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In Search of Crisis Alpha:: A Short Guide To Investing in Managed Futures
In Search of Crisis Alpha:: A Short Guide To Investing in Managed Futures
Crisis Alpha:
A Short Guide to Investing
in Managed Futures
Kathryn M. Kaminski, Ph.D.
Senior Investment Analyst,
RPM Risk & Portfolio Management
describe the strategy can be explained in simpler terms helping Globally diversified Trade both long and short contracts in FX, interest
rates, stock indices, energy, metals and soft
investors to more effectively use the investment strategy as part of
commodities in regulated and interbank markets
a larger investment portfolio. worldwide
Regulated Typically authorized and regulated by financial
supervisory authorities such as the Commodity
Futures Trading Commission (CFTC) in the U.S.
2
A Short Guide to Investing in Managed Futures
Characteristics of
Since futures contracts depend on the underlying asset’s value at Futures Markets
a future date in time, futures prices are highly correlated with their
Transparent Standardized contracts
corresponding underlying assets. This correlation makes them
Minimal counterparty/credit risk Daily marking-to-market,
excellent vehicles for taking directional positions in various asset pooling of investment profits
classes and hedging. The clearinghouse mechanisms of futures and losses for redistribution
markets, daily pooling and redistribution of funds, lower collateral via clearing house brokers
constraints, and transparency and standardization of contracts Highly liquid Ease of access and use, low
requirements for collateral, lack
create a market which is extremely liquid and relatively void of both
of asymmetry between long and
the counterparty risk and asymmetries between long and short short positions, standardization of
positions common in traditional markets. contracts, reduced counterparty risk
3
In Search of Crisis Alpha
1
This explanation is derived using a theoretical framework proposed by Andrew Lo (2004, 2005 and 2006) entitled the Adaptive Markets Hypothesis (AMH). This framework
explains how markets evolve and how market players succeed or fail based on the principles of evolutionary biology. For a more in depth understanding of this theory, please
consult Lo (2004, 2005 and 2006). Further analysis of Managed Futures in the context of the AMH is also presented in Kaminski and Lo (2011).
4 2
For a more in detailed explanation of crisis alpha, see Kaminski, K., “Diversify Risk with Crisis Alpha”, Futures Magazine, February edition 2011.
A Short Guide to Investing in Managed Futures
Futures Performance
MSCI Monthly TR Gross World Crisis Periods
400
Jan 94
Jul 94
Jan 95
Jul 95
Jan 96
Jul 96
Jan 97
Jul 97
Jan 98
Jul 98
Jan 99
Jul 99
Jan 00
Jul 00
Jan 01
Jul 01
Jan 02
Jul 02
Jan 03
Jul 03
Jan 04
Jul 04
Jan 05
Jul 05
Jan 06
Jul 06
Jan 07
Jul 07
Jan 08
Jul 08
Jan 09
Jul 09
Jan 10
Jul 10
by an investment in Treasury bills, Managed Futures
performance can be divided into those three pieces. In
the following figure (see Crisis Alpha Barclay CTA Index), CRISIS ALPHA BARCLAY CTA INDEX (1994–2010)
the performance of the Barclay CTA Index is decomposed Barclay CTA Index (BarclayHedge) Without Crisis
into crisis alpha, a risk premium, and the 3-month Crisis Periods 3-mo T-bill
300 6%
Treasury Bill return from 1994-2010. Over the entire
sample period, equity crisis periods make up roughly Crisis
250
Alpha
15% of the investment horizon but they are responsible
200 4% Risk
for roughly a third of Managed Futures return. When Premium
the NewEdge CTA Index is added for comparison 150
during the last ten years, equity crisis periods make up
Short
roughly 40 to 50% of the return of Managed Futures for 100 2%
Term
the NewEdge CTA Index, Barclay CTA Indices, Barclay Rate
50
Systematic Traders Index, and a Naïve Trend Following
Replication Strategy3 (see Crisis Alpha 2000-2010). 0 0%
Jan 94
Nov 94
Sep 95
Jul 96
May 97
Mar 98
Jan 99
Nov 99
Sep 00
Jul 01
May 02
Mar 03
Jan 04
Nov 04
Sep 05
Jul 06
May 07
Mar 08
Jan 09
Nov 09
Sep 10
the rate of return on short-term debt (see Crisis Alpha 3-mo T-bill Risk Premium Crisis Alpha
2%
1%
0%
-1% Barclay CTA Index Barclay Systematic Newedge CTA Index Naïve Trend Following
(2000-2010) Traders Index (2000-2010) Replicating Strategy
(2000-2010) (2000-2010)
3
The Naïve Trend Following Replication Strategy is based on 76 different futures contract prices from 1994-2010. The strategy does not represent an investable strategy or a
specific track record which has been invested in; it simply allows for a closer look into strategy decomposition of profit opportunities for systematic trend followers over time
(see Crisis Alpha and Portfolio Management).
5
In Search of Crisis Alpha
Crisis Alpha and By understanding why Managed Futures delivers crisis alpha, the commonly
cited benefits and characteristics which describe the strategy can be explained in
Portfolio Management simple terms.
15%
10%
Managed
Futures
5%
0%
1 2 3 4 5
Equity
-5% Straddle
6
A Short Guide to Investing in Managed Futures
Lower than Average Sharpe Ratios Manager Skill in Managed Futures Can Come from Two Sources
than Most Hedge Funds during Within the class of Managed Futures strategies, some strategies are more adaptable during
Equity Bull Markets crisis scenarios allowing them to provide more crisis alpha. The other source of manager
During bull markets, many Hedge Fund skill is an ability to find opportunities outside of crisis events. As explained in the previous
strategies realize high Sharpe ratios. section, these opportunities should be harder to find and strategies or managers which
Research in Hedge Funds has pointed out have a particular skill at finding these opportunities may be able to provide a risk premium
that these strategies can contain hidden above the short-term treasury rate.
risks often related to liquidity and credit
exposures. If Managed Futures deliver Market Timing: Managed Futures Strategies Do Not Predict or
crisis alpha, their performance during Time Equity Crisis Events, They React Positively in Response to Them
bull markets may lag other Hedge Fund Predicting the exact onset of a market crisis can be next to impossible. Market timing
strategies given that they only trade in ability for such rare events is highly unlikely. Yet, after seeing the exemplary performance of
markets void of these risks. This explains Managed Futures during the credit crisis, a popular misconception has been that Managed
why using Sharpe ratios during bull markets Futures strategies predicted and profited from equity market crisis using short positions in
will underestimate the longer term value of equity indices. During some of the past crisis periods Managed Futures strategies did profit
Managed Futures in comparison with other from short equity positions, but in general, gains in equity indices make up only a portion
alternative investment strategies. of the total crisis alpha. Managed Futures strategies react to market crisis and position
themselves across a wide spectrum of asset classes in highly liquid futures contracts to
Bulls vs. Bears: Reasonable profit from trends which occur across all asset classes during these periods (see Crisis
Performance during Bull Markets Performance by Sector). By decomposing crisis performance by sector, it becomes clear
When equity markets are not in crisis, that Managed Futures is not market timing equity crisis events but responding positively to
markets are highly competitive and the widespread price dislocations and trading opportunities which follow them.4
efficient, especially futures markets. Alpha
opportunities outside crisis periods should CRISIS PERFORMANCE BY SECTOR
(NAÏVE TREND FOLLOWING REPLICATION STRATEGY)
be less frequent and more difficult to find.
Since Managed Futures strategies should Bonds Softs Metals Equity Indices Currencies Energy Short Rates
R E FE RE NCES
• Bhansali, V., 2008. “Tail Risk Management”, Journal of Portfolio • Kaminski, K., and Lo, A., 2011, “Managed Futures, Tail Events,
Management 34(4), 68-75. and Adaptive Markets,” Working Paper.
• Chong, J., and Miffre, J., 2010. “Conditional correlation and • Lo, A., 2004. “The Adaptive Markets Hypothesis: Market
volatility in commodity futures and traditional asset markets.” Efficiency from an Evolutionary Perspective,” Journal of
Journal of Alternative Investments 12, 61-75. Portfolio Management 30(2004), 15–29.
• Fung, W., and Hsieh, D., 2001. “The Risk in Hedge Fund • Lo, A., 2006, “Survival of the Richest,” Harvard Business
Strategies: Theory and Evidence from Trend Followers,” The Review, March 2006.
Review of Financial Studies 2, 313-341. • Lo, A., 2005, “Reconciling Efficient Markets with Behavioral
• Kaminski, K, “Diversifying Risk with Crisis Alpha,” Futures Finance: The Adaptive Markets Hypothesis”, Journal of
Magazine, February 2011. Investment Consulting 7, 21–44.
• Kaminski, K., 2011, “Offensive or Defensive?: Crisis Alpha vs. • Miffre, J., and Rallis, G., 2007. “Momentum strategies in
Tail Risk Insurance,” working paper under review, RPM Risk & commodity futures markets.” Journal of Banking and Finance
Portfolio Management. 31, 1863-1886.
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