SEI Corp. has begun offering a low-fee, passive approach to managed futures, contending managed futures has a fundamental ecnomic return.
Because of the economic return argument, the SEI approach likely will be more palatable to pension executives than other managed futures products. That's because fund executives often are uneasy about investing in anything based solely on manager skill.
SEI is offering the BARRA/MLM index as a low-cost way (about 100 basis points annually) for pension funds to get into managed futures.
SEI has just begun marketing the product, and has no clients.
Unlike traditional stock and bond indexes, the BARRA/MLM Index goes long and short, using a simple computer program that tracks market trends in specific futures markets, and issues trade recommendations to ride out those trends. Underlying that is an attempt to capture a fundamental economic return to the futures market. (A futures contract is an agreement to buy or sell a real or financial asset in the future).
In contrast to other institutional managed futures programs, SEI's carries costs that are closer to traditional asset classes, said Charles A. "Tony" Baker, vice president in asset management services for Wayne, Pa.-based SEI.
SEI offers a BARRA/MLM strategy through separate accounts and a non-registered private partnership fund, often called a hedge fund. Mount Lucas Group, the Princeton, N.J., futures manager that created the index in 1988, will manage the index for SEI.
BARRA, based in Berkeley, Calif., got involved because the index's approach to managed futures made sense, said Ed Baker, senior vice president. BARRA's consultants also helped the index become a better representative of managed futures, and become investible, Mr. Baker said.
The 100-basis-point estimated cost includes everything but transaction costs and auditing, Mr. Baker of SEI said. In comparison, the reported fees paid by the Virginia Retirement System's large, but now-defunct, managed futures program were about 350 basis points.
A passive managed futures approach isn't totally new to pension funds.
Federal Express Corp., Memphis, Tenn., already has an undisclosed amount of assets in a fund - managed directly by Mount Lucas - based on the index (Pensions & Investments, June 23).
Views of the index among pension and managed futures experts vary widely, although most agreed the approach could prove to be a success among plan sponsors.
Richard Pike, a managed futures consultant for RP Consulting Group, St. Petersburg, Fla., said that while the return experience of the strategy "looks appealing," in the long run investors will want something more sophisticated.
"These guys are creating a marketing thing," Mr. Pike said. The BARRA/MLM Index is "sort of an introductory device" for institutional investors considering managed futures. "What I fail to buy into is that it will keep people interested."
Managed futures "is a business of 100% manager skill," said Bruce Cleland, president of Campbell & Co., a futures manager based in Baltimore. "There is no inherent return."
Others are less critical, but recognize some possible limitations to the index.
The BARRA/MLM Index uses "basically a volatility capture strategy" that has "an intuitive appeal," said Jeffrey Geller, managing director and portfolio manager for BEA Associates, New York, which uses options volatility strategies in some portfolios.
But the strategy carries an embedded option cost that results from whipsawing prices in individual commodities that won't necessarily be captured by the strategy, he said.
"It's kind of like the risk of portfolio insurance," where a manager tries to follow a trend that is constantly turning against him, Mr. Geller said.
Likewise, Pat Hart, chairman of Hart-Bornhoft Group Inc., Denver, a managed futures manager of managers said: "Obviously, the BARRA/MLM is probably one of the better" indexes. But, at this point, it's mostly a hypothetical index, he said.
"You have to go in (to the index) with your eyes open," he said.
Dave Love, president of Kenmar Institutional Investment Management L.L.C., San Diego, said his firm uses the index as a benchmark. Kenmar offers a manager-of-managers approach to futures investment.
"No, this isn't a perfect index," he said. But, "right now, I think it's the most useful benchmark around." He said the BARRA/MLM Index is useful because it replicates the basic exercise of managed futures, it's non-leveraged, it's investible, and it has been around long enough to be meaningful.
Sol Waksman, president of Barclay Trading Group Ltd., Fairfield, Iowa, said use of the index could be good for the managed futures industry. Just as there is an argument for investing passively and actively in stocks and bonds, one could make the same argument for managed futures. Barclay offers an index of futures traders that is sometimes used as a benchmark, and is also collaborating with BARRA on a futures-related project.
Mr. Baker of SEI said the goal of the index is to capture a theoretical premium - paid by users of commodities - that covers the cost of placing that hedge. For example, an agricultural processor might hedge by purchasing corn on the futures market, locking in prices in anticipation of selling a product. In theory, speculators are paid a premium for taking on the other side of that hedge, and the BARRA/MLM Index tries to capture that.
BARRA and Mount Lucas produce the index by creating synthetic long call and put options using futures. Put simply, as a price trend appears to develop in an individual futures market, the BARRA/MLM index will buy or sell futures to ride out the trend, using a 12-month moving price average as a gauge. Rather than being long commodities, the index seeks to be long volatility. Computers are used to calculate when to buy or sell.
The index has an annualized return of 15.16% from 1961 through 1993, with a standard deviation of 10.91%.
Many said the index's marketing pitch, based on a fundamental return in futures markets, is likely to be more appealing to plan sponsors than traditional managed futures marketing pitches, which often promote returns based solely on manager skill.
But the existence of a fundamental return to futures has not been established by research, and even if it eventually does, some question whether the index would capture it.
The returns displayed by the index are "retrofitted" to history, and have no bearing on the future, Mr. Cleland of Campbell said.
In response to that, Mr. Baker said the index is not retrofitted. He said if the creators of the index wanted to retrofit, they could have come up with some "outrageous" risk and return characteristics. He said he doubts a firm like BARRA would involve itself with anything related to "data-mining."
Mr. Cleland also questioned how much capacity a BARRA/MLM Index strategy could hold, given that some of the component futures markets, like live cattle and coffee, trade less actively than others.
Mr. Baker of SEI said a strategy based on the index would have an upper limit in how it could effectively be implemented, conservatively put between $3 billion and $4 billion. But he also said that in separate account strategies, investors could leave out particular contracts, if they desire to avoid less actively traded markets.
Mr. Baker noted also that while SEI's strategy will seek to replicate the index when placing trades, managers at Mount Lucas will have some leeway, which should limit the price effects of placing trades.
Meanwhile, academic research on the existence of an economic return in futures markets is inconclusive, said Don M. Chance, a professor of finance in the Center for the Study of Futures and Options Markets. The center is in the R.B. Pamplin College of Business at Virginia Polytechnic Institute and State University, Blacksburg, Va.
While the concept of hedgers paying a risk premium in the futures market is good - and is an old argument that originated with famed economist John Maynard Keynes - it's an "unresolved issue" in the academic community, Mr. Chance said.
