Asset Class Semantics, Comm Theory, and the Art of Debate

We’re not really loud on Twitter. Part of that is because we don’t do business lunches enough where they become so boring you need to snap a picture of your food to tweet; and part of it because the regulators make us keep it pretty vanilla as a disclaimer can’t be packed into 164 characters. However, when Josh Brown from Reformed Broker pointed out an article arguing managed futures is not an asset class and its author… well, we just couldn’t resist a debate. You can check out the back and forth with Michael Kitces on our Twitter profile, but one of the limitations of Twitter is its character limit- particularly when the NFA views each individual tweet as a singular piece of promotional material (makes compliance a little more complicated). So we’re moving the conversation here.

We don’t really want to bash too much on Kitces – he recognizes that managed futures performance can be valuable in a portfolio, and – in that regard – is well ahead of most everyone else in the financial planner space. The disagreement comes down to the use of the term “asset class” to describe managed futures. Our position, as we’ve explained in the past, is that, based on academic definitions of an asset class, managed futures passes the test. It’s subject to unique regulatory guidelines, has attracted a significant amount of capital, delivers performance that cannot be replicated by other established asset classes, and, despite varying strategies within the asset class, boasts similar risk and return characteristics.

Kitce doesn’t really care about the technical definition, and to be honest, the content of his original article wasn’t discussed very much during our back and forth, but he definitely disagrees with our position. Granted, his litmus test for whether or not managed futures should be considered an asset class is whether or not there’s an investable index through which he can get exposure, which had us scratching our heads for a minute. After all, does that mean stocks were not an asset class prior to the launch of index funds? Besides, there are investable indices of sorts in mutual fund wrappers; they’re just not very good. The absence of a quality investable index in managed futures doesn’t prove one couldn’t exist, just that it doesn’t currently.

Beyond the quibbling over criteria for being considered an asset class, Kitces raised another point during the conversation, and one that we hadn’t heard before: referring to managed futures as an asset class was dangerous to the end investor. Clearly, that’s the last thing we want, so we gave his argument some consideration. Kitces contends that if managed futures is an asset class, investors will assume they just need some kind of exposure, and neglect due diligence in the process- behavioral investing that he referred to as a matter of reality. He believes that by calling them managers instead of an asset class, investors will seek out the top talent instead of settling for something less.

We can agree with him on some of this. Investors chase trends. They chase performance. They chase whatever is considered the new hotness today. And, yes, all this chasing often results in poor due diligence on the investor’s part. However, this is where the agreement ends. First off, we don’t buy it. Yes, investors chase trends, but we can’t think of a single investor who says, “Hey, look, it’s an asset class, better get in… give me whatever you’ve got.” And really, any investor making allocations to ANYTHING without doing due diligence probably won’t be in a position to keep investing for long. Other people’s foolishness is not a reason to stop educating others, in our minds.

Ignoring that, though, does referring to managed futures as an asset class hinder investor education? Do they really stop asking questions and examining their options? Not in our experience. We’re in the managed futures space obviously, and we spend a lot of resources on creating educational materials and resources for investors. What we’ve found is that framing the conversation about managed futures as one about an asset class creates a common understanding about its significance in an overall investment portfolio, which is how investors should view the opportunity. Our resident communication geeks tell us it’s a manifestation of coordinated management of meaning, but, whatever you want to call it, it gets us on the right page.

This is a benefit you can’t get when you refer to managed futures as a bunch of active managers. At that point, they’re commonly associated with hedge funds, which, as we’ve covered again and again, are very different from managed futures. In defending managed futures technical classification as an asset class, we get a chance to highlight the features that make the asset class so unique from the rest of the hedge fund space: daily transparency, daily liquidity, non-correlation to traditional asset classes providing diversification value, and a strong history of crisis performance (Disclaimer: past performance is not necessarily indicative of future results). That means a more thorough education, not a more shallow one. The end result is a more informed investor who is better capable of making allocation decisions for themselves- and THAT is the kind of client we love working with.

So we don’t really understand the fear of investors abandoning due diligence en masse because managed futures is being called an asset class. Our experience has been one where investors find out it’s an asset class, learn why it’s different, and, upon learning those differences, very quickly realize that the investing process- including thorough due diligence- is of the utmost significance here. Let’s be honest. If we stopped referring to managed futures as an asset class, would that stop behavioral investing? No, of course not. There will be people who invest in things they don’t understand from now until the end of time. However, NOT referring to managed futures as an asset class DOES limit our ability to leverage the conversation into a greater public understanding of how it works.

Sorry, we’ll run the risk of a few already bad investors making a few more bad decisions in exchange for a more educated public any day. Who knows? Maybe all this babble about the definitions will prevent a few of those mistakes.

What say the rest of you?  What makes an asset class?