Will Simple Beat Complex in the Next 5 Years?

One of our favorite bloggers almost made us cry yesterday…  It’s Barry Ritholtz, formerly of The Big Picture Blog, but now plying his wares at Bloomberg – who grabbed the charts out of our own post on various markets movements and asset classes both before and after March 9th, 2009 (the equity low), and used them to kick managed futures while they’re down – claiming that because stocks beat (past tense) managed futures and hedge funds since the low, Cheap and Simple beats (present tense) Expensive and Complex.

“…the take away to a real-estate-owning-asset-allocator-stock-jockey like me is this: If you have a long enough timeline — a decade or more — simple beats complex, and low cost trumps expensive. Land and equities are likely to be the investments whose returns surpass everything else — assuming you start buying when you are young enough and at advantageous valuations.”

Suffice it to say that wasn’t the angle we were looking at… but let’s look at the data.

There’s no denying Barry Ritholtz is one of the most well respected voices in all of the financial blogosphere. We’re frequent readers of his blog, and enjoy his commentary most of the time, with the occasional exception (Sorry, Barry, Commodities Ain’t Managed Futures). And on the base level it sure looks like Barry has a point, with the ‘simple’ investments of stocks and real estate having beaten the complex investments of managed futures and hedge funds handily since the March 9, 2009 low, and even over the 10 year period starting March 9th, 2004, which includes the huge drawdown periods of stocks and real estate. The current run up in stocks has cured a lot of ills, to be sure.

But what if we push the look back another 5 years, to March 9th of 1999? It’s once again a different story, with the complex investments now back atop the scoreboard ahead of “simple” stocks, although “simple” real estate was a very high flier. Here’s the three five year periods in a row:

Last 5 Years (simple wins)

March 2009 20145 Years Before That (complex wins)

March 2004 - March 20095 Years Before That (a mixed bag)

March 1999 2004(Disclaimer: Past performance is not necessarily indicative of future results.)
Sources: Managed Futures = Newedge CTA Index (* = Data begins in Jan 2000),
Bonds = S&P/CitiGroup International Treasury Bond Ex-U.S. Index
Hedge Funds= Dow Jones Credit Suisse
Commodities = UBS Commodity Index (DJC)
Real Estate = iShares DJ Real Estate ETF (IYR) (* = Data begins Jun 2000)
World Stocks = MSCI ACWI ex US Index, US Stocks = SPDR S&P 500 ETF (SPY)

Of course, Barry could push the goal posts back yet another 5 years, where stocks would include their internet bubble run up and once again move to the top of the scoreboard, proving if nothing else that you probably don’t want to be looking at the best performers of the past 5 years for clues on where to put your money for the best chance of success over the next 5 years. No matter how simple or complex they are, these rankings and the resulting performance are highly volatile.

Which brings us to a little thing called risk. I’m sure we could get Barry to agree that it’s not always about returns. Whether you’re simple or complex, how much risk you’re exposing yourself to over the time span of the investment can really matter (it can be the difference between selling out of equities at the ’09 low versus remaining in). What if instead of looking at just returns, we consider the risk adjusted returns of the various asset classes, using the Sortino ratio (a fancier version of the more well known, but flawed Sharpe ratio) which measures returns over the volatility of the investment; and the MAR ratio, which measures return over the maximum risk of the investment (or worst peak to valley loss, known as the drawdown).

Sortino and MAR(Disclaimer: Past performance is not necessarily indicative of future results)

Adding risk into the equation pushes “complex” hedge funds up to the top of the scoreboard and “simple” real estate heads towards the bottom of the list, while stocks and managed futures are essentially equal – swapping places depending on which risk metric you use. {past performance is not necessarily indicative of future results}.  Turns out it isn’t as easy to say simple beats complex when incorporating risk into the equation.  From a risk perspective, bonds and commodities are really the standout; bonds for their high ranking and commodities for their negative ratios (meaning they’ve had a negative return over the past 10 years).

And while we’re on the subject of commodities, we don’t necessarily agree with Barry’s conclusion that one should have expected a greater return out of managed futures due to commodity rallies.

“The best performers leading up to the lows were managed futures and hedge funds. We’ve addressed hedge fund under-performance before. Surprisingly, despite screaming rallies in the 2000s in oil, food, gold and other commodities, managed futures only rose 26 percent during that five-year period. Given the 400 percent rally in gold, and the 500 percent in oil, one would have expected a greater return for this investment category.”

When we run the numbers, Oil didn’t provide a 500% return in that same time period, and neither did gold show a 400% return. Here’s how those commodities did if we line up the return mentioned by Barry with the same 5 year period (March 9th, 2004 – March 9th, 2009), with the commodity index itself actually down over that time, not screaming higher.

Commodity Exposure 2004 2009(Disclaimer: past performance is not necessarily indicative of future results)
Sources: Managed Futures = Newedge CTA Index, Commodities = UBS Commodity Index (DJC)
Corn, Crude, & Cold = Cash data from CSI.

Now, Barry did say the “screaming rallies in the 2000’s“, not the five year period before march lows, and if we look at just the rallies themselves, from 2000 to the high point of each, we see Crude up 469% and Gold up 317% at their highs. These were huge moves to be sure – but they didn’t come without a lot of risk, with each market seeing down moves of -78.85% and -12.74% from those highs during the financial crisis. And what about that commodity index itself, which was down over the period while managed futures was up.  Saying managed futures should have been up more when commodities overall were down, because Oil was up big; is a little like saying an investment advisor should be up when the overall stock market is down because Netflix was up 300%.  Diversification cuts both ways… whether in a stock portfolio or managed futures portfolio, intentionally dampening return in exchange for also dampening risk.

Finally, there’s the issue of the costs involved with the complex asset classes. We can’t argue that they are more expensive than “cheap” index investing via ETFs, but that’s hardly unique. “Simple” stock and bond mutual funds are also orders of magnitude more expensive. The real issue when it comes to cost is to make sure the structure and way you access the “complex” managed futures and hedge fund assets classes isn’t more expensive than it should be, which we tackled in this Bloomberg piece and would love to sit down and talk through with Ritholtz Wealth Management (which we suggested 5 better names for upon its launch).

At the end of the day, there’s no denying stocks magical run the past 5 years, but it pays to remember the high degree of risk and potential loss those gains were built off of, for it’s only a matter of when, not if, they will return. All in all, we’ll agree that simple has beaten (past tense) complex this round; but wouldn’t bet on a repeat performance in the next round. In fact, we would love to make a friendly wager with Mr. Ritholtz that managed futures will outperform stocks over the coming five year period. Barry, you up for it?

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

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