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DRS vs. Managed Futures — Strategy Comparison Series

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Managed Futures- Fad or Innovation?

One of the more eso­teric chal­lenges fac­ing today’s investors and finan­cial advi­sors is to keep up with the rapid evo­lu­tion of the prod­ucts and solu­tions avail­able. Some inno­va­tions, like exchange-trad­ed funds, are game-chang­ers and have gath­ered tril­lions in assets. Oth­ers turn out to be noth­ing more than fads (any­one remem­ber the hype sur­round­ing 130/30 funds?).

Until new invest­ment strate­gies become more estab­lished, the easy way out is to lump them all togeth­er in the loose­ly defined cat­e­go­ry “liq­uid alter­na­tives.” Since the Finan­cial Cri­sis of 2007-09, there has been an explo­sion of strate­gies labeled “dif­fer­ent.”

One of the hottest cat­e­gories in the loose­ly defined liq­uid alter­na­tive space is man­aged futures. Accord­ing to Morn­ingstar, there are cur­rent­ly 144 mutu­al funds with an aggre­gate $29.5bn dol­lars in this cat­e­go­ry, a sig­nif­i­cant increase from five, or even three years ago.

Fund Count over time in Morningstar Managed Futures Category | DRS vs. Managed Futures - Swan Blog

Swan has been pub­lish­ing a Strat­e­gy Com­par­i­son blog series (see links below) on the pros and cons of dif­fer­ent liq­uid alter­na­tive strate­gies . We will dis­cuss:

  1. What are the dri­vers of returns in each strat­e­gy?
  2. What are the risks in each strat­e­gy?
  3. What role does a giv­en strat­e­gy play with­in a port­fo­lio?
  4. How does the giv­en strat­e­gy com­pare to the Defined Risk Strat­e­gy?

Drivers of Managed Futures Returns

When it comes to man­aged futures, returns are gen­er­at­ed in the deriv­a­tives mar­ket. In fact, many man­aged futures funds have the major­i­ty of their hold­ings in noth­ing more than short-term cash posi­tions, used to col­lat­er­al­ize their futures posi­tions. The futures them­selves can be across a wide vari­ety of under­ly­ing assets. Futures-based invest­ing start­ed with com­mod­i­ty futures, giv­en the dif­fi­cul­ty of invest­ing in phys­i­cal com­modi­ties. As man­aged futures strate­gies have become more pop­u­lar, some have focused upon equi­ty and fixed income futures. Some strate­gies cov­er both cap­i­tal and phys­i­cal mar­kets.

Most man­aged futures strate­gies are momen­tum-based or trend-fol­low­ing. In oth­er words, recent short-term direc­tion dic­tates future short-term posi­tion­ing. Obvi­ous­ly, not all man­aged futures are this way, but trend-fol­low­ing tends to be a com­mon trait. The offi­cial Morn­ingstar descrip­tion of the Man­aged Futures Cat­e­go­ry is:

Man­aged Futures: These funds pri­mar­i­ly trade liq­uid glob­al futures, options, swaps, and for­eign exchange con­tracts, both list­ed and over-the-counter. A major­i­ty of these funds fol­low trend-fol­low­ing, price-momen­tum strate­gies. Oth­er strate­gies includ­ed in this cat­e­go­ry are sys­tem­at­ic mean rever­sion, dis­cre­tionary glob­al macro strate­gies, com­mod­i­ty index track­ing, and oth­er futures strate­gies. More than 60% of the fund’s expo­sure is invest­ed through deriv­a­tive secu­ri­ties. These funds obtain expo­sure pri­mar­i­ly through deriv­a­tives; the hold­ings are large­ly cash instru­ments.”

Source: Morn­ingstar Direct

Risks with Managed Futures

Any mar­ket-tim­ing strategy’s suc­cess depends upon being one step ahead of the game. The old say­ing “the trend is your friend” sums up momen­tum strate­gies well. The short­com­ings of such an approach, how­ev­er, is that a strat­e­gy has to be smart enough to rec­og­nize a trend and par­tic­i­pate in it as it is run­ning, but also nim­ble enough to aban­don the trend before it revers­es or just after. This is eas­i­er said than done. While sig­nif­i­cant prof­its can be gen­er­at­ed if the mod­el is work­ing, a rever­sal can just as eas­i­ly erase any or all gains.

Also, the fact that some man­aged futures funds call them­selves “hedged” is a bit mis­lead­ing. Most man­aged futures strate­gies aren’t hedg­ing any­thing — they are mak­ing a direc­tion­al bet on the per­for­mance of an asset class. It is true that in the past, many man­aged futures strate­gies have had low cor­re­la­tions to tra­di­tion­al asset class­es. Added to a port­fo­lio, an uncor­re­lat­ed asset can low­er over­all volatil­i­ty . How­ev­er, that type of result would be bet­ter described as diver­si­fi­ca­tion rather than a hedge.

Com­pli­cat­ing mat­ters is the fact that most of the liq­uid man­aged futures strate­gies were not avail­able dur­ing the last major mar­ket melt­down. Accord­ing to the pre­vi­ous table, only three funds were around dur­ing the finan­cial cri­sis of 2007-09. How these funds will per­form dur­ing a major mar­ket sell-off has yet to be seen.

Final­ly, the per­for­mance of indi­vid­ual man­aged futures funds on a year-to-year basis is fair­ly errat­ic. The graph below shows where the five largest man­aged futures funds in terms of assets plots rel­a­tive to their peer group. There isn’t a lot of con­sis­ten­cy.

Zephyr Managed Futures vs Managers | DRS vs. Managed Futures - Swan Blog

Role of Managed Futures in a Portfolio

Broad­ly speak­ing, peo­ple use alter­na­tives for two pur­pos­es — either risk reduc­ers or return enhancers. Most man­aged futures tend to fall into the lat­ter cat­e­go­ry, those of return enhancers or alpha dri­vers. Of course, this comes at a cost. Man­aged futures tend to be more volatile than oth­er options. In fact, in the con­text of Morningstar’s new alter­na­tive style box, man­aged futures most­ly fall on the high side of rel­a­tive volatil­i­ty (green dots below):

U.S. Liquid Alts Universe - Morningstar | DRS vs. Managed Futures - Swan Blog

How Do Managed Futures Strategies Compare to the Defined Risk Strategy?

At this point it should be clear that the typ­i­cal man­aged futures strat­e­gy is quite dif­fer­ent than the Swan DRS approach. The major­i­ty of the DRS’s hold­ings are long, buy-and-hold ETF posi­tions. Long-term puts are pur­chased to pro­tect against sell-offs in the ETFs. This “always invest­ed, always hedged” posi­tion is estab­lished because Swan does not believe that mar­ket-tim­ing is a viable, long-term solu­tion. Man­aged futures are the polar oppo­site, typ­i­cal­ly hold­ing the major­i­ty of their assets in cash and seek­ing to out­ma­neu­ver the mar­ket based upon their short-term pre­dic­tive mod­els.

That said, because the DRS and the typ­i­cal man­aged futures strat­e­gy are so pro­found­ly dif­fer­ent, one might con­sid­er mix­ing the two togeth­er to com­ple­ment each oth­er. The DRS acts as a risk-reduc­er, a beta-damp­en­er on the port­fo­lio, where­as an uncor­re­lat­ed man­aged futures strat­e­gy could be used as more of an alpha-dri­ver and diver­si­fi­er. Of course, imple­men­ta­tion depends upon the indi­vid­ual man­aged future strat­e­gy in ques­tion and a client’s spe­cif­ic sit­u­a­tion, but fun­da­men­tal­ly the whole point of mix­ing and match­ing man­agers is bring­ing togeth­er a diverse set of val­ue propo­si­tions and skill sets.

For more about how the Swan DRS com­pares and con­trasts with oth­er strate­gies, check out pre­vi­ous posts in our Strat­e­gy Com­par­i­son Series:

Look­ing for a deep­er dive into port­fo­lio strate­gies, check out our recent­ly updat­ed white paper on Asset Allo­ca­tion Strate­gies.

For more infor­ma­tion on the Defined Risk Strat­e­gy per­for­mance, call 970.382.8901.


Marc Odo, Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions - Swan Global InvestmentsAbout the author: Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Direc­tor of Invest­ment Solu­tions, is respon­si­ble for help­ing clients and prospects gain a detailed under­stand­ing of Swan’s Defined Risk Strat­e­gy, includ­ing how it fits into an over­all invest­ment strat­e­gy. For­mer­ly Marc was the Direc­tor of Research for 11 years at Zephyr Asso­ciates.



Impor­tant Dis­clo­sures:

Swan Glob­al Invest­ments, LLC is a SEC reg­is­tered Invest­ment Advi­sor that spe­cial­izes in man­ag­ing mon­ey using the pro­pri­etary Defined Risk Strat­e­gy (“DRS”). SEC reg­is­tra­tion does not denote any spe­cial train­ing or qual­i­fi­ca­tion con­ferred by the SEC. Swan Glob­al Invest­ments offers and man­ages the Defined Risk Strat­e­gy for investors includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. All Swan prod­ucts uti­lize the Swan DRS but may vary by asset class, reg­u­la­to­ry offer­ing type, etc. Accord­ing­ly, all Swan DRS  prod­uct  offer­ings  will  have  dif­fer­ent  per­for­mance  results  and  com­par­ing  results among the Swan prod­ucts and com­pos­ites may be of lim­it­ed use. Swan claims com­pli­ance with the Glob­al Invest­ment Per­for­mance Stan­dards (GIPS®). Any his­tor­i­cal num­bers, awards and recog­ni­tions pre­sent­ed are based on the per­for­mance of a (GIPS®) com­pos­ite, Swan’s DRS Select Com­pos­ite, which includes non­qual­i­fied dis­cre­tionary accounts invest­ed in since incep­tion, July 1997 and are net of fees and expens­es. All data used here­in; includ­ing the sta­tis­ti­cal infor­ma­tion, ver­i­fi­ca­tion and per­for­mance reports are avail­able upon request. The S&P 500 Index is a mar­ket cap weight­ed index of 500 wide­ly held stocks often used as a proxy for the over­all U.S. equi­ty mar­ket. Index­es are unman­aged and have no fees or expens­es. An invest­ment can­not be made direct­ly in an index. Swan’s invest­ments may con­sist of secu­ri­ties which vary sig­nif­i­cant­ly from those in the bench­mark index­es list­ed above and per­for­mance cal­cu­la­tion meth­ods may not be entire­ly com­pa­ra­ble. Accord­ing­ly, com­par­ing results shown to those of such index­es may be of lim­it­ed use. The adviser’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar ETFs and options in which the advis­er invests or writes may prove to be incor­rect and may not pro­duce the desired results. There is no guar­an­tee any invest­ment or the DRS will meet its objec­tives. All invest­ments involve the risk of poten­tial invest­ment loss­es as well as the poten­tial for invest­ment gains. Pri­or per­for­mance is not a guar­an­tee of future results and there can be no assur­ance, and investors should not assume, that future per­for­mance will be com­pa­ra­ble to past per­for­mance. Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970.382.8901 or vis­it 081-SGI-041217[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

By |2018-10-02T11:20:34+00:00April 17th, 2017|Blog|Comments Off on DRS vs. Managed Futures — Strategy Comparison Series

About the Author:

As Director of Investment Solutions, Marc is responsible for helping clients and prospects gain a detailed understanding of Swan’s Defined Risk Strategy, including how it fits into an overall investment strategy. Formerly Marc was the Director of Research for 11 years at Zephyr Associates.