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marzo 14, 2024

Managed Futures as a Potential Solution to Market Volatility

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marzo 14, 2024

Managed Futures as a Potential Solution to Market Volatility


Insight Article

Managed Futures as a Potential Solution to Market Volatility

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marzo 14, 2024

 
 

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 happened many times before, this period of buoyancy ultimately resulted in higher inflation, being tackled now by governments and central banks globally. Investors are experiencing further uncertainties as geopolitics are combining with fundamental forces to keep elevated volatility across a wide array of market sectors. In periods of such volatility, particularly coinciding with a period of exceedingly high equity/bond correlation, clients may be looking for an alternative investment which may not only provide diversification and potential portfolio protection to market fluctuations, but also potentially capitalize on increases 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 investment strategies as well. Viewed as an absolute return alternative investment strategy, managed futures investments typically have a low beta to risky assets and are uncorrelated to long-biased hedge funds, private equity, and other alternatives. 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 investments have also 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, as represented by the performance of the S&P 500 Total Return Index. Importantly, the periods of strong performance for the Barclay CTA Index coincide with S&P 500 bear markets, including recoveries to new “high water marks.”

 
 
DISPLAY 1
 
Barclay CTA Index vs. S&P 500 TR Drawdown
 

Data: January 1980- December 2023 Barclay CTA Index and S&P 500 TR Index. Data for Indices were provided by EurekaHedge. Past performance is not indicative of future results.

 
 

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 witnessing.

While certain volatility can be a potential 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 profitably capture.

Since the COVID pandemic, the interplay between inflation and central bank reaction has dominated market focus, pushing the correlation between equities and bonds to historical highs. As of December 31, 2023, the 36-month correlation between S&P 500 Index (TR) and Bloomberg U.S. Aggregate Bond Index (TR) was at its highest level since 1992, as represented by Display 2.

 
 
DISPLAY 2
 
Barclay CTA Index vs. Stock/Bond Correlation
 

Data: January 1980- December 2023 Barclay CTA Index and S&P 500 TR Index, and Bloomberg U.S. Aggregate Bond Index. Past performance is not indicative of future results.

 
 

When monetary policy is the primary source of uncertainty, markets focus on liquidity. As market expectations of monetary policy direction change, whether tighter or looser, it has the same directional impact on all financial asset pricing. Conversely, when global growth is the primary driver of uncertainty amidst stable monetary conditions, we would expect to see negatively correlated price action. For example, strong growth expectations driving equities higher, and bond yields up.

We believe that the market preoccupation with monetary policy globally is likely to remain for some time. Further, if the market remains primarily focused on monetary uncertainty, we believe the bond/ equity correlation is likely to remain positive. Given this, we also believe that managed futures can potentially provide diversification to other assets and strategies as shown by Display 2.

Of course, if the market shifts its focus toward real growth as the monetary policy turns consistently and transparently looser, then a reversion lower in the correlation between stocks and bonds is possible. In that case, managed futures as an investment strategy can still have the potential to capture alpha.

Currently, we see drivers of inflation volatility still arising from a tight labor market, deficiency of housing supply and solid overall economic growth, at least in the U.S., while the interest rate policy remains uncertain and lacking a significant degree of transparency. In terms of the global real growth outlook, a combination of risk around election cycles and their fiscal implications, geopolitical risk, more frequent trade and industrial policy interventions should all serve to keep volatility elevated, including occasional regime shifts.

In short, the combination of high bond/equity correlation, a high and volatile cost of capital, and ongoing policymaker-induced volatility should bode well for dynamic, diversified, multifactor, liquid trading approaches like those employed by the managers in managed futures investments.

INFLATION UNCERTAINTY STILL HIGH

  • Are we in a disinflationary, deflationary or even a reflationary environment in the U.S. and globally? Market expectation of coming rate cuts, especially in the U.S., may be overly optimistic.
  • Increasing growth dispersion between the U.S. vs. elsewhere around the world:
    • Japan and India may outperform, Europe seems likely to underperform, with the U.S. probably somewhere in between.
    • What is poison for some may be a cure elsewhere: reflation may drive Japan to a sustained recovery, while Europe is suffering under even slower deflation. With the most recent negative GDP growth print in Germany, the European Central Bank (ECB) may cut rates sooner and more aggressively than the Federal Reserve. At the same time, it is possible that Bank of Japan starts changing its decades long monetary policy, and possibly even hikes rates later this year.
  • Difference in reported inflation vs. reality for consumers and its potential economic impact as consumer spending, still resilient in the U.S., may turn for worse.


RECESSION EXPECTATIONS HAVE SUBSIDED BUT UNCERTAINTY STAYS

  • While markets are increasingly expecting a relatively “soft landing” for the U.S. economy, the potential for an economic slowdown is still a measurable risk for global equities and other risky assets. Managed futures is one of the few alternative investment strategies that have the ability for global equity exposures to go 100% short. For example, we saw Commodity Trading Advisors’ (CTAs) short exposures in equity indices emerge throughout 2022 as global equity prices overwhelmingly moved lower.


GLOBAL GEOPOLITICAL INSTABILITY

  • Current conflicts in Europe and the Middle East involving several nuclear powers: the U.S. and Russia, as well as Israel and Iran. Global polarization and deglobalization increase the chance of further spread of conflicts.
  • While energy market turmoil comes first to mind, trade and transportation bottlenecks, as we are currently witnessing in the Red Sea, currency wars and accelerating de-dollarization are some of the possible scenarios.
  • In the U.S., we may be facing an even more antagonistic Presidential election later this year. In the last few elections, no matter the outcome, risky assets benefitted from continued loose monetary policy and ever-increasing liquidity. This time around we may face sharp reversal of such policies, especially if Donald Trump wins. Despite his general pro-business stance, chances are he would have to respond to his caucus’ calls to stop and reverse increasing government spending and money printing, thus likely impacting U.S. growth.


GLOBAL CONUNDRUM ACROSS ENERGIES AND OTHER COMMODITIES

  • GROWING DEMAND VS. SHRINKING SUPPLIES: Many commodity traders believe that the underlying fundamental supply/demand equation in commodities has no real short-term fix. It is not just demand that is driving the volatility in commodity markets. The primary reason we may 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. Moreover, current higher working capital costs have fueled an inventory destocking cycle that has held back spot pricing. Both these dynamics may make prices less elastic on the supply side than in previous cycles. Given this, more volatility in the commodity markets could possibly lie ahead and there is still a meaningful probability of a “commodity supercycle” dynamic unfolding over time. This could offer some strong trading opportunities for commodity trading advisors.
  • WEATHER IMPACT: Weather impact on crops in the U.S. Midwest, South America, West Africa, and other geographies has arguably been more pronounced with climate change. As reported by the NOAA, 2023 was the hottest year on record since 1850. 2024 may bring even more weather havoc, and with it, reignited food inflation. Weather also affects power production and consumption as energy sourcing, transmission and demand are going through potentially revolutionary change. As a shift toward sustainable energy sources is taking place, electricity pricing may suffer extreme peak volatility due to inadequate energy storage and peak power gas turbines capacity. Moreover, electric vehicle (EV) participation, primarily in the U.S. and Europe, is increasing while artificial intelligence (AI) computing drives electricity consumption higher. All of it will require a significant metals production increase while a capacity increase has been severely curtailed by chronic underinvestment.
  • 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 EV conversions are just a few examples for this to create new investment opportunities, sometimes in unique commodity markets, such as in global carbon allowance futures. Carbon capture has been our investment theme for years and will likely be creating further investment opportunities as COP28 resulted in a global agreement to transition away from fossil fuels in energy systems. The growing global climate issue may also affect the energy markets in other significant ways. Increasingly, 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 to 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 also potentially have a dramatic impact across the globe and add even more volatility to the current global situation.


These are just a few of the themes that can potentially create investment opportunities for a strategy like managed futures. Uncertainties, whether economic, political, social, or weather-related, will continue to support heightened volatility. Historically, managed futures investment strategies have capitalized on such environments which feature prolonged volatility, adding diversification to a portfolio in different market environments.

 
 
 
MSIM's Managed Futures Investment Team:
PATRICK EGAN Executive Director Head of Managed Futures Group
  • • 30+ years of relevant industry experience
  • • B.B.A., University of Notre Dame
  • • Chairman and President of Ceres Managed Futures LLC
  • • Former Director on the Managed Funds Association's Board of Directors
  • • Series 3, 7, 24, and 63
  • • Experience: Morgan Stanley
SRDJAN TESLIC, PH.D. Executive Director Chief Investment Officer
  • • 25+ years of relevant industry experience
  • • PhD, Materials Science and Engineering, University of Pennsylvania
  • • B.S., Physics from University of Novi Sad, Serbia
  • • Experience: SEI, BNP Paribas, Parker Global, Ferro, JPMorgan
SCOTT DUNLAP Vice President Portfolio Manager
  • • 20+ years of relevant industry experience
  • • B.A., Lehigh University Finra Series 7
  • • Experience: Morgan Stanley, Ark Asset Management
 
 

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.

 
 
 
The Managed Futures Team provides multi-manager and single-manager managed futures and currency strategies.
 
 
 
Approfondimenti correlati
 
Approfondimenti correlati
 
 

INDEX DESCRIPTIONS

The respective indices used in this presentation are the S&P 500 Total Return Index, Barclays Aggregate Bond Index, Barclay BTOP50 Index, and HFRI Fund of Funds Composite Index.

The S&P 500 Total Return Index is based on a portfolio of 500 stocks. The S&P 500 Total Return Index is a market value weighted index with each stock’s weight proportionate to its market value. The S&P 500 Total Return Index accounts for approximately 80% coverage of U.S. equities as of June 30, 2016. Total return provides investors with a price-plus-gross cash dividend return. Gross cash dividends are applied on the ex-date of the dividend.

The Bloomberg Aggregate Bond Index covers the U.S. dollar-denominated, investment-grade, fixed-rate, taxable bond market of SEC-registered securities. The index includes bonds from the Treasury, Government-Related, Corporate, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS sectors.

The MSCI World Index is a free float adjusted market capitalization weighted index that is designed to measure the global equity market performance of developed markets. The term "free float" represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The performance of the Index is listed in U.S. dollars and assumes reinvestment of net dividends.

The Barclay CTA Index is a leading industry benchmark of representative performance of commodity trading advisors. To qualify for inclusion in the CTA Index, an advisor must have four years of prior performance history. Additional programs introduced by qualified advisors are not added to the Index until after their second year. These restrictions, which offset the high turnover rates of trading advisors as well as their artificially high short-term performance records, ensure the accuracy and reliability of the Barclay CTA Index.

HFRI Fund Weighted Composite Index is an index comprised of funds of hedge funds classified by Hedge Fund Research, Inc. as “diversified.” Funds of hedge funds classified by HFR as “diversified” do not necessarily meet applicable diversification tests under the Investment Company Act of 1940 or the Internal Revenue Code. Rather, funds of hedge funds classified by HFR as “diversified” seek to minimize losses during down markets while still achieving superior returns in up markets, and they seek to do so by investing in underlying hedge funds collectively pursuing a variety of investment strategies and managed by multiple investment managers. The Index is an index of funds of hedge funds comprising approximately 340 funds of hedge funds which report monthly returns to HFR’s database and have either a minimum of $50 million in net assets or a track record of at least 12 months.

S&P GSCIU TR Index is the first major investable commodity index. It is one of the most widely recognized benchmarks that is broad-based and production weighted to represent the global commodity market beta. The index is designed to be investable by including the most liquid commodity futures, and provides diversification with low correlations to other asset classes.

IMPORTANT INFORMATION

The views and opinions are those solely of the author or the investment team as of the date of preparation of this material and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views and opinions herein will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views and opinions expressed do not reflect those of other or all investment teams at Morgan Stanley Investment Management (“MSIM”) or of the firm as a whole, and may not be reflected in all the strategies and products that the firm offers.

Forecasts and/or estimates provided herein are subject to change at any time and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific MSIM product.

Any charts and graphs provided are for illustrative purposes only. Any performance quoted represents past performance. Past performance does not guarantee future results. All investments involve risks, including the possible loss of principal.

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Managed futures investments are speculative, involve a high degree of risk, use significant leverage, have limited liquidity and/or may be generally illiquid, may incur substantial charges, may subject investors to conflicts of interest, and are suitable only for the risk capital portion of an investor’s portfolio. Before investing in any partnership and in order to make an informed decision, investors should read the applicable prospectus and/or offering documents carefully for additional information, including charges, expenses and risks. Investors should read the prospectus and/or offering documents carefully for additional information, including charges, expenses and risks. Managed futures investments are not intended to replace equities or fixed income securities but rather may act as a complement to these asset categories in a diversified portfolio.

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IMPORTANT  INFORMATION

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Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

All investments involve risks, including the possible loss of principal. The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

The views and opinions are those of the Investment team as of the date of preparation of this material and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. The views expressed do not reflect the opinions of all Investment teams at Morgan Stanley Investment Management or the views of the firm as a whole, and may not be reflected in the strategies and products that the Firm offers.

Charts and graphs provided herein are for illustrative purposes only. This material has been prepared using sources of information generally believed to be reliable but no representation can be made as to its accuracy.

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