We couldn’t wait to get our hands on the July Edition of Modern Trader Magazine, dedicated entirely to Managed Futures. It’s a detailed examination into the current state of Managed Futures and where the future could take the industry.
The articles inside look at how exchanges are pioneering new contracts, the rise of AQR as the new leader in the Managed Futures space, the Turtle Trader that’s taking on AQR in the liquid-alt space, and how some in the business think Managed Futures is transitioning to a “benchmark business.”
There are good insights on each page, but the article we found the most interesting was “Chesapeake Capital: The Evolution of Managed Futures from the Eyes of a Turtle.” Futures Magazine (Modern Trader is the upgraded reincarnation of the old Futures Mag) veteran Dan Collins interviews one of the select few who were accepted and succeeded in the turtle traders program, Jerry Parker. And with more than four years of experience in the liquid alternative mutual fund world, Jerry is convinced this is the future of Managed Futures.
Here’s our takeaways from the article:
1. On the managed accounts/ private funds vs. mutual funds “game.” Parker, an advocate of mutual funds, makes it pretty clear where he thinks the industry is going.
“They want to go back to managed accounts and the private placement funds that charge 2 and 20, but that game is over. If you want to get in the mutual fund business and be serious you are going to have to compete with best practices.”
The main argument for that game being over is the success of AQR – which has raised Billions in short order with a flat fee of just 1.25%. On the flip side, Liquid Alts still only represent 12% of the entire Managed Futures space, so there’s plenty of happy customers still paying higher fees. The consensus from where we sit seems to be unique and different managers will still be able to charge traditional 2&20 like fees, while models which act more like trend following beta will continue to battle on fees. Of course, the next step will be firms offering Alpha at Beta prices in order to compete, which throws it all on its head once again.
2. On Crisis Period (negatively correlated) Performance vs. Non-Correlated Performance. We’ve been talking about this for a while, and it’s one of the few things we think everyone in the industry is on the same page about.
“One thing Covel and Parker agree on is that it is a mistake to focus solely on trend-following’s tendency to perform well in down equity markets, so-called crisis alpha. While managed futures’ performance during poor equity markets has been strong, its main advantage is non-correlation and ability to do well in all market conditions.
“I agree with Jerry Parker that the idea of selling it only as crisis alpha is a mistake,” Covel says. “It is part of this investment strategy but clearly you can make a lot of money [in trend following] whether stocks are cratering or not. It is that double-sided coin. The business is multiple.”
3. On a Managed Futures allocation of 50-60%! Jerry Parker goes way out on a limb here in terms of what’s currently socially acceptable in terms of allocation percentages, although you can’t fault his logic.
“Diversified CTAs should be 50% to 60% of your portfolio. Instead of adding 5% to 10% CTAs, you should start with CTAs and see what improves that. Perhaps some long S&P 500 [strategy], Parker says. “The truth of the matter is diversified CTAs have the highest risk-adjusted performance and should be the core.”
We’ve covered allocation percentages in detail here and here, and there is no right or wrong allocation number for Managed Futures, mainly because it doesn’t exist in a vacuum. The right allocation to Managed Futures differs greatly on your own personal expectations for the asset class. Are you expecting a certain annualized return, max risk, or merely a portfolio benefit as Mr. Parker suggests? You need to answer all these questions before you get an idea of how much Managed Futures should be in your own portfolio, although we’ll agree that the number is often too small to make a difference one way or the other.
4. On Single Stock Futures vs. Stock Index Futures? While you don’t hear of many futures professionals messing around with individual equities, Parker’s Equinox Chesapeake ($EQCHX) fund sees single stock futures as an advantage over the competition.
“We are probably one of a few CTAs that have a material allocation to equities and with those equities we trade single stock futures,” he says. “It is a huge edge to not trade those indexes and trade the single stock futures where you can get more suited to trend following as far as having outlier trades and massive diversification. If you trade 100 stocks versus 20 indexes, the stock can act a lot different, the indexes tend to be correlated even if they are Asian, European and U.S. indexes.”
We can’t fault the logic here. If a model has positive expectancy, you want to roll it out on as many markets as possible. Similarly, if one of the main risk controls is diversification, then it pays to diversify as broadly as possible – both among sectors and within a sector.
5. On the Sharpe Ratio Hurting interest in Managed Futures? We’ve always had issues with the Sharpe ratio (see here and here), because it believes risk equals volatility. There’s way more to risk than just volatility, and upside volatility surely can be a good thing – so why discount (via a lower Sharpe ratio) programs which put up big upside numbers. Jerry suggests looking at what your portfolio Sharpe ratio (after allocating to managed futures) rather than the ratio of one investment style in your portfolio.
It hurts in a couple of ways. They are hitting the CTAs like it is the only hedge fund strategy that is doing that. Trend-following CTAs feel a need to have these high Sharpe ratios,” Parker says. “It would be much better if they were just transparent and explained trend following and show that the clients portfolio will have a higher Sharpe ratio by [allocating to] trend following. The whole idea of trying to put [other elements] in a system and try to improve your own Sharpe ratio is not a good business idea. Clients appreciate knowing exactly what they are going to get and trend following offers that. When markets trend you are going to make money, when they don’t you won’t.”
For the full article on Jerry Parker, Michael Covel by Dan Collins, check it out here.
