Managed Futures Have Been Good, Diversified Alpha Will Be Better

Managed Futures managers’ strong performance this year is reviving the sector after nearly a decade of disinterest. Industry elites are once again promoting the strategy and ETFs are seeing record inflows. The surge in interest is classic return chasing - buying for little reason other than a strategy *has* done well. Investors are likely setting themselves up for disappointment.

Specific strategies rarely continue to outperform for long. Take the last 3 times Managed Futures outperformed over 6 months over the last 20+ years. Over the subsequent 2 year periods the strategy massively underperformed holding a diversified index of hedge fund strategies. Investors are much better off focusing on creating a highly diversified portfolio of alpha strategies than trying to pick out which strategies will be the best. It results in much more consistent returns and is a whole lot less work.

The chart below put the returns of Managed Futures and diversified alpha - represented here by the Composite Total HF Index - in perspective. Returns are put on a like-for-like basis, gross of fees. While Managed Futures have done well at the start of this year, diversified alpha has created a much more consistent return over time.

Source: BarclayHedge, Bloomberg, Credit Suisse, and Unlimited calculations.

The summary performance data makes the difference clear. The Total Hedge Fund Index has delivered a higher and more consistent return for the last 20 and last 10 years.

 

Source: BarclayHedge, Bloomberg, Credit Suisse, and Unlimited calculations.

Chasing Managed Futures returns has proven costly in the past. If we look at the periods following Managed Futures outperformance (2002, 2008/9, 2015) it would have been very costly to hold managed futures instead of the Total Hedge Fund Index. There is also reasonable fundamental intuition about this dynamic. While there are periods where markets move consistently in a certain direction, it's typical that eventually the moves reflect the available information leading to increasing uncertainty and with it more chop. In addition extreme outperformance is typically aligned with high cross-market correlation periods which is rarely persistent over the long-term.

Source: BarclayHedge, Bloomberg, Credit Suisse, and Unlimited calculations.

 

Others have highlighted the value of managed futures during negative stock periods as well - suggesting that even though the strategy isn't as consistent, it benefits from negative correlation to traditional portfolios particularly during downside periods. The evidence is pretty weak. The chart below shows the cumulative return of managed futures over the last 20 years broken into months with positive equity returns and months with negative equity returns. The vast majority of positive returns came during periods of positive equity performance. Cumulative returns during downside equity periods are roughly zero.

 

Note: this is shown in simple cumulative return space in order to limit the impact of path dependency. Source: BarclayHedge, Bloomberg, Credit Suisse, and Unlimited calculations.

There will always be an inclination for investors to rush to the strategy that has just made money, it's a natural tendency to adjust for missing out on a previous rally. It is bad money management. The only reliable way to improve return and reduce risk is through strategic diversification. At Unlimited are focused on creating highly diversified index products that will generate more consistent returns than any one individual sub-strategy.

For informational and educational purposes only and should not be construed as investment advice. The historical analysis discussed herein has been selected solely to provide information on the development of the research and investment process and style of Unlimited.  It does not constitute an offer to sell or a solicitation of an offer to buy any security. Opinions expressed are our present opinions only. The material is based upon information which we consider reliable, but we do not represent that such information is accurate or complete, and it should not be relied upon as such. The historical analysis should not be construed as an indicator of the future performance of any investment vehicle that Unlimited manages. No investment strategy or risk management technique can guarantee return or eliminate risk in any market environment. No Representation is being made that any investment will or is likely to achieve profits or losses similar to those shown herein.