Capital weighted benchmarks might have a negative effect on managed futures, says Salus Alpha’s Ritesh Jain
Ritesh Jain, analyst at Salus Alpha Capital, has looked at views on benchmarking as they affect managed futures funds.
Equity markets are today scaling new highs after a six year bull run, and many are asking how long it will continue. Commodity markets are struggling with high volatility and most trend-following managed futures funds are presently underperforming equities. Given the current risk-on/risk-off environment, systematic, trend-following strategies are struggling to perform. But does this mean there are no trends in the current low interest rate environment that they could be profiting from?
Paul Tudor Jones, a billionaire veteran of the industry, recently called the trading environment “as difficult as I’ve ever seen in my career.” Tudor Investment Corp’s main fund is down about 4% this year.
Most trend-following hedge funds have lost money, possibly because they were not able to be on the right side of the trend in a rallying market with a strong run-up in several commodities this year.
Sol Waksman, founder and president of BarclayHedge, says “trendless zigzagging equity markets, volatile commodity markets, and a difficult bond market” have contributed to poor performance this year.
The Newedge Trend index is down -2% this year as of end of May. The Newedge Trend Index is comprised of the largest 10 trend following managers based on assets under management.
So finding a managed futures strategy that produces robust risk-adjusted returns in this present environment is proving to be relatively challenging. Managed futures are not necessarily on a down-trend but investor expectations seem to be misguided. The principle role of managed futures funds, one could argue, is diversification rather than equity outperformance. But should they not also be capable of generating positive return in the current environment?
There is much data showing that the addition of CTAs to a diversified portfolio improves diversification as they tend to be uncorrelated to wider markets. Indeed, a portfolio without managed futures could be viewed like driving a car without insurance. But as in any type of insurance there are some you should buy and others you should not. So to extend the analogy; investing in managed futures funds with negative returns is like buying the wrong insurance policy.
Frank Seidel of Amandea Asset Management AG says that “virtually all systematic trend followers are stuck in a corrective phase, although the lows should be overcome in the meantime.”
But these views look highly biased given that the data shows that the biggest guys are the ones that have been mostly down. Academic findings show that excessive assets under management have a negative influence on performance.
However it seems that investors are still pilling money into a handful of managers. And it appears that these managers are failing to deliver returns even when trends are predominantly noticeable. This is a problem of benchmarking. Investors are afraid to deviate from the benchmark and take decisions. But the opportunity is there.
Oliver Prock CIO of Salus Alpha says: Being up around 17% YTD, for us the year is excellent. We do not share the widespread complaints about the recent environment since there were huge positive trends in commodities and bonds while equities were stable so far this year. But maybe we are doing simply better than others since our model is adaptive and can switch between long term and short term and trend following and contrarian.
Capital weighted benchmarks or benchmark indices that equal weight the biggest managed futures funds in the industry seem to be a victim of their own success. The biggest managed futures models are deteriorating now due to the mere fact that they need to allocate huge capital. Smaller funds that tried to mimic the successful models of the big funds are also affected.
The investor challenge is obvious, but the solution may too be obvious: Picking smaller proven managed futures funds with proven ability to perform in all market environments might reward investors handsomely who deviate from the benchmark.