Practical analysis for investment professionals
12 October 2015

Managed Futures: Will They Thrive with Higher Interest Rates?

Posted In: Derivatives

Managed Futures: Will They Thrive with Higher Interest Rates?

When will the US fixed-income market shift into a secular bear market?

In 1981, the 10-year Treasury peaked at close to 16%. Since then, the US fixed-income market has more often than not enjoyed a bull market over the past three decades (Here is an excellent New York Times article from 1981 that shows a completely different perspective on the future of yields). Furthermore, the US Federal Reserve has maintained a zero interest rate policy (ZIRP) since December 2008. How long can this last? What are the ramifications if we enter a multi-decade fixed-income bear market? This future shift in the capital markets has large implications for fixed income and equities alike.

The discussion about the future of fixed-income markets has coincided with highly volatile equity markets. Volatility can be painfully endured or it can be captured to a portfolio’s benefit. One challenge traditional long-only portfolios face is their inability to take advantage of volatility in their respective financial markets. They also miss the opportunities afforded by volatility in non-financial assets, such as currencies and commodities.

One asset class that has historically thrived in chaotic and crisis environments is managed futures. Though a lesser-known asset class, managed futures still measure $328 billion in assets under management (AUM) as of June 2015. Managed futures can be added to traditional portfolios — institutional, hedge fund, and smaller retail portfolios — to lessen portfolio risk for the same level of return and, during times of crisis, deliver alpha.

But what are they? Managed futures are portfolios holding long or short positions in currencies, commodities, or financial exchange-traded futures. These portfolios are professionally managed by Commodity Trading Advisers (CTAs), the majority of whom use proprietary trading algorithms, though some employ fundamentally managed portfolios. Futures are liquid and transparent and are also leveraged contracts. As such, most CTAs embrace very strict rules on portfolio allocations, capturing gains and limiting losses.

While CTAs have performed well in volatile times, the firm of Welton Investment Corporation sought to determine how CTAs fared during periods of rising rates and falling bond prices. In the white paper, “Going Up? Where to Find Returns If Rates Begin to Rise,” Welton looked at annualized returns for various asset classes during periods of rising rates. The paper tracked the S&P 500, the MSCI World Index, 10-year Treasuries, AAA corporate bonds, and Welton’s proprietary multi-asset model and compared the returns over multiple periods when rates increased. The periods of rate increase were defined as “all periods with sustained rises in interest rates of at least 1.5% trough-to-peak” from 1970–2012. During that 42-year timespan, there were six periods of acute/sustained rate increases: 1973–1974, 1977–1981, 1983–1984, 1987, 1993–1994, and 1999–2000.

The asset class winner by a wide margin was Welton’s trend-following, multi-asset futures models, which was up an average annualized 12.4% during those periods of rate increases. MSCI World Index was a distant second place at 2.4%. The S&P was flat at .2%. In the red were the 10-year Treasury at -1.4% and AAA corporate bonds at a whopping -10.4%.

Gains within Welton’s multi-asset class trend following came from:

  • Long positions in commodities
  • Long positions in currencies
  • Short positions in currencies
  • Short positions in fixed income

The losses came from:

  • Long positions in equity indices
  • Short positions in equity indices
  • Long positions in fixed income

Other CTA firms address performance and sector attribution in rising rate environments. Some white papers have findings similar to Welton and some disagree. All of this research is worth reading.

Many of these studies use hypothetical models in part because they are attempting to capture a longer period of time than the existence of a particular CTA or even the recorded history of CTAs, which represent a relatively new asset class. Nonetheless, performance histories provided by CTAs are audited. Their weakness just happens to be their lack of historical data. Traditional long-only portfolio managers have limited options at their disposal to offset, buffer, or take advantage of market volatility by simply holding equities or bonds. Therefore, managers should look to add asset classes that were designed to handle volatility while maintaining liquidity and transparency.

For the purposes of full disclosure, I have had no business dealings with the CTAs whose studies support the case for CTAs in times of rising rates.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

An investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Photo credit: ©iStockphoto.com/FrankRamspott

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About the Author(s)
Jeannette Showalter, CFA

Jeannette Showalter, CFA, is a commodities futures and managed futures specialist, working with institutions and individuals. She is an AP with Walsh Asset Management headquartered in Chicago. Previously, Showalter worked as an institutional manager for People's Bank (the bank's account); family wealth office management; and risk arbitrage at Paine Webber. She was the Money and Investing columnist for Florida Weekly ( 2010 -2015). Showalter earned her MBA (Magna Cum Laude) from New York University in 1978, and her undergraduate degree from the University of Connecticut in 1974.

2 thoughts on “Managed Futures: Will They Thrive with Higher Interest Rates?”

  1. Brad Case, PhD, CFA, CAIA says:

    Your analysis is way to clever for its own good, Jeanette–especially when you say, incorrectly, that “One challenge traditional long-only portfolios face is their inability to take advantage of volatility in their respective financial markets.”
    Traditional long-only portfolios capture the volatility premium–higher returns that investors in (all) relatively volatile assets earn because other investors want to avoid volatility. In fact, investors can make use of the volatility premium in one of three ways: (1) try actively to time the market to take advantage of volatility, as you suggest, but fail miserably and end up with worse returns; (2) try actively to time the market to take advantage of volatility, as you suggest, and succeed on a gross-of-fees basis but pay out all of the incremental performance in the form of high active management fees; or (3) ride out the volatility and simply collect the premium.

  2. jeannette rohn showalter says:

    Thank you for your comments.

    Firstly, the posting’s purpose was to put forth several studies undertaken by well-known CTAs that attempted to address how CTAs might perform in a rising rate environment. Not my studies and conclusions; their studies and conclusions. You made no comment about the studies referenced.

    As best I understand your comments, you take objection to my premise that traditional equity/bond investors cannot capture/take advantage of the volatility in equities or bonds (…as, it is my contention, they lack an appropriate vehicle or aptitude or disciplines or emotional wherewithal etc.) You take the opposite position as you state that:
    1 “Traditional long-only portfolios capture the volatility premium–higher returns that investors in (all) relatively volatile assets earn because other investors want to avoid volatility”
    2 “… Long only investors can ride out the volatility and simply collect the premium.”

    And to that I take objection. Research does indicate that the hefty equity-volatility premium can be captured by a buy-hold strategy…but this capture (or as you state “simply collect the premium”) can only be expected to be true for investors over a long time horizon. e.g. investors who “can ride out the volatility” over a 25 to 30 year period. This would not be the case for: many retirees, those soon to retire, or pension funds looking to meet commitments within a much shorter period of time e.g. one to five year time periods.

    The size of the equity volatility premium is large, 5.95% per year, figured as “the mean of the annual equity (volatility) premium from 1963–2011.” But, as “the standard deviation of the equity premium is also large—17.85%, or three times the mean, …the year-by-year values of the premium are volatile….Fama and French estimate there is almost a one-in-four chance that the average premium for a five-year period will be negative; that is, T-bills will beat stocks. …As the time horizon increases, the standard deviation of the average equity premium drops from 17.85% for a one-year period to 7.98% for five years, 5.65% for ten years, 3.57% for 25 years, and 2.53% for 50 years. (Source: Cardiff Park Investors referencing Fama and French; http://www.cardiffpark.com/portfolio-design/volatility-and-premiums.)

    As to your other points…Yes, the typical investor fails to time the market ….as typically their tools, systems, portfolio rules are not technically oriented and they are fundamentally trying to decide peaks and troughs. That is just does not work well for those investors does not mean it does not work well for other types of investors. For CTAs that are algo based, you need to only look at the history of returns (audited and after all fees) to see that the CTA indices are less volatile than stocks and have been able to take advantage of past equity crises.

    Lastly, you suggest that portfolios that “actively time the market to take advantage of volatility…. succeed on a gross-of-fees basis but pay out all of the incremental performance in the form of high active management fees.” That is simply not true for the asset class of CTAs and again I reference the histories of several CTA industry indices which are net of all fees.

    Jeannette Showalter, CFA
    Walsh Asset Management
    Branch Office Naples FL
    jshowalter@walshtrading.com
    239-571-8896

    An investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

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