Back to the Futures?

Prompted by China’s stock market falling back to earth, volatility soared as stock prices gyrated wildly around the globe. The stress test led many investors to ask if managed futures had, in fact, provided protection on the downside. More to the point, did managed futures repeat their stellar 2008 performance and deliver the only positive performing strategy out there (not counting cash)?

As I write this, the third quarter has a few weeks to go, so it’s too early to know whether to applaud or throw tomatoes. Still, a hint emerges from Morningstar’s flash report on a week in late August that compared the returns of nine categories of liquid alternative mutual funds with the S&P 500 Total Return and the MSCI World Index.

As the table below shows, only two categories showed positive returns: bear market funds (which are, by definition, always short the market) and managed futures funds.

For a couple of reasons, our view at Altegris is that volatility, after years of (mostly) low levels, will revert to the mean and be higher. One reason for higher volatility is the anticipation of the Fed raising interest rates. More broadly, it will be spurred by diverging economic policies among Europe, Japan and the U.S. As the U.S. ends its policy of quantitative easing, Europe and Japan are still priming their economic pumps. Years of placid prices, all moving in lockstep regardless of the fundamentals, could be coming to an end. We also expect inflation to show up and contribute to volatility.

It’s our view that managed futures and active management generally do better in volatile markets. Volatility gives managers — and their computers — the chance to identify trends and run with them. As my colleague Jack Rivkin observes, managed futures managers are always on the lookout for signals, for patterns that point to a trend. During periods of low volatility, it’s “hard to separate signal from noise,” he wrote in an Altegris blog, adding that when volatility spikes even briefly (as it did late this summer), “there’s a signal in there somewhere.”

If these markets behave the way we think they will, we’re likely to see larger gaps between the top-performing and bottom-performing managers. Whereas the performance of managers of large-cap stock portfolios has been clustered in a tight range, managed futures managers have shown much greater dispersion over the last few years. That’s why we favor the multi-manager approach in managed futures. While investing in one manager offers the chance to hit the ball out of the park, he or she could also strike out. Instead, we think it makes sense to try to build a whole team of strong hitters.