Managed futures index beats equities but not bonds - sort of a good year-to-date?

What is the right traditional asset benchmark for determining the value of a managed futures fund or portfolio? This is not a easy problem because there is a big difference if you choose an equity or fixed income benchmark. 

The diversification mantra for managed futures has been that it adds value when there are "bad times" such as a recession or an asset market sell-off. Some have argued that managed futures has a crisis alpha and have measured the excess return during these bad time periods.  Managed futures will do better when there is a market dislocation. A normal marketing chart shows that managed futures will do well when stocks have a sell-off like the Tech bubble decline, the Asian crisis, and the Great Recession. However, bonds also did well during those crisis periods. Given the lower return profile of managed futures over the last few years,  some have now stated that managed futures is a good bond substitute. In fact, many say that the allocation to alternative investments should come from bonds. So which one should be used for comparison?

Of course, what is perhaps the odd answer is both. Managed futures should provide better diversification than bonds in bad times and it should have a better return profile than the yield carry from bonds. That said, given the active trading and volatility, managed futures should match closer to stock index returns over the long-run but with diversification benefits. Certainly, the information ratio should be higher than either. This is the holy grail.

The graph above shows the SocGen (Newedge) CTA index compared with stocks and bonds through the first three quarters of the year. Managed futures beat both in the first quarter, underperformed both in the second quarter and now has served as crisis alpha versus equities in the third quarter. Bonds actually did better in the third quarter and has had a smoother return. Managed futures have been between the two major asset class returns. 

No strategy should be judged on a nine month period, but a close comparison provides more information on the usefulness of this alternative strategy. The performance of the managed futures index through the first nine months has been mixed. 

Hedge fund behavior for September - some minor bright spots

News headlines have focused on the poor performance of hedge funds for month of September. This was not a great period for gains. Many strategies may have been surprised by the Fed, but there were a few bright spots in a lackluster month. Only four strategies generated positive return across the major HFR hedge fund indices style benchmarks. Managed futures, equity market neutral, absolute return, and merger arbitrage showed gains, but the average return across all strategies was -1.5 percent. The S&P 500 was down approximately 2.5 percent. Four strategies did worse than the stock index. There was nothing to be proud about this behavior, but there was diversification benefit from hedge funds.

On a year to date basis, there has been greater return dispersion across strategies as should be expected. The S&P 500 was down 529 bps through the first three quarters, but hedge funds, on average, were down only 188 bps for the year. What is interesting is that event-driven and special situations underperformed versus the equity benchmark. Market directional and EM composite also showed poorer performance. One should expect that all of these strategies should provide more diversification versus holding a long-only stock basket. 

The market stand-outs include absolute return, absolute market neutral, and merger arbitrage. Merger opportunities in 2015 have been better on the back of cheap financing. Generally, merger arbitrage is highly correlated with the number of opportunities. The market neutral managers have down better with the increase in stock dispersion. Overall, this has not been a good nine months for hedge funds. Expectations are for better absolute return and not stories of relative performance against poor stock returns. Nevertheless, there is strong return dispersion across styles. All hedge funds are not the same.

Managed futures in October - Positive returns in a difficult environment

The leading managed futures indices both showed gains in September. The Barclay BTOP 50, gained 1.74 percent for the month while the SocGen (NewEdge) CTA index rose 1.17 percent for September. Both moved to a flat return for the year to date with the BTOP 50 down 48 bps while the SocGen index is -2 bps for the year. Performance is mixed after hitting highs of 5 percent over the first four months of the year. We like to follow both indices given there different composition of managers.
Performance has reversed with the increase in market uncertainty after the first quarter.

This positive September return was after a strong negative August. This return profile was somewhat surprising given the volatility changes in September and the rangebound behavior for many markets. A closer look at the daily performance shows that loses accumulated for the first half of the month until the FOMC announcement. It was as if there were two separate parts for the month.

To get a feel for managed futures performance, we have presented the performance for the entire third quarter. There usually is a close association of performance across a two month period as positions from the prior month are carried over to the next month. It is hard to get a full picture of the attribution for returns for the indices,  but we can look at the trend behavior over the quarter to get some indication of what were the drivers of performance. 

• Stock indices - The sharp sell-off in late August and early September saw a bounce off of the lows with the dovish announcements of the Fed, but September was still a down month and a continuation the August sell-off. Longer-term CTA's were rewarded for holding positions.
• Bond and rates - Bonds actually rallied through August and September even with a sell-off with equities in late August and a quick reversal around the FOMC announcement. Longer-term traders were rewarded by holding long positions.
• Foreign exchange - Currencies more closely matched the behavior of stock indices with September dominated by chop. For example, the Euro saw little change over the month. The yen was range bound after as strong rally in August. The delay in Fed action has placed downward pressure on the dollar, but slower global growth is putting pressure on EM currencies.
• Energy - The strong down trend in WTI crude oil was arrested in late August, but there was little follow through in September. Any trading gains in energy were focused on short natural gas positions.
• Metals - Metals have still been dominated by China economic announcements. With firming of equities and mixed economic versus policy signals, there has been more market volatility.
• Commodities - Commodities showed mixed market movement with cattle and hogs rallying but other markets following the slowdown trend. Volatility was affected by the Fed announcement. When risk-off or risk-on behavior takes holding financial markets, there is a spill-over to commodities.

While performance for managed futures is flat going into the fourth quarter, the increasing concern about economic growth will often lead to market dislocations and divergences. This type of environment should be good for managed futures if there are no attempts at market manipulation by governments. 

October Global Macro Themes on One Page

Fed fatigue is upon us. Of course, we should care but after so many false starts, the market seems to have moved on to new themes. The chief new theme is slower global growth. EM out flows is not just a currency issue but a response to increased equity and bond risks in EM. This time is not different. It is following the patterns of the past. There will be more focus on economic numbers this quarter than what we have seen in quarter three. Volatility has come down from highs but risks have been going up.