Morningstar Advisor - June/July 2013 - (Page 45)
Managed Futures and Cash Rates
By Terry Tian
Before attempting to cash in on managed-futures funds,
understand how these funds use cash.
Managed-futures mutual funds introduced
the concept of momentum-based futures
trading strategies to many investors. Before the
first such mutual fund launched in late 2009,
managed-futures strategies were only
accessible to those who had the wherewithal
to open a futures trading account and several
hundred thousand dollars to invest. Now,
50 different managed-futures mutual funds are
available to all types of investors, with
minimum investments as low as $500. These
funds often lure investors with statistics
such as the near-zero long-term correlations to
stocks and bonds, as well as the amazing
historical returns of various managed-futures
industry indexes. What the fund marketing
materials, and even academic literature,
fail to explain, however, is how many of these
historical returns were attributable to high
interest rates. After all, since short-term
interest rates dropped to near-zero levels at the
end of 2008, managed-futures strategies
have languished.
In this article, we estimate the proportion of
cash returns of managed-futures trading
programs (both private pools and separate
account composites) in the Morningstar MSCI
Systematic Trading Hedge Fund Index (which
had 128 constituents as of January 2013)
and the relationship between interest rates and
managed-futures returns.
Cash Efficiency
Unlike traditional investments, such as stocks
and bonds, futures contracts are traded on
margin. This means that an investor needs only
a small percentage of the total (notional) value
of the contract up front (about 5% for the
E-mini S&P 500 contract, for example). Margin
requirements are higher for more-volatile
assets, such as some commodity contracts.
Often, managed-futures trading programs only
use 15% of their assets for margin (this is
called the margin/equity ratio).1 The rest of the
assets sit in cash-like instruments, typically
short-term U.S. Treasuries.
This special structure enables managers to
easily adjust a managed-futures fund’s
leverage to match their clients’ risk appetites
(a two times leveraged program, for example,
would use 30% of the total account assets for
margin purposes, instead of 15%), and it also
frees up the capital to earn additional
short-term interest-rate returns aside from the
futures strategy returns.
Excess Returns of Managed Futures
Many studies touting the benefits of managedfutures returns often fail to mention that
these returns come from both futures trading
as well as from interest earned on the
cash collateral. For example, Schneeweis,
Spurgin, and Szado (2012) studied the return
drivers of three indexes—Barclay CTA Index,
CISDM CTA Asset Weighted Index, and
CSFB/Tremont Managed Futures Index, each of
which had returned more than 6% annualized
between 1994 and 2009—but do not delve
into the effects of interest rates on the funds’
returns.2 In today’s near-zero interest-rate
environment, the returns on cash seem
negligible, but over the period studied,
short-term interest rates were much higher.
Looking at our own data, the Morningstar
MSCI Systematic Trading Index returned
an annualized 8.6% between January 1994 and
December 2012, while three-month U.S.
Treasuries returned an annualized 3.1%. If we
assume that the index constituents invested
85% of their assets in three-month Treasuries
and 15% in futures contracts (which results in a
notional exposure of more than 100% of
assets), the cash portion would have contributed 2.6% of the returns over the time period
1 Based upon commodity-trading-advisors programs that disclose this information in Morningstar’s hedge fund database. 2 “Managed Futures: A Composite CTA Performance
Review,” by Thomas Schneeweis, Richard Spurgin, and Edward Szado.
MorningstarAdvisor.com 45
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Table of Contents for the Digital Edition of Morningstar Advisor - June/July 2013
Morningstar Advisor - June/July 2013
Contents
Contributors
Letter From the Editor
Not Your Values
How Do You Use Alternatives for Clients?
Working to Build a Niche
How to Put Buffett’s Investing Philosophy into Practice
Sophisticated Strategies for the Masses
Investments á la Carte
Investment Briefs
The Percentile Trap
Defense Firms Will Stay Aloft
Beware the Lure of Diversification
Using Alternatives in Practice
Managed Futures and Cash Rates
The World Is Getting Grayer
Waiting to Pull Up Anchor
The Price of Managing Volatility
Let’s Get Back to Basics
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Mutual Fund Urban Myths
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