Managed futures offer protection when equity markets are at their worst. But they don’t come cheap — or easy.
Allocators seeking exposure to managed futures have to pay high fees to the hedge funds that trade futures contracts, known as commodity trading advisors. And, since performance varies widely among these CTA hedge funds, allocators have to diversify their investments across five, six, or more managed futures hedge funds in order to offset volatility.
Liquid alternatives firm Dynamic Beta investments has launched an exchange-traded fund that it believes solves both of these problems. The actively managed ETF — an iM Global Partner fund that is subadvised by Dynamic Beta — replicates the returns of a diversified pool of hedge fund managers by using exchange-listed futures contracts with a price tag of 85 basis points. This is compared to fees of 300 to 500 basis points on average for a hedge fund doing the same thing, according to Dynamic Beta, which recently sold a minority stake to iM Global.
The fund’s goal is to match or outperform the pre-fee performance of leading CTA hedge funds.
“We were trying to identify a strategy that would diversify equity and bond risks. We evaluated managed futures because it’s hard to add something to protect a portfolio that doesn’t also cost investors a huge amount of money as they wait for an event,” said Andrew Beer, managing member of Dynamic Beta investments. “Tail risk strategies, for example, cost money every year and people give up.”
Beer started researching the pre-fee returns of hedge funds that report data to Societe Generale’s CTA index, which has a history dating back to 2000, in 2015.
“We found in our research that if we decomposed the returns over the past 20 to 60 trading days, we could figure out if — as a group — these funds were long or short commodities, the euro, U.S. Treasuries,” he said.
The results showed that the before-fee performance of managed futures offered the best protection of a range of alternatives. “Managed futures offered more diversification bang for the buck than we were able to identify from any other area,” he said. "Managed futures had outperformed stocks and bonds, had no correlation to either one over the past 18 years, and tended to do best when equity markets do the worst.”
Using returns-based analysis, Dynamic Beta now identifies on a weekly basis the market exposures of a pool of hedge funds by analyzing the past 20 to 60 days of activity. The firm then implements those views in the ETF by investing in long and short positions in domestically traded futures contracts.
In addition to being cheaper than a hedge fund, the ETF addressed the need to invest in either multiple hedge funds or a fund-of-funds.
“One of the biggest changes in liquid alternatives has been an appreciation of single manager risk,” Beer said. “If a pension fund decides to invest in managed futures, few would say we’ll only invest in this one fund. They know that every year the difference between the top and bottom performers might be 30 percent, and in more volatile markets it could be more than 50 percent. You need six to eight managers to diversify that out.”
The trick, according to Beer, is to keep fees and trading costs low.
“Fee reduction is pure alpha,” said Beer.