Explaining Managed Futures to an ERISA Audience

“It is not the number of securities in a portfolio that determines diversification; it is the number of risk factors.”

Robert Sinnott, portfolio manager for AlphaSimplex Group, is often called on to explain his firm’s active investment strategies to institutional clients.

These institutions are generally endowments and foundations, but increasingly the firm is dealing with Employee Retirement Security Act (ERISA) defined benefit (DB) pension funds and even some forward-thinking defined contribution (DC) plans. It’s not the easiest job to explain managed futures or the other strategies employed by the firm, he admits; in a nutshell, he and fellow AlphaSimplex portfolio managers “leverage proprietary risk-control technology and computer-assisted trading to manage the dynamic relationship between risk and return in financial markets.”

The firm’s roster of strategies include Active Volatility Management, Global Alternatives Strategy, Managed Futures Strategy, Global Macro Strategy, Risk-Efficient Allocation Strategy and Tactical U.S. Market Strategy. “The strategies can get pretty sophisticated, yes, but investors have an easier time understanding the goal of the firm,” Sinnott says. “We want to help shield investors from the disruptive effects of surging risk and extreme loss during events such as the 2008 crisis, or a tech stock bubble, or an August/September 2015. One way we do this, for example, is through use of managed futures.”

Sinnott, who concentrates on liquid alternatives and ’40 Act funds, explains managed futures as a strategy that “seeks positive absolute returns over a full market cycle with low correlation to equity markets during periods of dislocation. The composite portfolios take long and/or short positions in a variety of markets using systematic trading disciplines and multi-horizon trend signals to exploit market moves.”

The portfolios may hold positions in a variety of markets through instruments such as equities, exchange-traded funds, futures, forwards, fixed-income securities and other instruments. “Portfolio volatility is monitored and actively managed in an effort to maintain and stabilize annualized volatility within a range. In our case, the benchmark is the Newedge Trend Index,” he says.

In this sense, managed futures are “systematic and trend-following,” searching to identify price momentum in futures markets including equities, fixed-income, currencies, and commodities. “We typically have the flexibility to go long or short in these different futures markets, thereby giving these strategies the potential to profit even when traditional asset classes are falling,” Sinnott adds. “A few other features to mention, rising interest rates tend to act as a tail-wind for managed futures, and the strategies can remain very liquid.” 

NEXT: Potential role of managed futures under ERISA

Those familiar with the quirks of the retirement planning market will certainly wonder, how could a DC plan participant or a small employer’s DB plan investment committee be expected to put managed futures to work properly?

“It’s true the strategies take some education, even for sophisticated investors,” Sinnott says. “In this respect, we see managed futures best being used as part of a wider solution. It makes sense that the other increasing point of contact with the ERISA plan space for us is via target-date fund managers.”

Sinnott explains the TDF managers are looking to add aspects of active management and improve diversification through alternative investments, including managed futures. “They are seeking out skilled and affordable sub-advisers to help deliver these strategies, all while keeping things affordable and sufficiently liquid, again with the goal of helping manage the downside risk that can scare people out of the markets at just the wrong time.”  

Sinnott says AlphaSimplex (and the firms against which it competes) are “very aware of the pricing pressure in the ERISA space, which is why we keep our all-in user fees below 100 basis points for our funds.” He adds that the firm is not flippant about the recent performance of managed futures, or other active strategies for that matter, which until recently have underperformed lower-fee, index-based products during the strong market-wide growth of the post-crisis era. “After delivering for investors in 2008 with a 21% total return, managed futures strategies have seemingly struggled, posting negative returns in three of the past seven years and a near-flat return in 2015,” he notes.

“Over that same period, the S&P 500 Index has more than doubled, leaving some to wonder if the diversification benefits of managed futures have amounted to little more than a drag on portfolio performance,” Sinnott says. “It won’t be surprising that we recommend patience and point out that allocations to certain managed futures strategies do provide benefits to a portfolio, even if those benefits haven’t been that apparent over recent years when compared to the strong performance of equities.”

Already in 2016 the picture is shaping up differently, with several firms publishing research suggesting the macroeconomic picture ahead is much friendlier for active-fund outperformance. Sinnott stresses that the funds he manages do not try to time the markets: “We are not tactical, in that respect, so we cannot say what 2016 may have in store for managed future performance relative to equities.” So far in 2016 the firm’s ASG Managed Futures Strategy Fund has “outpaced both the market and peers with a return of 2.89%.”

“The takeaway for plan advisers and sponsors is that managed futures outperformed U.S. equities on a relative basis during all 10 of the most recent quarters when U.S. equities experienced their largest quarterly declines, and even posted positive absolute returns in seven of the 10 periods,” Sinnott says. “We hope more retirement plans will see the role for managed futures in helping protect their participants.”