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2016 Insights

Managed Futures During Equity "Crises"—An Update

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 majority of the total risk of these portfolios is driven by equities. Hence, most financial crises, almost by definition, involve large declines in equities, accompanied by similar 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 can often prove to be an environment in which managed futures have thrived.

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.1

The latest example of this was the period December 2015 – January 2016, when the S&P 500® Total Return Index lost −6.5%, while the VIX® Index, a forward-looking measure of equity market volatility, spiked by more than 25% (increasing from about 16% at the end of November 2015 to more than 20% at the end of January 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 +1.3%.

Several commentators, including us, have addressed and analyzed this characteristic of managed futures during other past crises. Here, we update those results, using a slightly different and perhaps more “rigorous” definition of a crisis. We look for periods since 1987 when the VIX® Index has either shown an increase of 25% or greater, or has reached an absolute level of at least 30%. We then try to identify the qualitative reason for such an increase, 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, managed futures, over those periods.  

Our results are summarized below, and speak for themselves. In every single one of these crises, as we define them, equity markets trade lower, ranging from −6.5% to from −46.4%. Managed futures, by way of contrast, show only three periods with negative returns, ranging from −2.8% to −0.2%, but twelve periods with positive returns, ranging from +1.0% to +18.7%.

Historical Performance of Equities and Managed Futures during Crises (%)
1987 - Present
PERIOD

starting
VIX

ending
VIX

Change in
VIX

Equity
RETURNS

Managed
Futures
Returns

Description of
Crisis

SEP-NOV
1987
-- -- -- -29% 8.5% Black Monday
JUL-OCT
1990
21.11 30.04 42.3% -14.1% 13.5% Iraq invades Kuwait
FEB-MAR
1994
10.63 20.45 92.4% -7.0% 1.0% First Fed hike since 1989
JUL-AUG
1998
19.71 44.28 124.7% -15.4% 5.4% Russian default and LTCM crisis
SEP-NOV
2000
16.84 29.65 76.1% -13.1% 6.0% USS Cole; Mad Cow outbreak; Bush v Gore
FEB-MAR
2001
22.02 28.64 30.1% -14.9% 5.3% Bush inaugurated; US and Britain attack Iraq
JUL-SEP
2001
19.06 31.93 67.5% -14.7% 4.1% Events leading up to 9/11 attacks
APR-SEP
2002
17.40 39.69 127.1% -28.4% 18.7% Enron and WorldCom; End of tech bubble
DEC-FEB
02'-03
27.50 29.63 7.7% -9.7% 17.5% War in Iraq; SARS outbreak
JUN-FEB
'08-09
17.83 46.35 160.0% -46.4% 7.2% Global financial crisis (The Great Recession)
MAY-JUN
2010
22.05 34.54 56.6% -12.8% -2.8% Greek crisis
MAY-SEP
2011
14.75 42.96 191.3% -16.3% -2.1% Eurozone debt crisis; US credit downgrade
APR-MAY
2012
15.50 24.06 55.2% -6.6% 2.2% Continuing European crises
AUG-SEP
2015
12.12 24.50 102.1% -8.4% -0.2% Chinese currency crisis
DEC-JAN
'15-16
16.13 20.20 25.2% -6.5% 1.3% Draghi stimulus fiasco; first Fed hike since 2006

 

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 crisis.
     
  • 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. Further, 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 traditionally defined as an asset that has a high negative correlation.

 

FOOTNOTES

Please refer to the glossary for definitions of terms and indices.

PAST PERFORMANCE DATA QUOTED HERE REPRESENTS PAST PERFORMANCE. CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE PERFROMANCE QUOTED ABOVE. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS.

Diversification does not ensure profit 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.

A Word About Risk
The purchase of a managed futures investment involves a high degree of risk. Specifically, you should be aware that, in addition to normal investment risks, managed futures investments entail certain risks, including, in all or some cases:

• Managed futures often engage in leveraging and other speculative investment practices that may increase the risk of investment loss.
• Managed futures can be highly illiquid.
• Managed futures are not required to provide periodic pricing or valuation information to investors.
• Managed futures may involve complex tax structures and delays in distributing important tax information.
• Managed futures are not subject to the same regulatory requirements as mutual funds.
• Managed futures often charge high fees

THE MATERIAL PROVIDED HEREIN HAS BEEN PROVIDED BY EQUINOX FUND MANAGEMENT, LLC AND IS FOR INFORMATIONAL PURPOSES ONLY.  EQUINOX FUND MANAGEMENT, LLC IS THE ADVISOR TO ONE OR MORE MUTUAL FUNDS DISTRIBUTED BY NORTHERN LIGHTS DISTRIBUTORS, LLC MEMBER FINRA/SIPC.

Securities offered through Equinox Group Distributors, LLC, Member of FINRA. To obtain more information, contact Equinox Funds at 1.877.837.0600 or info@equinoxfunds.com.

5134-NLD-02/18/2016