Thursday, June 23, 2016

Managed futures has lost market share - whose fault is it?

The premise for holding managed futures is that it is a true diversifying investment style. Managed futures will have a low correlation with traditional asset classes and it will have crisis alpha, the ability to have negative correlation during a market dislocation. 

Managed futures is able to deliver this low correlation and crisis alpha because it is divergent trading strategy whereby it makes money when markets have movement away from an equilibrium price. Trend-following has been characterized as being long volatility or long a straddle. It makes money when markets move to extremes. By any style description, it will be different than mean-reverting or convergent strategies that try to generate return in traditional asset classes through alpha generation with lower market beta. It is a different style.

Yet, managed futures has been getting a smaller piece of the alternative investment allocation pie. After the Asian Crisis and Tech Bubble, allocations went from 20% to less than 10% of money invested in alternatives. Managed futures generated its crisis alpha and investors allocated to other strategies. The allocation percentage increased in 2008 but this may have been partially associated with better performance as opposed to investor allocations. Nonetheless, allocations moved up to 15% three years after the Financial Crisis only to fall again to approximately 10%. The vivid fear of a crisis increased allocations only to fall again as the crisis began a more distant memory.

While investors ultimately are responsible for their allocation decisions, the burden is on the managed futures industry to tell a better story for why an allocation to a divergent strategy is needed. Any investment like managed futures that does better in "bad times" will have a lower risk premium and may underperform during normal times. 

I am not going to use an insurance argument that poor performance is a price that must be paid not different than a premium paid for protection, but the industry has to better articulate both crisis alpha and stand-alone or normal return expectations. It is the responsibility of managed futures managers to educate and manage expectations on performance and its diversification benefit. Investors do not seem to get the story, so the burden is on managers to craft a more effective message or rework their funds to deliver what investors want without throwing out their uniqueness. 

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