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November 11, 2010 at 01:05 PM
The managed futures industry has always suffered a kind of identity crisis that is reinforced in popular culture as well as by our own nomenclature. Images of the Chicago and New York exchange pits from the 1980’s and 90’s featuring open outcry, hand signals, pit runners and the prospect of fortunes made and lost on beans or oil are far more stimulating to the public’s imagination than the reality of today’s largely computer-driven, trend following trading systems.
Eddie Murphy and Dan Ackroyd selling short the market in orange juice futures in the 1983 film "Trading Places” is arguably more entertaining to most than watching a team of researchers discussing stochastic oscillators. Names like,the Grain Futures Act of 1922, the Commodity Exchange Act of 1936, the Commodity Futures Trading Commission (CFTC), Commodity Trading Advisors (CTAs) and Commodity Pool Operators (CPOs) lead many people, including financial reporters and investors, to just assume that today’s managed futures managers—and therefore the asset class category as a whole—trade exclusively in commodities. However, the data, I believe, points toward a different conclusion.
What does the data show? And how does it relate to managed futures?
The general perception is that the words “commodity” and “volatility” are normally found in the same sentence. Two of the best known commodity indexes are the S&P Goldman Sachs Commodity Index (GSCI Total Return Index) and the Reuters-Jefferies CRB Index (CRB Index). Both feature baskets of futures contracts designed to represent a broadly diversified, unleveraged long-only position in commodity futures. Significant differences in composition methodology, weighting and revision policies require more detail than we have room for in this discussion. However, a key difference between the two is the role of energy contracts, specifically crude oil. The CRB Index limits the impact of petroleum on the index to 33%. The GSCI Total Return has no such limit.
Accordingly, the respective performance of both indexes reflects this difference in energy contracts. Since 1990, the GSCI Total Return Index has returned 4.1% compounded annually through September 30, 2010. Volatility, driven mostly by fluctuations in crude oil and measured by annual standard deviation, comes in at 21.8% over the same period. The worst losing period, known as “worst drawdown” in the alternative investment world, captures the worst losing streak from top to bottom (in months). The statistic is a whopping -67.7% for the GSCI Total Return Index, and occurred between June 2008 and February 2009. The collapse in crude prices from over $140 a barrel to below $40 is arguably the primary explanatory variable. Meanwhile, over the same time frame, the CRB Index has returned just 1.1% annually, with a 12.8% standard deviation and a – 54.3% worst drawdown. Despite the lower weighting of crude oil, the losing period also occurred between June 2008 and February 2009.
Correlation statistics between the two indexes are interesting. The correlation coefficient is a number between -1 and +1 with the number zero representing non-correlation. Over 20+ years since January 1990, these two long-only commodity benchmarks correlate at 0.76, which is materially high. Over shorter periods, the correlation is even higher; since January 2000 (10+ years) it is 0.84 and since January 2005 (5+ years) it is 0.94.
Interesting (or not), but how does managed futures relate to this discussion? Despite the commodity nomenclature that drives the industry, managed futures should generally not be considered an exposure to commodities It can be, if you choose a specific
