June 13, 2016: Managed Futures For Portfolio Building

Jun 14, 2016 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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For regular SAA and TAA portfolios, the next re-balance will be on Monday, July 11, 2016. You can also find the re-balance calendar for 2015 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Managed Futures For Portfolio Building

Investing in commodities is mostly through futures market. Even though one can purchase and hold commodities physically, the logistics (storage, transportation etc.) just makes this approach much harder, if not unfeasible. Futures are contracts for speculators to bet whether the underlying commodity price is going to rise or fall in the future. Long-ing a futures means betting the underlying commodity price is goingup while short-ing a futures means betting it to go down. 

In the long term, it is believed that commodity prices can keep up with inflation. However, this assertion has been challenged because nowadays inflation is impacted by many other factors such as service cost, technology (think about your smart phones and computers), in addition to material cost. Furthermore, commodity prices can experience a secular downtrend in a very long period of time. For example, DBC (PowerShares DB Commodity Tracking ETF), an ETF that tracks the prices of a broad base basket of commodities has had a -4.1% annual return for the past 10 years (see the table below). It is thus challenging to invest in commodities in a long only fashion. 

Managed futures invest in futures using both long and short approaches. Since futures in general exhibit rising and falling trends, managed futures try to long futures that exhibit a rising trend while shorting those that are in a downtrend. It should be noted that even though futures are predominantly commodities, they also include financial futures which are for interest rates, currencies and even stock market indices. 

Managed Futures Funds

Since the financial crisis in 2008-2009, there have been a flurry of introduction of managed futures funds after investors realized that trend following in futures markets can be a good diversifier. In the following table, we compare performance of some of these funds: 

Portfolio Performance Comparison (as of 6/13/2016):

Ticker/Portfolio Name YTD
Return**		 1Yr AR 3Yr AR 5Yr AR 5Yr Sharpe 10Yr AR
P S and P Diversified Trend Indicators 3.0% 0.5% 2.3% 0.3% 0.05  
P S and P Commodity Trend Indicators Strategy 5.8% 2.7% 0.4% -2.3% -0.34  
WDTI (WisdomTree Managed Futures Strategy ETF) 2.7% -1.9% 1.9% -3.6% -0.6  
LSC (ELEMENTS S&P CTI TR ETN) 8.0% 5.5% 2.9% -7.2% -0.45  
AMFAX (Natixis ASG Managed Futures Strategy A) 4.5% 1.7% 10.4% 4.0% 0.35  
AQMNX (AQR Managed Futures Strategy N) -0.1% -0.7% 5.5% 3.5% 0.33  
AMFQX (361 Managed Futures Strategy A) -2.7% -10.6% 0.4%      
GMSAX (Goldman Sachs Managed Futures Strat A) -1.2% 1.8% 3.0%      
PQTDX (PIMCO TRENDS Managed Futures Strat D) 2.2% -4.0%        
DBC (PowerShares DB Commodity Tracking ETF) 15.0% -14.3% -16.3% -12.7% -0.82 -4.1%

 detailed comparison

The first two portfolios are maintained by MyPlanIQ on Advanced Strategies page. These portfolios invest in commodity, currency and bond ETFs in a long/short fashion, using exponential moving averages as indicators to decide to go long or short an ETF. P S and P Diversified Trend Indicators does much better than WDTI (WisdomTree Managed Futures Strategy ETF), which tracks the same S&P Diversified Trend Indicator. Similarly , P S and P Commodity Trend Indicators Strategy and LSC (ELEMENTS S&P CTI TR ETN) both track S&P Commodity Trend Indicator (CTI). Again, our portfolio outperforms the corresponding ETF LSC. 

Notice performance of the managed futures funds in the table varies greatly. Among them, we like AMFAX (Natixis ASG Managed Futures Strategy A) and AQMNX (AQR Managed Futures Strategy N). Both funds are managed by very reputable teams. AMFAX is managed by AlphaSimplex Group which is headed by MIT Professor Andrew Lo. The team has done extensive research in investing strategies. See a recent Wallstreet Journal article on the fund.  AQR fund is managed by one of the largest hedge fund manager AQR. AMFAX, even though it is a A class share fund, is available in Schwab as a no load and no transaction fee fund. 

The other three funds all have inconsistent performance. For example, PQTDX was up 20.2% in 2014 and then promptly lost the same amount in 2015. 

Advantages of Managed Futures 

There are several advantages for managed futures:

More consistent returns than a long only approach

It is clear from the above table that all these funds have done better than DBC, a long only commodity index fund. This is mostly attributed to their long and short approach and often exhibited trends in futures market. 

Less correlation with stocks and commodities

Because of their investments in a long and short fashion in multiple futures simultaneously, managed futures funds are not tightly correlated with stocks and commodity prices, making them an excellent candidate for diversification in a portfolio. 

An interesting observation: when financial markets are under stress, often futures exhibit strong trends. For example, in 2008 and 2009, both interest rate futures and commodity futures exhibited strong trends during the panic selling. Investors often sell stocks and other risk assets at all cost and take a flight to safe havens such as Treasury bonds. Managed futures funds can easily capture the trends and deliver good returns in these periods. For example, in 2008, P S and P Diversified Trend Indicators returned 20.7% while P S and P Commodity Trend Indicators Strategy returned 23.8%. See the detailed comparison for the above table or the following chart: 

Unfortunately, all of the funds in the above table didn’t exist in 2008 and 2009, thus it’s impossible to know how these funds will respond in a financial market downturn. However, given the nature of the trend following strategies these funds use, we suspect they will do equally well in those situations. 

Managed futures funds in a portfolio

Managed futures thus can be used in a portfolio for diversification purpose. You can either allocate a small portion of a portfolio for these funds or you can just simply replace the commodities with these funds. Unfortunately, there isn’t a good managed futures ETF at this moment so one has to invest in a mutual fund. 

In the following, we show portfolios that replace commodities with manged futures: 

Portfolio Performance Comparison (as of 6/13/2016):

Ticker/Portfolio Name 2008 Return YTD
Return**		 1Yr AR 3Yr AR 5Yr AR 5Yr Sharpe
Six Core Asset with Managed Futures S And P DTI -21.4% 2.8% -0.9% 4.2% 4.8% 0.56
Six Core Asset with Managed Futures ASG Fund N/A 3.0% -0.8% 4.7% 4.9% 0.59
Six Core Asset ETFs Strategic Asset Allocation – Optimal Moderate -24.6% 3.8% -0.6% 3.6% 4.6% 0.48

Six Core Asset with Managed Futures ASG Fund: uses AMFAX (Natixis ASG Managed Futures Strategy A) instead of DBC.

Six Core Asset with Managed Futures S And P DTI: uses P S and P Diversified Trend Indicators instead of DBC. 

To summarize, managed futures funds or portfolios can be an excellent portfolio diversifier. This is especially useful in a time that is close to a financial market downturn. However, one has to be careful to choose among many managed futures mutual funds. 

Market Overview

Stocks underwent a fast retreat after hitting a level close to all time high. Since May 2015, S&P 500 has not been able to break through the 2130 level. This might be a long dragged out top formulation. For now, there are many unfavorable factors including Britain’s possible exit from European Union, China’s ongoing painful readjustment, the Federal Reserve’s intention to raise interest rates etc. However, as long as we have a proper risk exposure, we are confident that our well thought out strategies will carry us through. 

For more detailed asset trend scores, please refer to 360° Market Overview. 

We would like to remind our readers that since the financial crisis in 2008-2009, we have not seen substantial structural change in the U.S., European and emerging market economies. Economies have heavily relied on low interest debts. Capital might be misallocated to unproductive investments and consumption. U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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