Managed futures setting stage for dramatic growth

Updated with correction

Investment in managed futures strategies is on the rise as asset owners tap into the equity risk reduction and downside protection inherent in systematic trend-following approaches.

Institutional investors have been pumping assets into managed futures strategies, with especially strong asset gains in the early months of 2017.

Net inflows into managed futures strategies in the quarter ended March 31 were $4.9 billion; total assets under management in the category, including investment gains/losses, rose 2.2% from $125.8 billion as of Dec. 31, showed data from eVestment LLC, Marietta, Ga.

At the current pace, net inflows into managed futures in 2017 could reach $19.7 billion, a 94% increase over net inflows into the category in 2016 and the largest one-year increase since eVestment began tracking the category in 2009. If the pace continues, total managed futures assets could top $145 billion, the highest since 2012 when assets totaled $177.7 billion.

The appeal of managed futures strategies for institutional investors is “their unique returns, which are uncorrelated to long-only strategies, commodities and other hedge funds,” said Yao Hua Ooi, a principal in AQR Capital Management LLC's global asset allocation team and a managed futures portfolio manager.

“Managed futures tend to do well in prolonged downturns, such as from 2000 to 2002 and in 2008, and bring tail-risk protection,” Mr. Ooi said, stressing many institutional investors “still have a huge downside risk in their portfolios through high equity exposure. Managed futures can help by adding diversification to portfolios.”

Greenwich, Conn.-based AQR manages $20 billion in managed futures in various formats.

Hedge fund researcher Anthony K. Caruso, vice president and head of quantitative and macro strategies, Mesirow Advanced Strategies Inc., Chicago, said investment in systematic managed futures approaches have grown almost linearly since 2008 when the strategies were the only hedge fund approaches that made money after the financial crisis that year. Mesirow manages $10 billion in hedge funds-of-funds and customized strategies for institutional investors.

Rush of assets

The big rush of assets into systematic managed futures strategies comes despite what eVestment researchers called “questionable performance” of 0.7% in 2016 and -0.3% in the first quarter of 2017 in a March 31 performance report.

“The last good year for CTA and managed futures strategies was 2014. Performance over the last 18 months was very poor,” said Christopher Solarz, managing director and head of global macro hedge fund strategies in the New York office of alternative investment consultant Cliffwater LLC.

“We've seen a lot of ins and outs and ups and downs in the managed futures space in the past few years,” Mr. Solarz said, noting conditions are not favorable for systematic trend-followers because signals are muted as the result of prolonged quantitative easing that has created artificial market conditions.

“My theory is that we're in a cyclical downturn for trend-followers. There's nothing to do but wait it out,” he added.

Institutional investors appear willing to remain invested in managed futures strategies in anticipation of a sharp, unexpected, lingering downturn, which is exactly the kind of environment that best suits the strategy.

“This is further evidence that institutional investors are using the segment of the industry in hopes of benefiting from systematic approaches that have worked well in past periods of market turbulence,” eVestment data trackers wrote.

Among funds that have invested in systematic trend-following funds over the past year:

• the $58.9 billion Alaska Permanent Fund, Juneau, which invested $150 million with Winton Group Ltd.;
• State of Wisconsin Investment Board, Madison, which oversees the $96.4 billion Wisconsin Retirement System, invested $125 million with Efficient Capital Management;
• the $31 billion Indiana Public Retirement System, Indianapolis, invested $100 million with Man AHL, a division of Man Group PLC;
• Oregon Investment Council, Tigard, which runs the $70.5 billion Oregon Public Employees Retirement Fund, invested $250 million with AQR Capital Management;
• Teachers Retirement System of the State of Illinois, Springfield, invested $100 million with KeyQuant; and
• the $15.4 billion Hawaii Employees' Retirement System, Honolulu, allocated a total of $1.6 billion to seven managers for its new crisis risk offset portfolio, including three managed futures managers and three alternative risk capture managers. One manager runs the portfolio's Treasury-duration capture strategy.

Campbell & Co., Crabel Capital Management LLC and Aspect Capital Ltd. manage $225 million each in trend-following strategies and Graham Capital Management LP, P/E Investments LLC and Welton Investment Partners LLC run roughly $150 million each in alternative risk capture strategies for the Hawaii Employees' fund.

Specific role

The specific role of the trend-following strategies in the crisis risk offset portfolio is “clearly for downside protection, but we also want positive returns during prolonged down market periods,” said Vijoy Chattergy, chief investment officer.

The portfolio began trading on April 4 and performed as expected during a mini-downturn on May 17, Mr. Chattergy said.

The Dow Jones industrial average index was down 1.8% that day and the Chicago Board Options Exchange Volatility index leaped up almost 40%, but Hawaii ERS was down just 0.8% and the CRO portfolio declined 1%.

The trend-following strategies did lose money that day because of “the unexpected market swerve, which was what we expected. It was only a one-day decline but it reassured us that the CRO portfolio and the trend-following strategies have real potential to produce positive returns when we need them, as well as providing us with a bit of insurance,” Mr. Chattergy said.

The allocation to the CRO portfolio is 10% now and will rise to 13% at the end of 2017 when Mr. Chattergy expects to add two managers — AlphaSimplex Group LLC to manage $225 million in managed futures and Mellon Capital Management to run $150 million in a risk-capture strategy. The long-term target for the CRO portfolio is 20% of plan assets.

Howard Hodel, Hawaii ERS' investment officer - risk management, is “watching the CRO portfolio and the trend-following strategies every day and is seeing first-hand the diversification these investments provide to the portfolio,” Mr. Chattergy said.

In addition to providing useful diversification overall to an institutional portfolio, sources said part of the current investment surge is coming from investors' expanding the spectrum of managed futures approaches.

“What every investor is looking to do is expand their CTA exposure,” said Victoria Vodolazschi, senior investment consultant-hedge fund research, who is based in the New York office of Willis Towers Watson Investment Services.

“A diversified multistrategy CTA portfolio provides a more consistent return on a monthly basis as opposed to a traditional systematic strategy, which tends to have a very lumpy return stream,” Ms. Vodolazschi said.

In down market periods, for example, a systematic trend-following strategy might produce a high return for a few months until the trend trails off, she said, adding what Willis Towers Watson is recommending to clients “is to combine a non-traditional, diversified multistrategy managed futures portfolio with a traditional trend-follower to produce smoother returns.”