February 9, 2012

‘Crisis Alpha’ With Risk Management: a ’40 Act Managed Futures Mutual Fund

Managed futures promise noncorrelation as well; there are benefits and drawbacks to advisors and their clients

Jon Sundt of Altegris speaking at Gemini Fund Services' Managed Futures Forum in New York, Feb. 7, 2012. Jon Sundt of Altegris speaking at Gemini Fund Services' Managed Futures Forum in New York, Feb. 7, 2012.

Advisors are always looking for alpha on behalf of their clients, but they’re also–especially since the 2008-2009 crisis–focused more on risk management since at a minimum they don’t want their clients to lose money.

If they’re going to pick managers to run their clients’ money, they also want to know those managers well, and want to make sure that their clients’ investments are liquid. Moreover, if an asset class is not correlated with the overall markets, that’s a significant advantage, too, in building an asset allocation for clients.

At a press conference in New York on Tuesday, the benefits of ’40 Act managed futures mutual funds were on display. Speakers Jon Sundt, Greg Anderson and Dave Kavanagh argued that advisors who allocate some portion of their clients’ portfolios to such funds will generate alpha–especially “crisis alpha,” said Sundt, the CEO of Altegris–while managing risk, all wrapped up in a non-correlating asset class. Since the vehicle for delivering those value-adds is in a mutual fund, advisors can also see what the fund is holding, even if in aggregate.

Sundt (left) defined “crisis alpha” as the ability to generate returns at a time of crisis, and cited 20 years worth of data from his firm’s Altegris 40 index of top commodity trading advisors (CTAs) to prove the point. During the tech wreck of the early 2000s, he said the index was up 40%. It outperformed well during the credit crisis of 2008, and while 2011 was not a good year for managed futures over all, they did perform well during last year’s “summer shock.”  

“Investors are hungry for managers who can make money in rising and falling markets,” he said. The Altegris 40 index, he reported, has “better risk-adjusted returns by a long shot over the past 10 years,” though it is important to remember that the “biggest risk” with managed futures is that you can lose money,” so end clients must be carefully educated on their  expectations.

The gathering was sponsored by Gemini Fund Services, which, according to Eddie Lund, VP of business development, currently administers some 225 mutual funds, half of them in the alternatives space.

Introducing the three men, Tim Selby, a partner at Alston & Bird in New York, called managed futures “the quintessential hedge funds” for their ability to manage risk, while Anderson (below), CIO of Princeton Fund Advisors, said that managed futures belong in every portfolio, but since you can lose money on them, for those clients who can’t accept the downside of managed futures, he said “we allocate managed futures to risk capital.” Being able to go long and short in 150 different markets, Anderson said, make it one of the best tools to manage risk.

Sundt pointed out that while most long managers “predict the future,” most managed futures managers “react to price movement,” and won’t try to predict where interest rates are headed or what the price of oil will be. “Managed futures is a waiting game,” Sundt said, “for trends to develop.” Anderson agreed that most CTAs are trend followers in the intermediate time frame,” though there are some CTAs who are more fundamentals-based and are thus “more predictive.” But he suggested that one of the benefits of trend following is that “it takes the emotions out of investing.”

Sundt said that while “It’s not hard to understand how managed futures work,” it’s more difficult

to “understand when you’re in a trend.” That’s where having access to the best CTAs is so important, he says. Yes, gaining access to those managers, such as the managed futures-fixed income mutual fund Altegris launched with Jeffrey Gundlach and London’s Winton Capital Partners, is expensive, but he argued that “it’s talent worth paying for.”

In a separate conversation, Sundt said that advisors understand that those managers “come with a price,” but also that many clients of advisors would not be able to meet the minimums of a private placement with the likes of Gundlach or Wilton. There’s another benefit of having those managers in a mutual fund, Sundt said: since the holdings of the managers are aggregated for mutual fund reporting purposes, the individual managers “are protected from public scrutiny “ on their specific holdings, while the advisor can see those aggregate holdings. “We net their holding with all the other managers” in the fund, he said.

Moreover, he said, “advisors like the liquidity of a ’40 Act fund,” and that expenses on a fund can sometime be lower, all while gaining access to those top managers.

Kavanagh (left), founder and CEO of Chicago-based Grant Park Funds, said that “cost becomes an issue in the absence of value,“ and pointed out that while those managers might be expensive, to get those fees in subsequent years, the manager has to get above his high-water mark in returns. He suggested that managed futures should be a “core part” of your portfolio, partly because they are “the quintessential diversifier.” An allocation of 5% to 15% of a client’s portfolio would be prudent he said, especially if that portfolio already includes a “long-term interest in fixed income or equities.”

Summing up, Kavanagh said that from a risk-reward vantage point, “there’s never been a better time than now to get into managed futures.”

Long-time AdvisorOne blogger and Investment Advisor contributor Ben Warwick's own managed futures mutual fund was profiled by editor John Sullivan in the January 2012 issue of Investment Advisor.

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