Wow! That was quite the trashing of managed futures in a Bloomberg story by David Evans on Tuesday. The Gawker website took the story about managed futures to new depths with this headline:
If I was selling junk bonds, penny stocks, stock loans, reverse mortgages, or synthetic collateralized debt obligations, I would be feeling pretty good right now. Those managed futures charlatans are the new bad boys of Wall Street. Yeehaa!
Having been a commodity trading advisor for nearly a decade, I found the article appalling on multiple levels. On one level I found it appalling for its cherry picking, something that industry professionals are disciplined for when they do. Yes, there are funds with high fees. And there are funds that lose money. And there are funds that lose money partly because they have high fees.
Picking those funds to write about, condemning an entire asset class/product line in the process, does not give a complete picture of managed futures. Nor is it a fair picture. It is cherry picking.
Making money is no sure thing. In fact, every disclosure document is required to state the following: “Past performance is not necessarily indicative of future results.” If a trader made money in the past, there is no guarantee that he or she will make money in the future. It is as simple as that.
Futures trading is a high-risk endeavor that is not for everyone. If you can’t lose it, don’t use it.
On another level, many of the problems highlighted by Mr. Evans are not exclusive to managed futures. Any structured product with multiple layers of management and related fees is going to have a steep profitability curve to overcome. Also, there are structural and fee differences between managed futures and managed futures funds that he ignores.
After 2008-09, when managed futures were the only asset class to make money as other markets experienced a meltdown, managed futures have not performed as well as many expected. The stock market volatility of 2008, combined with the fact that managed futures are not correlated with other asset classes, helped CTAs boost performance and attract a lot of money.
Since then, however, the performance of CTAs has been pretty abysmal. Flat to negative performance, with lots of fees and commissions in a product will lead to negative returns. The same thing is true for mutual funds.
Managed futures, though, are often sold as a hedge. They are in a portfolio because they can balance the performance of a portfolio when other components are not performing well. Right now, in general stocks are performing well, which means the hedge allocated at 10% or less of a portfolio is less important. Equities are the dog and managed futures are just the tail.
Hindsight being what it is, the right thing to do would have been to load up on stocks and bonds in 2009 when the markets made their lows. But that was the hard trade. The easy trade was to invest in something that worked well, made money when everything else proved to be correlated and toxic. It is not surprising the better performing story sold well.
While you can make a lot of money going all in on a particular investment, I have learned it is best to have multiple investments. Diversification works for me.
Let me relate a story told to me by a former Goldman Sachs partner. He received this advice from his boss. Goldman Sachs had some 23 different business lines at the time. They didn’t know which of those particular business lines were going to be profitable from year to year. If they did, he said, it would be easy to put all your resources into those things you knew were going to be most profitable.
The problem is, he said, no one was smart enough, even at Goldman Sachs, to know which lines of business were going to have big years. Thus, they had to diversify their portfolio and support the 23 business lines.
I have no pretensions that, broadly speaking, managed futures can be profitable year after year. I am not smart enough to be able to tell you that. In Part 2, I am going to tell you my history as a CTA and another story about the impact of fees and commissions.