Airbags and Antilock Brakes

Over the past year, the Managed Futures category has suffered net outflows of approximately $2.8 billion, equating to roughly a 10% reduction in total AUM on a year-over-year basis, after accounting for the performance of the category. Those net outflows give Managed Futures the unenviable distinction of landing at the bottom of all of the Morningstar categories that we track, inclusive of both live and dead¬†mutual funds and ETFs, across 8 alternative categories, 18 equity categories, 18 fixed income categories, and 1 commodity category. This may be understandable (albeit unjustifiable we’d argue) in light of the fact that with a one-year category average return of -4.7% through the end of August, only Bear Market (-24.4%) and Long Government (-5.7%) funds performed worse. Interestingly, Bear Market and Long Government funds experienced performance-adjusted net inflows equating to 18% and 5% of total assets under management, respectively, despite their performance. Hmm.

We’re not exactly sure what to make of this. All three of these categories offer diversification benefits and hedging properties, all three have posted poor 1-year returns, and yet only Managed Futures has struggled from a flows perspective. Admittedly, the Bear Market category is by far the smallest category that we track, appealing to only a narrow subset of investors, and therefore, perhaps we shouldn’t read too much into those numbers. Long Government is also relatively small, but is almost ten times the size of the Bear Market category, and is about a third larger than the Managed Futures category. But as we think through the reasons that investors may want to take on the risk that comes with a duration of almost 18 years (based on TLT) for so little yield, we’d hazard a guess that the forces governing flows into Long Government are more tactical in nature, perhaps as a hedge to all of the geopolitical issues in the news and/or a long-awaited equity correction of some sort. In any event, strategic allocations to Long Government funds at this stage in the interest rate cycle seem unlikely (as do strategic allocations to Bear Market funds over any time period).

If investors are gravitating to Bear Market and Long Government funds because of North Korea, fears of the impact of de-globalization and increased nationalism, or because they caught a glimpse of an odd-looking horseman riding across the fire charred plains of the west, the hurricane ravaged beaches of the Caribbean, or the piles of rubble in Mexico, they might want to stop and rethink the rationale for these allocations, the costs and risks associated with those trades, and the foresight required for these tactical bets to pay off. In fact, investors more broadly, who have been pumping vast amounts of capital into all things equity and fixed income, at the expense of almost all things hedged or uncorrelated, apparently sanguine in the belief that we’ll have continued growth without inflation for years to come, would be wise to consider the merits of a group of strategies that can, according to a recent paper co-authored by the Alternative Investment Management Association and Societe Generale:

  • offer diversification benefits, dampen portfolio volatility and provide uncorrelated returns
  • demonstrate strong performance over long-term horizons, especially in comparison to
    traditional equity and bond markets
  • lower and shorten drawdowns associated with a traditional 60/40 portfolio

For those who would brush off such advice because “everything in my portfolio has been working”, or because even as a seasoned investment professional with 5-7 years of experience, there’s never been much of a reason to own managed futures or other liquid alternatives, we’d pose the following question, exactly how many accident-free miles can one drive before deciding to buy a car without airbags and antilock brakes?

Read our related article, Managed Futures: Complex Strategy, Simple Purpose