Managed futures: An all-weather investment

By TIM RUDDEROW/Mount Lucas Management

When most people hear the word “futures,” they associate them with commodities like corn, oil and precious metals. In reality, the futures market is incredibly complex, with contracts encompassing both physical goods as well as financial instruments such as currencies, stocks and bonds.


Managed futures are portfolios of futures contracts that are bought and sold by investment professionals. Managers employ hedging strategies to take advantage of upward or downward pricing trends identified through quantitative technical analysis. As an asset class, their main purpose is to manage risk within a portfolio by delivering uncorrelated returns, although historically they have often outperformed the broad market in times of economic duress.

Hedgers and Speculators

Futures investors generally fall into three categories. Buy-side hedgers, such as oil refineries and food manufacturers, who use futures to lock in future purchasing prices for the raw materials they use. Sell-side hedgers, such as farmers, shale oil producers and mining companies, use futures to lock in higher future selling prices for the commodities they produce to offset potentially lower prices in the physical markets. Speculators attempt to profit by taking on the risk premium both buy-side and sell-side hedgers are willing to pay to reduce their own price risks.

A Trend-Based Strategy

Managed futures is a general description of an asset class comprised of a professionally managed portfolio of futures contracts. Their overall purpose is to improve the risk/return profile of a portfolio by delivering returns with low correlation to those of the equity and bond markets. They also offer the additional benefit of generating strong returns during periods of market stress, such as we’re going through right now.


Nearly all managed futures investors employ trend following strategies. Trend following is a quantitative trading method used to capture risk premiums that occur during periods of market volatility and price dislocation. Professional trend followers use patented algorithms that signal the beginning of potential large pricing trends, and then take short and long positions to capture the returns.


While managers may consider current economic and market conditions when looking for certain sectors, currencies or countries to focus their analysis, their actual trading decisions are based primarily on pricing trends. Fundamental factors are not considered.

Non-Correlated Returns Plus Outperformance in Times of Stress

Managed futures are most commonly used to deliver non-correlated results under most market conditions, serving as a risk mediator within the alternative investments allocation of an institutional portfolio. Generally, they deliver lower relative returns during periods of price stability. But during periods of market stress, managed futures often outperform the broad market, as illustrated in the following chart. 

This chart represents all declines of more than 10% in the S&P 500 since 2010. Past performance is not indicative of future results. No investor has achieved the exact performance results presented herein. The performance shown for the MLM Index™ EV (15V) and MLM Global Index EV (15V) is based upon a historical index and is gross of any fees and expenses. There is no guarantee that performance results in the future will be similar to those shown herein. The S&P 500 index is an unmanaged index consisting of 500 stocks chosen by the Index Committee of the Standard and Poor's Corporation that generally represents the Large Cap sector of the U.S. stock market. Returns for the S&P 500 index reflect the reinvestment of all dividends.

Over the past decade, when global economic and market events have spurred a selloff in the broad market, managed futures, as represented by the MLM Index, a recognized benchmark of the returns available to managed futures investors, often delivered exceptional non-correlated returns during these periods.

A Frequent Chart-Topper

When included in a diversified asset allocation strategy, managed futures not only can mitigate risk but often outperform all other asset classes, particularly during recessionary periods, as illustrated in the following table of periodic returns spanning the past 20 years.

Past performance is not indicative of future results. This is not an offer to sell or a solicitation to buy any security. Any such offer will only made by the Confidential Offering Memorandum of the Fund. No investor has achieved the exact performance results presented herein. The performance shown for the MLM Index™ EV (15V) is based upon a historical index and is gross of any fees and expenses. There is no guarantee that performance results in the future will be similar to those shown herein. * 2020 results represent YTD results through 4/30/2020.

As we see, the MLM Index was the top-performing asset class in four of those years and in the top three in five other years. More impressively, in 11 of those years the MLM Index outperformed the S&P 500. As of this writing, the MLM Index is the top-performing asset class index in 2020.


Because managed futures investors employ trend following strategies to capitalize on pricing spikes, they tend to perform best during periods of high market volatility such as those that occur during market downturns. Thus, we see that the MLM Index was a top performer in the wake of the burst of the high-tech bubble in 2000 and in the post 9/11 recession of 2001 and 2002, as well as during the collapse of the markets in 2008 that marked the start of the Great Recession.


Conversely, managed futures tend to underperform in years when domestic and international equity markets grow at a steady pace with low levels of volatility. In fact, over the past 20 years, returns have historically correlated most closely with those of investment-grade bonds, a reason why many institutional investors use them as risk mitigators.

Managed Futures in the COVID-19 Era

The current Coronavirus-driven bear market has provided numerous opportunities for managed futures investors to exploit pricing opportunities in various categories.


One example: When the global economic contraction began in March, savvy investors took short positions in oil and natural gas futures, a strategy that paid off handsomely when fossil fuel prices collapsed in April.


Another example: When the extent of the economic damage in the U.S. became apparent, many investors, anticipating a global stampede to safety, went long on U.S. Treasury futures, which rallied strongly in spite of interest rate cuts that have driven yields to near-microscopic levels.


With the growing uncertainty of the long-term global economic impact of the pandemic, the markets are likely to experience periods of high volatility for the immediate future, creating a wealth of opportunities for managed futures investors to exploit.

How Much Should Investors Invest in Managed Funds?

In an institutional portfolio, managed futures usually comprise a portion of an allocation to alternative investments. Typically, we see managed futures allocations ranging between 10%-20% of the portfolio as whole, depending on the institution’s risk-return profile.


Managed futures can play a variety of roles within an institutional portfolio. The uncorrelated returns they generate can help reduce risk in times of market volatility. When markets are falling, they can often deliver positive returns through effective use of shorting. And when markets begin to recover, savvy managers can get in on the ground floor of upside momentum before the rest of the market catches on. Thus, for many institutions, managed futures can be an attractive all-weather investment.

This article is intended for informational purposes only. This material contains the opinions of the manager and such opinions are subject to change without notice. This commentary does not constitute an offer to sell or a solicitation of an offer to buy securities and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Any offer for an interest in a fund sponsored by Mount Lucas Management LP (“Mount Lucas”) will be made only pursuant to an offering memorandum of such fund.

 

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