As managed futures becomes more and more mainstream, we’re likely to keep running into more and more arguments from those threatened by their existence (stock and bond, buy and hold type financial advisors), leading to us having more and more friendly debates pointing out the flaws in their arguments.
The most recent example: Larry Swedroe, of the Buckingham Family of Financial Services, published an article yesterday that cited a study on managed futures and, ultimately, told investors to run in the other direction. Why? He makes three key points, each of which deserve to be addressed.
The impression of attaining alpha (read: returns beyond traditional asset return levels) provided by managed futures indices is misleading due to survivorship bias in the indices and fee level representation.
We’ve got a couple of problems with his position. First, he cites a study from Yale that was written based on data from some of the stock market’s most profitable years, and that was published before 2008- the year that managed futures really showed the world what they were capable of. This skews the data in favor of his argument while ignoring the huge out performance of managed futures over traditional asset classes.
Second, all indices suffer from survivorship bias. Did you know that 290 stocks have been deleted from the S&P 500 from 2000-2009? That’s 58% of the index as it stood at the turn of the century gone from the index today. 5% of the index has been deleted in the past year, which is admittedly significantly less than the 15% turnover in the managed futures indices– but probably much higher than most people realize.
But not all managed futures indices have such high turnover. In fact, we responded to a similar piece in the Wall Street Journal back in 2009, and at the time confirmed with Credit Suisse, operator of the Dow Jones Credit Suisse Managed Futures Index that they see an average of just 3% of index constituents fall out of the index each year. That’s less than the turnover of the S&P 500.
In that same retort back in 2009, we cited a test run back in 1994 by Sol Waksman, operator of the BarclayHedge CTA Index, comparing the performance of the entire universe of CTAs in his database versus just those in the index, finding that the entire universe actually had better performance than the index.
Following up with him today, he (sadly) has not updated the results, but did have more to add to the debate.
“[To my knowledge], the Newedge CTA Index has only reported real time results since its inception in approximately 2001. And I do not believe that any of the managers included have gone out of business while in the index,” he pointed out. “In addition, our BTOP50 Index was created in such a manner as to completely avoid survivor bias, instant history bias, and selection bias. So there are plenty of examples that do not support the authors’ conclusions.”
As the kids are saying these days- pwned. (Yeah, we don’t really get it, either, but it’s supposed to be a good thing. Good job, Sol.)
Third, are you investing in the index, or in a specific program? If investing in a specific program – then who cares about the issues inherent in an index? The specific programs’ track record is real, includes all fees, and real people have made and lost money with it (which is required by regulations, contrary to what Swedroe asserts). If you are worried about the issues surrounding a specific program, then just concentrate on the specific program and do as much due diligence as possible on that program, thereby removing any survivorship, backfill, or other additional bias.
That doesn’t mean indices aren’t of value. Think of them as a snapshot of a given asset class or market. They are the vacation brochure which gets you interested, but not the actual experience you have once you get there….that part is up to you and the specific program you invest in.
The primary strategy utilized is trend following, which investors can replicate on the retail market.
Investors can replicate trend following on the ‘retail market’, but that replication will be far short of the real thing, in our opinion, due to thousands of factors- from the speed of trade execution to how much money and staff is spent on research and development.
The Aberration trading system was an off-the-shelf trend following system available to retail investors, which Attain has executed for clients. We can tell you factually that traders utilizing that trend following program on their own have experienced much more volatility and bigger drawdowns than a typical trend following CTA.
We’d be willing to bet that ¾ of people trading futures on the retail side are losing money. Sure, you could try to trade it on your own, but why? You could also cut your own hair, but odds are you’re willing shell out some extra cash to make sure it’s done right. Don’t cut your own hair- invest in managed futures.
These findings mirrored the findings of similar studies performed in the 1980s that found that publicly traded commodity funds didn’t create positive returns for investors. Therefore, the combined evidence shows 20 years without outperformance.
We thought we’d save the best for last. If you follow the paper trail of academic citations provided by Mr. Swedroe and the paper he cites, you find out that the data used to reach this conclusion is way out of sync with the current state of managed futures. The lack of alpha returns assertion was based off assumed average transaction costs in 1985 (you know, the 1985 that was 26 years ago…), with the data being collected from a grand total of….wait for it….20 CTAs. Today, there are around 10,000 CTAs in BarclayHedge’s database, and the total fees charged, based on the CTAs we track, looks to be about half (47% lower) of what Irwin and Borsen calculated in 1985.
The takeaway is two-fold. First off, these criticisms of managed futures are based on bad data, and in no way indict the performance of managed futures as an asset class, or the veracity of its value in a portfolio. Second, you should always check the data being referenced in commentary to ensure it’s being interpreted correctly, or you may end up falling for shoddy assessments like these.