Today marks an important anniversary in the world of futures trading, and for managed futures in particular. On this day 35 years ago, the Chicago Board of Trade introduced US Treasury Bond Futures, and the CME Group marked the occasion by posting a photo of the pits from the 1980s. This is an occasion we’re happy to mark, because managed futures in particular owes the bond pits one heck of a birthday present. You see, bond futures have been very good to the industry, and a big part of that crisis performance we’re always talking about. We wrote in depth about this topic about a year ago, but here’s the gist:
To show just how much of a lift the bond sector provides to managed futures, we ran a test using a basic trend following model as a proxy for managed futures (a very large assumption, but stick with us for a moment). We ran a back test using this trend following model on a portfolio of 49 markets on data back to 1990 to see just how much of the model’s overall performance (and by extension managed futures) was thanks to the bond sector.
Our trend following model was a simple Bollinger Band breakout approach where long trades were entered when a market broke above the top Bollinger band, and a short trade initiated when the market broke below the lower band. Stops were placed at the 80 day moving average.
We assumed a $1 Million account value and risked a fixed 0.25% of equity ($2,500) on each trade. Further, we applied sector limits by only allowing the model to take up to 4 positions in any one sector at a time. The resulting test showed the following percentage share of overall performance per sector:
[Disclaimer: the following tables and charts are examples of the educational topic discussed herein and do not represent trading in actual accounts. Any results should be considered hypothetical in nature].
That’s right – over 24% of this trend following model’s returns were from the bond sector. That’s a far cry from boring, and why CTAs usually get excited when they see a new bond position initiated. It is also worth noting in the above that close to 60% of returns since 1990 for this model were from financials (bonds, stocks, and F/X or currency futures). Now we know why the Winton Capital’s of the world are able to manage Billions of dollars (hint – it’s not in Lean Hogs).
Here’s where things get fun – in looking at bonds in a classic managed futures type strategy during crisis periods. After all, that’s one of the main reasons people look at managed futures – to get access to that crisis period performance. We first checked to see that our trend following model correlated highly to managed futures in general during the past six crisis periods, and it did with positive performance in all six crisis periods. We then looked at what the performance of just the bond sector was during each of those periods, and finally calculated what share of the model’s performance during those crisis periods was due to the bond sector. Turns out over half of the performance is from the bond sector.
Crisis Period Stock Market Trend Following Model Bond Sector Perf. within Trend Model Share of Performance Feb – Jun 1994 – Surprise Fed Rate Hike 0.05% 0.71% 0.81% 114.08% Jul – Aug 1998: Long Term Capital Mgmt -15.57% 10.97% 1.45% 13.22% Mar 2000 – Sept 2002: Internet Bubble Bursts -45.60% 21.19% 13.43% 63.38% Sept 2001: 9/11 Tragedy -8.17% 2.56% 0.99% 38.75% Oct 2007 to Mar 2009: Credit Crisis -52.56% 16.68% 9.75% 58.45% Avg 12 Month Performance 7.20% 8.47% 2.14% 25.26% Average Share of Performance 52.19%
So while the bond sector trades tend to perform well overall for our base trend following model (and by extension managed futures as a whole), they are an even bigger share of the performance during crisis periods. Whether this is the case because a crisis tends to make people flock to bonds as they sell their stock holdings and riskier assets (causing an uptrend in bonds), or because a crisis is fueled by a rate decision which effects bond prices is up for debate – but the worth of bonds to managed futures sure isn’t. They are a big part of what fuels managed futures returns.
So what do we get as a birthday present for the futures market that has everything? I guess we’ll have to settle for wishing them another 35 years of solid volume and liquidity!