according to Morningstar.
As stocks have rebounded, there's been less attention on alternatives, but during periodic market routs, they can prove their mettle for jittery investors.
Managed futures are supposed to tamp down volatility during falling markets. But it doesn't always work that way. High fees and poor performance have put the brakes on the enthusiasm, but AQR, short for Applied Quantitative Research, has been a standout on both fronts. Launching in 2010, the Greenwich, Conn., firm rolled out three alternative funds that are targeted at advisors and based on the hedge fund strategies it was already using for institutional accounts.
In a category where the typical fund charges an astounding 2.97% expense ratio, the AQR Managed Futures Strategies fund levies just 1.5% (and just 1.25% in the institutional share class, which has a $5 million minimum).
Running a managed futures fund, Hurst says, comes down to extensive data analysis and trend spotting. "We go long on things that have gone up and short things that have gone down, then bet that those trends will continue," he explains.
AQR Managed Futures' four managers try to identify which trends are prominent and how much risk it would entail to pursue them. They buy futures contracts in one of four asset classes: equities, fixed income, currencies and commodities. They are active in 120 markets worldwide, creating a portfolio with global and asset diversification. Position sizes vary by the strength of the trend; strong trends that are expected to persist command bigger positions.
"We think trend following works in every single market," Hurst says.
Commodities proved a bit trickier; that asset class had a number of sharp and frequent trend reversals last year. Despite losses there, the fund returned 2.7% for full-year 2012, in the category's top 7%. Even so, Hurst says, the fund can do better. In addition to following trends, AQR uses signals to help it spot those that have become overextended. "That tells us where the trend might have gone on too long or moved too quickly," Hurst says.
Hurst doesn't discriminate against any of the asset classes, even though at any given time he expects one or another to outperform. He says that many asset classes can be similarly risky - and offer similar returns - over the long run, "but it varies a lot through time," he notes. Over five to 10 years, equities (via both long and short positions) should produce the same amount of risk and the same return as, say, commodities or currencies, he argues.
The fund has about 120 positions. "And not one of them dominates," Hurst insists. In the first quarter, the managers were long on Japanese and U.S. equities. That paid off well as those markets rallied. In the second quarter, AQR Managed Futures shorted gold and other commodities like copper and some agriculture. And a short of the Australian dollar vs. the New Zealand dollar helped that quarter's performance, as slumping commodity prices and worries over a weaker economy in China weakened the Australian dollar.
Not all the fund's calls proved right. A short of the euro earlier in the year failed when eurozone countries moved away from austerity measures toward more stimulus spending, leading the currency to rally. And a position in Canadian stocks didn't do well when the market there fell because of declining commodity prices. But at the same time, the fund successfully followed overextended signals to short fixed-income bets. The best climate for the managed futures fund is "a market that is generally rising, but choppy along the way," Hurst says. "If you're more focused on the short term, you would lose, but if you're focused on the long term, you can take advantage of that trend."
To be sure, managed futures funds aren't for every advisor or client. But for those who cannot stomach severe losses, a well-managed fund with relatively low expenses is an option worth investigating. And even then, a managed futures fund should just be a small slice of an overall portfolio, helping to smooth out returns when markets turn dicey. MME
Ilana Polyak, a Money Management Executive contributing writer in Northampton, Mass., has also written for The New York Times, Money and Kiplinger's.