Hedge Funds: Managed managed futures
What value can a fund of funds add for the managed futures investor? Martin Steward asks Thomas Weber of LGT Capital Partners, whose Crown Managed Futures fund is celebrating its tenth birthday
Of all the mainstream hedge fund strategies, managed futures delivers perhaps the most consistent diversification against core portfolios. Most investment decisions are made by people, based on fundamentals, creating positions that are short-volatility and demand liquidity from the market. By contrast, managed futures is biased towards systematic trading of technical price signals, and creates long-volatility positions that provide liquidity to the market. It is one of the oldest hedge fund styles; it trades the most liquid markets; despite the ‘black box' caricature it is probably the most transparent, and certainly the most amenable to managed accounts; and it has seen hardly any disorderly blow-ups.
In fact, count up investor gripes about hedge funds in 2008 - no performance, no diversification, no liquidity, no transparency - and managed futures scores well against them all. Few asset classes can match its 6.5% annualised returns over the past 10 years (as defined by the Barclays CTA index), and investors are beginning to look past its volatility and even see it as a positive in combination with its diversification benefits. Some will want to overweight in addition to what they get from their diversified fund of funds - or perhaps even allocate to managed futures alone among hedge fund strategies.
The first instinct will be to go to a fund of funds adviser. But is that necessary? Another interesting characteristic of managed futures is that it is dominated by programmes specifically designed to achieve their own diversification - across markets, instruments, trading time horizons and styles. Can placing them together in a portfolio add more? As David Harding, founder of leading trend-follower Winton Capital Management told IPE earlier this year: "Most managed futures programmes are strongly correlated with each other - it's as simple as that." So what value can a fund of funds add to simply picking a handful of robust managers and letting the returns roll in?
Thomas Weber, partner and head of hedge fund investments at LGT Capital Partners, is well-placed to make the arguments. The firm has been allocating to managed futures since 1996 and now has about $1.5bn in the strategy. Ten years ago it created its Crown Managed Futures Fund, a portfolio that spun out and extended the allocation from its diversified fund of hedge funds. At 9.1% net annualised since inception, it has comfortably improved on the Barclays CTA index.
With its holding of 8-15 programmes, it implicitly acknowledges some limits on diversification. Weber says that it is possible to diversify trend followers by time horizon, markets (some have more or less of a bias to commodities, for example) by model (some are based on moving averages, some on pattern recognition, others on complex interactions of these and other signals) and of course by size and business risk. "But," he concedes, "if there are very strong trends they will all tend to be long or short of them."
Where diversification really does help is in markets where there are no strong trends - like the sideways, whipsawing markets of 2004 or 2009. Trend followers thrive even, indeed especially, when trends are as apocalyptic as they were in 2008. But in whipsawing markets the best you can hope for is to sit on cash and deliver LIBOR minus a fee; worst-case, you pick up false trends, keep getting stopped out when they reverse early, and die a slow death by a thousand cuts.
"The whole concept of a CTA fund of funds is to create a long-volatility profile overall," Weber explains. "But this is not an insurance product. Insurance products cost money. So we need to mitigate against those periods of whipsawing markets."
This is why the Crown portfolio is, to some extent, conceived as being split between a set of trend followers (exhibiting relatively small diversification against one another) and a set of non-trend followers (exhibiting good diversification against both the trend followers and one another). These are a collection of systematic fundamentals-trading managers, classic discretionary global macro, short-term traders and ‘miscellaneous' FX specialists and multi-strategy programmes.
"Last year suited short-term traders much better, and they were also good for some fundamentals-based strategies and currency funds," says Weber. "They also helped out in May this year, when markets reversed unexpectedly with the euro-zone crisis and the ‘flash crash'. By managing the different sub-categories actively we believe that we add value."
The fact that strong trends can concentrate and unify many managed futures portfolios - even across both trend followers and high-frequency traders - makes top-down exposure management important, too.
"At the end of August we had a significantly net-long exposure to fixed income in our programme and we were worried about a reversal," says Weber. "We had one manager in particular with 80% of his value-at-risk in fixed income, so it was a simple decision whom we should take risk away from. By contrast, by the end of September our managers had moved onto the equity trend, but at portfolio level we thought we had too much and rebalanced back towards managers with more fixed income. Usually we are not that active because timing is very difficult, but if you see a significant concentration like long-equities or long-carry currencies you begin to feel susceptible to reversals and may want to take some risk out."
Moreover, there is an important bottom-up discipline, too. We have already noted the excellent liquidity available in managed futures - Weber warns of its dark side. When investors' illiquid credit hedge funds lost money through 2007-08, many had little choice but to sit there and take it. But if managed futures hits a losing streak it is also too easy to pull your money - and, by its nature it is among the worst strategies for sucking investors into the ‘buy-high, sell-low' reflex.
"CTAs can have big drawdowns," says Weber, "and we oblige our salespeople to talk about those drawdowns. A CTA with a double-digit net return since inception eight years earlier once told me that his clients had all lost money with him, net-net. How could it be? Because they came in at the height of his performance, and gave up hope in the trough of his subsequent drawdown."
An institutional investor who wants to go it alone might protest. Surely diversifying between trend followers and other strategies and then rebalancing the portfolio can be done with a simple, non-emotional process around a dozen or so programs? Weber is not so sure.
"Timing investment strategies is the Holy Grail - and no less so with CTAs," he says. "Many have tried to systematise the process - but of course the CTAs themselves are moving their risk up and down very quickly and it really can't be done. Also, active management involves cutting managers where you think there are business risk issues or where you feel the programme simply doesn't respond well to the markets anymore. I think it's quite a craft to make those decisions about taking managers out at the right time."
After 10 years at the helm of Crown, few bring the same level of experience to that craft as Thomas Weber and his team at LGT.