More options in managed futures

Clients who include a slice of this asset class within a balanced portfolio could smooth out the ride. They also may gain some protection from inflation as a result of including commodities in such a broadly based managed-futures strategy.

“The driver behind demand for these products is the low correlation of managed futures with financial markets,” says Dan Hallett, vice president and director, asset management, with HighView Financial Group in Oakville, Ont. “History has shown that managed futures can help protect a portfolio in bear markets.”

Managed futures contracts have been traded for more than 30 years. However, this strategy traditionally has been accessible primarily through hedge funds, which often charge expensive management and performance fees that eat away at returns. In addition, hedge funds usually are restricted to sophisticated clients or those who can afford to make large investments.

But these new ETFs make managed futures available to a wider range of clients at reasonable fee levels, and provide exposure to a broad mix of managed futures contracts.

And these ETFs, notes Rudy Luukko, investment funds and personal finance editor with Morningstar Canada in Toronto, also provide greater transparency in their methodology, strategy and risk constraints than the actively managed futures used in hedge funds.

iShares Managed Futures Index Fund, sponsored by BlackRock and launched earlier this year, tracks the Guggenheim managed futures index and seeks to capitalize on both the negative and positive price trends of a diverse universe of 30 commodity, currency, equity and fixed-income futures contracts through a systematic trend-following strategy.

That strategy is dictated by a quantitative model and covers an even larger base of futures contracts than the iShares Broad Commodity Index Fund introduced in 2010, which tracks a commodities-focused futures index.

Horizons Auspice Managed Futures Index ETF, launched in April, is based on the Auspice managed futures excess return index developed by Calgary-based Auspice Capital Advisors Ltd.

Horizons previously has introduced ETFs that track the price movements of a single commodity, such as copper, oil or gold, using futures contracts, but Auspice Managed Futures Index ETF is based on a diversified index. This ETF also employs a computer-driven, trend-following strategy, taking long and short positions in 21 futures contracts within a mix of asset classes, including energy, metals, agricultural commodities, interest rates and currencies.

In the same product genre, XTF Capital Corp. of Toronto, a subsidiary of First Asset Capital Corp., has obtained the licence to use the Morningstar diversified futures index and expects to launch a corresponding managed-futures ETF later this year.

“Sophisticated investors have been able to participate in managed-futures strategies for many years, and it’s nice to be able to bring out product that allows the retail market to get exposure,” says Oliver McMahon, director and head of product development with BlackRock’s iShares Canada division. “In a falling stock market, almost every stock goes down. But the managed-futures ETF is diversified across many investment themes, and the various investments react differently to changing conditions.”

Auspice president Tim Pickering points out that although some investors attempt to achieve commodities exposure by investing in the shares of resources-based companies, these stocks are vulnerable to market risk as well as the price risk in the underlying commodity. Even if the underlying commodity is rising in value, such stocks can suffer due to negative market conditions.

However, managed futures can be profitable in both “up” and “down” markets due to the use of both short and long strategies. This asset class represents a pure play on the underlying investment that is not affected by the management risks that can affect companies or by the vagaries of the stock market.

“Managed futures are a powerful diversification tool,” says Pickering. “We don’t care why the markets are going up and down. The goal is to capture the trend.”

The index strategies used by these managed futures ETFs employ computer programs to adapt the mix of managed futures positions systematically according to changes in the value of the contracts. The program signals when to go long or short, and when to increase or decrease the exposure.

“As a commodity goes higher in price, for example,” Pickering says, “the risk level is changing. And we adjust our position size as the probability of hanging on to gains is decreasing. There are rules surrounding the size of a position and when to take it off. It’s a dynamic process, and the weights of the components change according to market conditions.”

Limits on the exposure to any single contract mean that large, risky bets are not allowed and the leverage is controlled.

The process is rules-based, says McMahon: “And it does not allow for the emotional element to enter into decision-making.”

Although the weightings of the contracts are dictated by actual price movements in the underlying investments – rather than by subjective predictions about the future – managed-futures ETFs are more complex than basic ETFs that passively follow a stock or bond market index in which the components rarely change.

“The [managed-futures] ETFs are active, in terms of the decisions that have been made in crafting the index,” says Luukko. “In assessing these kinds of funds, advisors should check the risk constraints and the maximum exposure to any one contract.”

The proof in the pudding will be in how well the ETF index strategy works as financial market conditions evolve and change. Unindexed managed-futures funds can be volatile – particularly those that are run aggressively with loose constraints on leverage and weightings.

AGF Managed Futures Fund, a mutual fund that was closed in 2007 by its sponsor, AGF Funds Inc. of Toronto, had an average annual loss for 10 years of 21.6%. But that fund also boasted a 12-month period during which it jumped by 112%.

There still are a small handful of mutual funds – including Exemplar Diversified Portfolio, sponsored by Blumont Capital Corp. of Toronto; and Criterion Diversified Commodities Currency Hedged Fund, managed by First Asset Funds Inc. of Toronto – that use managed-futures strategies, but they do not use the index strategies employed by the new ETFs.

And, unlike the hedge funds and mutual funds that invest in managed futures, the new managed-futures ETFs disclose their positions on a daily basis.

In addition, the new ETFs’ management fees are lower than for most mutual funds and significantly lower than for hedge funds, which tend to charge a base management fee plus a performance-based fee.

The basic annual management fee on both the iShares and the Horizons products is 95 basis points. Horizons also offers an advisor-class option that charges an additional 75 bps to cover trailer fees. IE

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