The view from my office gives me the chance to watch dolphins commute along a stretch of the Pacific Ocean every day. I have always been fascinated by the duality of these creatures—mammals that behave like fish.
Having a fin in two worlds, so to speak, may be intriguing in the animal world, but it doesn’t go over well in the investment world. Investment professionals are more comfortable with clear, well-defined categories that help organize their thinking and are more easily explained to their clients.
That gets to the heart of a debate I am having with investment professionals over whether managed futures should be considered an asset class or an investment strategy. My answer, one that probably won’t satisfy anyone, is that managed futures are both.
Simply put, an asset class is a group of securities that have similar risk/return characteristics and behave similarly in the marketplace. Traditionally, we’ve had three—equities, bonds and cash. I think the time has come to include alternatives: hedge funds, managed futures, real estate, commodities and derivatives contracts.
Managed futures are the younger siblings of hedge funds. They’ve been around for about 30 years, and like hedge funds, they are actively managed and typically charge management and performance fees. The people who run managed futures strategies are called commodity trading advisors, a name that harkens back to the days when most of the action was in traditional commodities, like corn, sugar, cocoa and wheat. Today, though, most of the action is in financial futures markets and driven by computer models that spot trends and signal to managers to go long or short the S&P 500, for instance, or interest rates or currencies.
Managed futures meet the definition of an asset class: shared characteristics, attributes and risk/return relationships. They tend to be highly liquid, sometimes volatile, and have little correlation with stocks and bonds. Look at the Altegris 40 Index of managed futures’ performance in 2008 (see chart, left). Then (as now), managed futures were going in the opposite direction of the S&P 500. That’s exactly what an asset class is designed to do. Managed futures were even more non-correlated than other alternatives such as long-short hedge funds in the 2008 crisis.
The first question you must decide for your clients is, what assets belong in their portfolios? An investment strategy, on the other hand, answers the “how” question: How are you going to allocate money within the asset class? For instance, once you decide to allocate 65% of assets to equities, do you steer assets to U.S. equities or foreign stocks? Value or growth? Small cap or large cap? Developed or emerging?
Similarly, once you decide to allocate assets to alternatives, you decide on a strategy using hedge funds, managed futures, real estate, commodities or derivatives. In this formulation, managed futures are more like a strategy than an asset class.
In his classic book on portfolio management, “Pioneering Portfolio Management,” Yale University’s Chief Investment Officer David Swensen wrote that “just as sartorial styles change, investment fashions ebb and flow.” The basic challenge, he said, “lies in fashioning portfolios positioned to succeed in the environment to come.” I think alternative investments, especially managed futures, have a place in the environment to come.
The graph originally published with this article incorrectly identified the indexes. The graph above has been corrected.