Managed Futures Disappoint in Latest Sell-Off

Since the late 1960s, no other asset class has earned more impressive returns amid market carnage than volatile managed futures, or Commodity Trading Advisors (CTAs).

In almost every sell-off, crash or bear market over the last 37 years, managed futures logged big gains, including the 1987 stock market crash, 1990 bear market, 1997-98 Asian financial crisis/Long Term Capital Management collapse and most recently, the 2000 to 2002 bear market. Futures offer a truly negative correlation to traditional investments like stocks and bonds and therefore are optimal portfolio diversification products for the long-term growth investor.

But starting on February 27, when global markets began to roil, futures traders got walloped.

I rank and track some of the best-performing CTAs in my Global Mutual Fund Investor -- two in particular, that have never suffered a losing calendar year. But since February 27, both star managers have suffered major draw-downs in excess of 10%, quite alarming for a short period of time. More disappointing, however, is the high degree of market correlation logged by CTAs since the mini-panic began last month. These products are supposed to have a negative correlation to stocks.   

Trend-following CTAs, which dominate the futures industry in terms of overall assets, failed to protect capital in the latest sell-off because they were hugely long global stock indices, and to a lesser extent, gold and the Japanese yen.

Starting on February 27, global stock markets, which have been the strongest-performing assets since the bear market low of October 2002, suffered a mini-crash while the yen and gold prices violently reversed, two other trades that have been immensely profitable for long-term traders over the last few years. In one day, many existing trends that were previously highly profitable for CTAs, literally crashed. Trend-followers saw massive reversals in a short period of time and therefore were caught wrong-footed. This was certainly not the case in previous market events or stock-market crashes over the last 20 years, which beckons me to believe that many CTAs have grown too highly correlated to stock indexes over the last four years -- a bearish development for asset allocators like myself.

I still invest in managed futures and historically, they've been great performers in all markets. But as they eventually recover from this draw-down cycle, I'll be reducing my stake to a more manageable level and increasing my allocations to managers that harbor a short-bias in stocks to protect my portfolio's downside risk.

I'm off to Rome very early tomorrow morning, so I won't be able to post until Monday morning from Copenhagen. Have a good weekend.

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