Insights
Managed Futures as a Potential Solution to Market Volatility
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Insight Article
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November 01, 2022
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Managed Futures as a Potential Solution to Market Volatility
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November 01, 2022
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Managed Futures as a Potential Solution to Market Volatility
Managed Futures as a Potential Solution to Market Volatility |
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For more than a decade, global market volatility was generally constrained, largely attributed to the quantitative easing and low-to-negative interest rate policies of most central banks around the world. Combined with a bearish cycle across the broad spectrum of commodity markets, the global investment marketplace experienced one of the most prolonged equity bull markets ever. As many times before, this period of buoyancy ultimately resulted in higher inflation, being tackled now by governments globally. Investors are experiencing further uncertainties as geopolitics are combining with fundamental forces to create a surge of volatility across a wide array of market sectors. In periods of such volatility, particularly following a period of extended high equity valuations, clients may be looking for an alternative investment which may not only provide potential protection to market fluctuations, but also potentially capitalize on this increase in volatility.
Historically, managed futures investments have offered low correlation not only to traditional portfolio investments such as stocks and bonds, but to other alternative hedge fund investments as well. Viewed as an absolute return alternative investment strategy, managed futures typically have a low beta to risky assets and are uncorrelated to long-biased hedge funds, private equity, and others. Moreover, managed futures have no inherent long bias to any asset class, and at periods may be short any number of markets. That could make managed futures an important part of a retail or institutional investor’s portfolio in the current environment which may continue for some time.
Managed futures have historically performed well in periods of extended equity drawdowns. This “crisis alpha,” as it is often referred to, can offer a key component of portfolio insurance in such a period. This is represented by Display 1 which plots the performance of the Barclay CTA Index during periods of stock market drawdowns represented by the performance of the S&P 500 Total Return Index. Importantly, managed futures index’s strong performance includes not only an initial drawdown period but recovery to the “high water mark” as well.
Why the Current Macro Environment May Favor Managed Futures
The current global economic environment is exhibiting widespread volatility which has not been experienced in many years.
Many of the current macro and micro impacts experienced by investors may not be transitory and, in fact, could persist for an extended period of time. Below is a partial list of some of the major fundamental drivers of the volatility we are currently experiencing.
While certain volatility can be a danger to a traditional portfolio, it may also provide trading opportunities for the “right” investment vehicle. Looking forward into the remainder of the year and beyond, there are a number of factors that could point to longer-term volatility that managed futures investments have historically been able to capture.
INFLATION VERSUS CENTRAL BANK POLICIES IN THE U.S. AND INTERNATIONALLY
- Rising rates and tightening of central bank balance sheets have and will likely continue to rattle global bonds and currencies.
- Directionality driven by central bank interest rate policies has recently been a major profit driver for the managed futures strategy in general.
- We expect prolonged inflationary pressures to continue into 2023.
Quantitative tightening, relative to a decade of quantitative easing, has practically just begun, and global money supply is still elevated. Thus, current interest rate policies and other anti-inflationary government actions may continue for the foreseeable future.
RECESSION EXPECTATION AND CONTINUING EQUITY MARKET VOLATILITY
One of the other major factors is the potential for recession and even a prolonged economic slowdown, having a negative impact on global equities and other risky assets. Managed futures is one of the few alternative investment strategies that have the ability for equity exposures to go 100% short. In fact, we have seen short exposures emerge throughout 2022 as global equity prices have moved lower.
DETERIORATING GLOBAL GEOPOLITICAL SITUATION
- U.S. dominance versus serious threat from Russia, China, etc.
- Russia/Ukraine war and long-term implications of global sanctions on Russia.
- Socio-economic concerns across both the Developed and Emerging Market nations (including potentially growing violent political divisions as well as food and energy shortages).
- U.S. mid-term 2024 presidential elections. We believe political divisions in the U.S. have rarely been so stark in the nation's history. Broadly diverging policy among the two parties have the potential to impact both financial and commodity markets in profound ways.
GLOBAL CONUNDRUM ACROSS ENERGIES AND OTHER COMMODITIES
- GROWING DEMAND VS. SHRINKING SUPPLIES: Many of the commodity traders we work with believe that the underlying fundamental supply and demand equation in commodities has no real short-term fix. It is not just pent-up demand that is driving the volatility in commodity markets, but the primary reason we see the current commodity cycle being prolonged is the widespread weakness of the global supply chain and how it has been brought on by a decade of underinvestment in capital expenditures at nearly every level.
- POTENTIAL ENERGY CRISIS: The energy complex, in and of itself, has a multitude of factors driving prices in the near and long term. The above-mentioned supply issues weigh heavily on the global energy marketplace. At the current time, the war between Ukraine and Russia appears to have no clear outcome. Even if there is a resolution between Ukraine and Russia in the near future, the sanctions against Russia by much of the western world are most likely here to stay for years and will continue to impact global energy prices. This is also potentially exacerbated by geopolitical and economic tensions between the U.S. and China, and the U.S. and OPEC.
- CONTINUED GROWTH OF “GREEN” INITIATIVES, REGULATIONS, AND FINANCING: Also of growing significance is the ESG movement and governments' actions to fight climate change. This has the potential to greatly impact markets in profound ways for years to come. Energy transitions, infrastructure upgrades and electric car vehicle conversions are just a few examples for this to create new opportunities, sometimes in unique commodity markets, such as in global carbon allowance futures. The growing global climate issue may also affect the energy markets in other significant ways. More and more the efforts to move away from hydrocarbon energy to sustainable energy sources, which thus far have not been able to reliably provide for demand volatility, run up against the underlying fact that demand for energy will remain constant in the least and is most likely grow. These imbalances have the potential to inject a considerable amount of volatility into the energy complex.
- DEGLOBALIZATION NOT LIMITED TO MANUFACTURING: Many of the themes listed above can be seen in terms of a reversal of the “one-world” globalization trend which has emerged over the last 20 years. Any profound change to this trend could potentially have a dramatic impact across the globe and add even more volatility to the current global situation.
We feel that these are just a few of the themes that have the potential for a strategy like managed futures to outperform for an extended period of time, given the current global economic environment. Uncertainties, whether economic, political, or social, will continue to support heightened volatility. Historically, managed futures have capitalized on such environments which feature prolonged volatility, adding diversification to a portfolio in any market environment.
| MSIM's Managed Futures Investment Team: | |||||
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PATRICK EGAN
Executive Director
Head of Managed Futures Group
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SRDJAN TESLIC, PH.D.
Executive Director
Chief Investment Officer
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SCOTT DUNLAP
Vice President
Portfolio Manager
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MSIM's Managed Futures team, which has roots dating back 40-plus years, specializes in providing high net worth and institutional investors access to multimanager investment solutions. In our view, an allocation to managed futures is an essential component of a well-diversified portfolio. Over the long term, we believe these strategies provide important diversification benefits versus other traditional and alternative asset classes.
For more information, please contact the MSIM Alternative Investments Hotline at (212) 296-7676.