The managed-futures space continues to evolve, with some managers, such as Winton and Aspect, using non-trend signals to complement their price momentum inputs, according to the latest ‘Sector Wrap’ report on alternatives by Morningstar Australia. Investors need to be wary of rising asset prices.
The report says that trend-following across asset classes has boasted strong Sharpe ratios throughout history. “However, ballooning asset prices may change the dynamics of this persistent Sharpe ratio into the future,” Morningstar says.
“Managed-futures funds’ return profiles can clump and be volatile depending the type of solution. Investors need to understand this to ensure they assign the appropriate time horizon when judging success.”
The managed futures part of the general alternatives ‘Sector Wrap’ was written by Kunai Kotwai, a senior analyst in Morningstar’s manager research department.
Higher-volatility offerings are expected to have higher drawdowns, but may also have higher upside capture in trending markets, he says.
Within the Australian alternatives investment landscape, managed-futures strategies are among the most popular exposures for investors. “It seems the confluence of cheaper entrants, such as CFM IS Trends, combined with strong return profiles from programs such as Winton Global Alpha through the financial crisis, are giving investors comfort in the persistence of returns from momentum-based strategies.”
Managed futures are trend-following programs that use futures contracts to allocate to markets across all asset classes which are experiencing sustained movement up (long investment) or down (short investment). Futures funds also use leverage to vary positioning depending on their conviction level.
“As investor conviction increases in trend-following programs, it may surprise many to know that models are evolving, and programs such as Aspect Diversified and Winton Managed futures offer less trend-following exposure than one may expect,” the report says. “While we don’t cast judgement either way, we wish to outline the spectrum of choice available and hypothesise about why some programs may have decided to supplement their trend models with other premia.”
In the case of Aspect, the manager has always allocated about 20 per cent to non-trend signals. With Winton, the strategy has evolved and non-trend signal allocation has gone from 15 per cent to 40 per cent in recent years.
There are two primary reasons for this:
- Reduction in risk adjusted return (Sharpe ratios) from pure trend-following, and
- To reduce the lumpy return path associated with trend following. Sharpe ratios are very important for managers within this space and directly affect how portfolios are positioned.
“While Sharpe ratios are dynamic, they do provide managers an insight into the efficacy of a trend-following model across multiple asset classes. On average, the expected Sharpe ratio from trend following is around 0.6 to 0.7, though these are gross figures and fees and implementation costs can materially affect the net outcomes,” the report says.
“An exponential increase in assets within this space can have a significant impact on Sharpe ratios, as trend-crowding can manifest due to the magnitude of players looking to exploit the same anomaly which would naturally erode Sharpe ratios…”
“We think the main points from a quantitative perspective to consider when selecting managers are cost, volatility, and correlations. From a qualitative perspective, it is critical for investors to be comfortable with the volume and depth of the intellectual firepower within the firm, as these models do need varying degrees of maintenance and innovation to maintain their edge.”
The report also has detailed analyses of the increasing popularity of risk-premia strategies, such as smart beta, and the growing appetite for ‘diversified’ alternative funds.