Managed Futures During Equity “Crises”–An Update

BY DR. AJAY DRAVID, EQUINOX FUNDS CIO


The Managed Futures asset class has acquired a reputation among investors for providing what is known as “crisis alpha” – the ability to generate returns at a time of market crisis.


Most individual and institutional portfolios generally have substantial (often 50% or larger) positions in equities and equity-related asset classes. Because the “risk” of these asset classes is generally quite high, the major portion of the total risk of these portfolios is driven by equities. Hence, most financial crises, almost by definition, involve large declines in equities, often accompanied by trends in other markets, as most investors resort to panic selling of risky assets all at the same time. Generally, market volatility also spikes during these times. Many equity market crises are also characterized by a “flight to safety,” with increased investments into assets such as the US Dollar, precious metals, and US Treasury securities. These strong price trends and the accompanying volatility expansion has often proved to be an environment in which managed futures have thrived.

A good recent example of this was the period December 2015 – February 2016, when the S&P 500® Total Return Index lost -6.6%, while the VIX® Index, a forward-looking measure of equity market volatility, spiked by more than 27% (increasing from about 16% at the end of November 2015 to more than 20% at the end of February 2016). The “crisis,” in this instance, has been attributed to Mario Draghi’s underwhelming stimulus measures announced in early December, perhaps exacerbated by the US Fed’s first rate hike, albeit widely anticipated and long overdue, since 2006. Over this period, the Barclay BTOP 50® Index, which is often used as a proxy for the managed futures asset class, gained approximately +3.5%.1

Several commentators have addressed and analyzed this characteristic of managed futures during past crises. Here, we update those results, using a slightly different definition of a “crisis.” We look for periods since 1987 during which the VIX® Index increased by 25% or greater, or hit an absolute level of at least 30%. We then try to identify the qualitative reason for this volatility spike, e.g., the events of 9/11/2001, the Greek crisis, etc. Next, we examine the returns on the S&P 500® Total Return Index, equities, and the BTOP 50® Index—a proxy for managed futures—during those periods. Our results are summarized in the table below.

In every single one of these seventeen crises, as we define them, equity markets traded lower, ranging from -0.8% to from -46.4%. Managed futures, by way of contrast, showed only five periods with negative returns, ranging from -2.8% to -0.2%; each of these returns, however, in four of these five instances, managed futures outperformed equities. In the remaining twelve “crises,” managed futures earned positive returns ranging from +1.0% to +18.7%.


Historical Performance of Equities and Managed Futures during Crises (%)

1987-PRESENT

It is worth exploring possible explanations for these historical results. These are summarized succinctly in the paper by Kaminski, cited earlier, as follows:

  • Managed futures strategies tend to be highly liquid and trade almost exclusively in futures markets with minimal credit exposure; hence, they may be less susceptible to the illiquidity and credit traps that are generally prevalent during equity market crises.
  • They are dominated by systematic trading strategies, with no long equity bias; hence, they tend to be less susceptible to behavioral biases and the emotion-based or panic-driven selling that is often triggered when large losses are experienced.
  • They trade across a wide range of sectors and markets, and can hold either long or short exposures, depending on perceived price trends; hence, they have the potential to profit from both up-trends and down-trends across multiple global futures markets.

Our evidence is based purely on historical data, and there is no assurance that these patterns will necessarily repeat during future crises. Managed futures as an asset class tend to have low correlations to most other asset classes, which means they have the potential to provide diversification benefits by lowering the overall risk of a portfolio. However, they should not be viewed as “hedges,” because a hedge is identified by its high negative (rather than low) correlation to the asset under consideration.

The Sharpe ratio was calculated using the Annualize Rate of Return on 3-month T-Bills, which was 0.78%.



Definitions of Terms

No amount of diversification or correlation can ensure profits or prevent losses. An investment in managed futures is speculative and involves a high degree of risk. You can lose money in a managed futures program. There is no guarantee that an investment in managed futures will achieve its objectives, goals, generate positive returns, or avoid losses.

Past performance data quoted here represents past performance. current performance may be lower or higher than the performance quoted above. Past performance does not guarantee future results.