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Back to the Futures?

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I wish I had Lee Lantz’s marketing talents. Lantz was a Los Angeles fish merchant who repackaged the Antarctic toothfish in 1977. He called the fearsome-looking specimen, with its bulging eyes and protruding teeth, Chilean sea bass, even though it’s not a bass and doesn’t swim off Chile’s shores. As evidence of Lantz’s marketing success (and the fish’s dwindling numbers), my local fishmonger charges $33 a pound for it.

About the same time Lantz was toying with new fish names, I was starting my career in a then-obscure corner of investments: managed futures. Even though I think managed futures belong in everyone’s portfolio, the concept has been a marketing challenge. If my relatives thought “managed futures” was a counseling service for college seniors, well, who could blame them?

Explaining its strategies to newcomers and tackling, say, the role of algorithmic-driven trend following can lead to clients’ eyes glazing over. The managed futures industry is very diverse, but managers who rely on trend-following models to identify patterns early that will last for a period of time have the bulk of the assets under management.

Yet if it’s diversification you are looking for, it’s worth spending some time getting comfortable with this asset class sooner than later. Financial markets are creating a potentially favorable environment once again for this historically highly non-correlated approach.

Start with what some commentators are calling the “stress test” of 2015, those weeks in late August and early September when markets swooned and volatility increased.

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.

Alternative Mutual Fund Returns During August 2015 Downturn Source: Morningstar

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.


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