Many investors are familiar with commodities but less familiar with the futures contracts that represent corn, wheat, oil and gold. As we mentioned in a prior post, most commodities are simply not available in physical form to most investors. To obtain exposure to this asset class, they are compelled to buy potentially value eroding commodity futures based funds or ETFs such as the Pimco Real Return Strategy or DBC-the Deutsche Bank Commodity ETF.

Most of the funds in this category are only long commodities without the mandate to short them if they feel that the fundamentals or trend has changed. The investor is in essence stuck in a basket of commodities that may not have legitimate forward looking potential. As we mentioned in our prior piece, a lot has to go well for these type of funds to do well on an absolute or risk adjusted basis. However, if there was a fund structure and mandate that allowed the team to go “long” the areas of the commodity complex they favored and also able to go “short”, it may be worth the time of an investment committee. Let’s take an initial look.

Managed futures at their core attempt to manage the risk inherent in these markets by expanding their mandate to include shorting those markets that they do not favor.

Their goal is to provide an investor with a non-correlated return stream that adds diversification to a portfolio. We have been highly skeptical for years on this asset class and thought we would take another look.

Managed futures as a category were not a great place to be invested generally over the last three years although they are touted as solid diversification tools.  The Credit Suisse Managed Futures Index and its return for the trailing three years was an average annualized -1.99%. That is only one of a few major indexes in this space as funds chose the index they track.

Fund managers attempt to achieve this diversification and potential return through a range of strategies centered on buying and selling futures contracts on a wide range of asset classes. As opposed to futures based long-only commodity funds, most of these products have exposure to commodity, currency and interest rate futures. An investor hopes that the manager is long and short the correct futures in the markets they trade in such as wheat, corn, euro dollars, or Treasury bond futures.

In attempt to achieve consistent returns, many managers will adhere to systematic trading in the short, intermediate or long term. Getting the trend correct regularly is imperative since these funds typically are exposed to a lot of markets. While a long only stock fund can focus on the factors that drive the selection for one asset class, managed futures managers need to have a deep team in order to keep track of all these markets either systematically or through discretionary assessment.

A glimpse into a well know ETF provider (Wisdom Tree) and its managed futures product WDTI may shed some light on a complex product.

“WDTI seeks to achieve positive total returns in rising or falling markets that are not directly correlated to broad market equity or fixed income returns. The Fund is managed using a quantitative, rules-based strategy designed to provide returns that correspond to the performance of the Diversified Trends Indicator™ (“DTI Index” or “Benchmark”).”

“The Fund intends to invest in a combination of U.S. treasury futures, currency futures, non-deliverable currency forwards, commodity futures, commodity swaps, U.S. government and money market securities. The Benchmark is a widely-used indicator designed to capture the economic benefit derived from rising or declining price trends in the markets for commodity, currency and U.S. treasury futures.”

It holds about $143 million in assets and has been around for roughly 2 years and its rules based methodology has as its current weightings;  commodities 41%, 58% financials and cash at about 11%. They are able to rebalance on a monthly basis the DTI index that is comprised of 24 liquid financial or commodity futures contracts.

Since this is a trend following index, it has the potential to do well in up and down markets. In flat or oscillating markets, it can perform poorly. For .96% an investor can have access to this 40 Act fund that requires no K-1 for tax purposes. That fee actually seems reasonable given the complexity of the strategy except that the cumulative returns since inception Jan 5th 2011 have been negative 16.88%.

Most relatively new products such as this, appeal to the need for additional ideas in a portfolio and for the advisers’ desire to “diversify” but a close look is imperative into this asset class given the high fees, disparate underlying indexes, overall complexity and the reasonably high disappointment in performance over the last couple of years.

We will continue the insight into the managed futures asset class in additional articles in part to uncover the amount of underlying indexes and to examine more managers.

Sincerely,

Tom Koehler CIO

 

“Managed Futures represent a complex asset class and while we covered a very small amount, there is a lot more information needed prior to making an investment decision. Let us know if we can provide more information to help in that process.”