When I joined Futures in 2001 my first beat was the managed money world. This involved researching, interviewing and profiling money managers primarily in the managed futures space. Through the years this has included several hundred managers and traders.
Interviewing managers, learning their backgrounds and what gave them their edge, was one of the most interesting parts of my job. Some of the smartest and most successful traders in the world were in the managed futures space.
I never understood why it occupied a dark corner in the managed money world or even in the alternative investment world.
When folks made the case for a 10% allocation to managed futures at the numerous alternative investment conferences, I thought, why 10%? Why not 30% or 50%? After all, this is a more diversified investment than a long equity mutual fund. You could be long or short in a much more diverse group of markets than simply equities. Turtle trader Jerry Parker makes this case (see “Chesapeake Capital: The evolution of managed futures from the eyes of a turtle,” page 28) that managed futures should be at the core of an investment portfolio and not simply a 10% diversifier.
However, Parker says there will be a cost, a toll commodity trading advisors will need to pay along the way. And that cost will be the traditional 2% management fee/20% incentive fee. In fact, when it comes to the broad trend following space, that is already happening.
What has changed is the ability of a broader swath of the investment universe to access these strategies through 40-Act mutual funds.
It is something we have been talking about for years, and it finally has arrived. And there is one firm that is the leader in the space: Applied Quantitative Research (AQR). There are many reasons for AQR’s success but the most obvious may be that they planned for it (see “AQR: New era, new leaders,” page 20). While much of the hedge fund and alternative investment world was resisting any affiliation with offering to retail to keep regulation to a minimum, AQR has been embracing the concept.
At an industry awards ceremony one year ago AQR Founder Cliff Asness received a lifetime achievement award and talked about how retail investors should have the ability to access alternative investments. He understood the value of managed futures and wanted to help a broader group of investors access it. This is something that many of us have over the years said needed to be done, but Asness took the steps to make it happen.
But these products face a serious challenge in the SEC proposed Rule 18f-4. It is basically a reinterpretation of an existing rule, but one that left unchecked would challenge the ability to offer managed futures in a 40-Act wrapper (see “SEC crashes 40-Act party,” page 34).
While commenters are too polite in their criticism of the SEC to say it, there is an element of the rule that reveals there are still folks at the SEC who view managed futures as not quite legitimate. However, given that the size of the universe — AQR’s Managed Futures Strategy 1 alone has more than $11 billion in assets — that cat may already be out of the bag.
We recently talked to MichaeI Covel, who is founder of TrendFollowing.com and a long-time advocate of the strategy. Covel is not completely sold on the 40-Act format and wondered if by trying to make sure you never have a 10% or 15% drawdown, or lose more than 20%, something is lost in the process. “You need these big freakin’ gains to come out of nowhere to pay for the other stuff,” says Covel, who is more a fan of the Bill Dunn no-holds-barred approach to trend-following.
But it is the gunslinger nature of managed futures that has always made it not quite ready for prime time. Perhaps, as Parker said, the industry was a little late in reining in volatility.
I am not sure that 40-Act structure is the best way for everyday investors to access these strategies, but it is the best available today. And I am convinced that they should be able invest in these strategies.
Like everything in life there is a trade-off. The most important thing for ordinary investors is that they have the ability to invest in a strategy that can produce solid returns in bear equity markets. They now have that choice thanks to Asness and others.
Daniel P. Collins
Editor-in-Chief, Modern Trader