Hedge Fund Strategies: Managed Futures

July 11, 2011

While many hedge funds outperformed the overall market during the financial crisis of 2008, they still lost money, down 14% as opposed to crashing 30% to 50% like that of major indices.

But as an article in MoneyControl pointed out recently, one group of hedge funds managed to do better … much better. Gaining 17% in the same time period.

That group was managed futures strategies, which use sophisticated computer programs to trade on pre-programmed market signals. Managed futures are increasingly seen as a type of “insurance policy” against market upheaval. Which may explain while total allocations to managed futures has risen from approximately $20 billion to $250 billion over the past decade.

One advantage is that managed futures (also known as commodity trading advisors or CTAs) exhibit a low correlation to other markets. They trade according to algorithms and can go short or long on a security, based on market signals. It’s “black box” trading. Firms are notoriously secretive about their proprietary trading systems, as they should be. Such computer-driven trading can also take the emotion out of market decisions.

“No one believed oil would go beyond USD 50,” says Nigol Koulajian, founder and chief investment officer of Quest Partners, a US-based managed futures firm. “But it reached USD 140 at its peak. CTA programs are dispassionate about large emotional price moves that are not explained by news flow, and are willing to keep the trade on longer than consensus-driven investors.”

Many CTAs are trend-followers, relying on constant research into market trends and new markets opening up around the world. One such firm is Winton Capital, a London-based firm started in 1997 with just $2 million in assets. Today, the firm employs over 200 professionals, half of which are directly involved in researching new market trends and patterns. Winton Capital now has over US$17 billion in assets under management, according to its website.

“History does not repeat, but it rhymes,” says Matthew Beddall, chief investment officer of Winton Capital’s Diversified Program. “Historically, there has been only a 53% chance of us being right on any given day,” he says. “Managed futures are not an insurance against a crash. But over the long run, the low correlation to stock markets has made them a good portfolio ¬≠diversifier.”

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