This article first appeared online in
the April issue of REP. magazine
In January, while the S&P 500 Composite (
) slid 3.6 percent, the Dow Jones UBS Commodity Index (DJUBS)
gained 0.3 percent. DJUBS is a long-only benchmark made up of 20
non-financial futures. It wasn't much of a gain and one month
doesn't spell "turnaround," but this isn't just a one-month deal.
Commodities, on the outs since 2011, have actually broken above a
multi-year downtrend line. (See Chart 1.)
There are, in fact, a number of technical signals suggesting the
commodity sector has put in a major cycle low. Several futures
markets are in near-term price uptrends, a confluence of bullish
scenarios not seen in years. As long as prices trend upward, the
path of least resistance seems to be sideways to higher.
All this is certainly good news to holders of long-only
commodity index products. There are a fair number-16, in fact-of
these domestic exchange traded funds and notes representing $10.4
billion in market capitalization.
But index trackers aren't the only products populating the
commodity sector. Active products-emulators of managed futures
hedge funds-are making inroads. The question advisors and investors
seeking commodity exposure now face is, "Active or passive?"
If history is any guide, the answer ought to be "active."
Managed futures have outperformed long-only commodity investments
over the past two decades, as evidenced by the track record of the
Credit Suisse Managed Futures Liquid Index (CSMF).
CSMF mimics the trades a typical momentum-following hedge fund
would make, i.e., buying when the short-term moving averages for
various commodity futures exceed their long-term averages, and
selling when long-term averages exceed short term. Since 1997, CSMF
has outdone DJUBS by a three-fold margin, earning a Sharpe ratio of
1.04 versus the -.36 ratio booked by the long-only benchmark.
Simply put, the rewards earned by an actively managed futures
strategy have more than compensated abiding investors for the risks
CSMF, unlike DJUBS, is negatively correlated to the S&P 500,
making managed futures a better portfolio diversifier than
long-only commodity exposure. The hedge value of an active futures
strategy was clearly demonstrated when SPX toppled 29 percent in
the second half of 2008; DJUBS nosedived 43 percent, while CSMF
rose 17 percent. (See Chart 2.)
The reason for the performance disparity is simple: The
long-only approach leaves alpha on the table. Since any futures
trade-short or long-is margined, bearish positions can be
undertaken with the same ease (and risk) as bullish bets. A lot of
commodity price volatility is, in fact, downward variance, and
represents a rich trove of potential profits for short-enabled
strategies. While down days account for roughly half of all futures
trading sessions, the average daily losses for many key
contracts-such as coffee, corn, cotton, cattle, hogs, natural gas
and wheat-are greater than average daily gains. These commodities
offered exceptional short-selling opportunities over the past two
decades. All, in fact, are currently trading at prices lower than
their December 1997 levels.
Managed Futures ETFs
There are three players in the managed futures ETF derby. The
eldest launched in January 2011 and the youngster debuted in
October 2013. In a side-by-side comparison, youth seems volatile,
The segment's granddaddy is the WisdomTree Managed Futures
Strategy Fund (
), which managed to emulate, but not directly track, the returns of
the Diversified Trend Index, a long/short strategy that juggles two
dozen currency, commodity and Treasury futures.
Since October, granddad has doddered a bit. WDTI's weak
performance came about because the strategy missed out on uptrends
in agricultural commodities, such as wheat and soybeans. In fact,
WDTI was most recently short beans. The fund was also short natural
gas heading into a very cold winter.
Still, WDTI has a lot going for it. Number one, its size. With
$142 million under management, the fund's closure risk is low.
Number two is its liquidity. Bid/ask spreads are relatively tight
for an ETF of this type, and volume's solid at 26,000 shares ($1.1
million) a day. Lately, WDTI's traded at a 3 basis point premium
Because there's no stock exposure in the WDTI stratagem, the
WisdomTree portfolio shows the least correlation to equities. While
that's not been a return-enhancer over the past quarter, it makes
the old man a good risk-diversifier.
The fund also exhibits a low correlation to fixed income, owing
to its net zero exposure to Treasurys. (At last look, WDTI was long
10-year notes and short an equal slug of 30-year bonds, essentially
putting the fund in the yield curve, steepening business.)
Of the three ETFs, WDTI acts most like a managed futures hedge
fund, reflected in its r
(r-squared) and beta coefficients against CSMF. (See Table 2.)
There's been a more tenuous correlation to managed futures
exhibited by the $5 million First Trust Morningstar Managed Futures
Strategy Fund (
). Launched in July 2013, FMF uses commodity, currency and equity
futures in roughly equal proportions. Similar to WDTI, FMF attempts
to model, not mimic, its benchmark (in this case, the Morningstar
Diversified Futures Index, or DFI), reserving for its portfolio
runners the right to manage contract selection and rolls in the
pursuit of excess returns.
Recently, FMF has been biased towards equity, devoting more than
a quarter of its heft to long positions in S&P 500 and German
DAX futures. There's not a drop of fixed income exposure in the
portfolio, however. Unlike WDTI's net long tilt in commodities, FMF
had a slightly bearish bias over the past quarter, highlighted by
short positions in precious metals and corn. Net currency exposure,
like WDTI's, has been long.
Bid/ask spreads are about four times the width of WDTI's market,
and daily volume averages just 4,400 shares ($224,000). That
average, however, should not be expected on any given day. Since
October, nearly 60 percent of FMF's trading sessions were actually
Not surprisingly, the apparent spread between FMF's market price
and its portfolio value is pretty wide. Slack demand for the ETF is
reflected in an average 16 basis points discount. There's been
considerable volatility in this spread, however, as values have
ranged between a 112 basis points premium and a 127 basis points
discount, four times the variance found in WDTI.
The sector's newbie is the First Trust Global Tactical Commodity
Strategy Fund (
), which launched just three months after its FMF sibling debuted.
FTGC's asset growth has been on a more dramatic trajectory than
FMF's; the newer fund has more than $16 million under management
now. Trading FTGC is easier than FMF, as daily turnover averages
31,000 shares ($988,000) and zero-volume days make up just 15
percent of its track record.
FTGC's bid/ask spread tends to be tighter than FMF's, but the
average variance between market prices and NAVs-at 18 basis
points-tends to be just as wide, if not wider. The big difference
is that FTGC trades at a premium, not a discount, symptomatic of
greater demand. In its lifetime, FTGC has traded at an apparent
premium as high as 104 basis points and a discount as deep as 105
FTGC is now handily outdoing the other two actively managed
futures ETFs, though not without a fair degree of volatility. While
FTGC's standard deviation is less than that of SPX, it's still
twice that of WDTI and FMF.
The outperformance is largely due to concentration. Its
portfolio is comprised of just 14 positions-all commodities, no
financials-half as many as WDTI or FMF. FTGC's managers make big
bets, too. The fund's average position size is 98 contracts. For
FMF, the typical wager is just two contracts, and for the much
larger WDTI, it's 73 contracts. FTGC's outsized positions are all
the more remarkable when you consider that the newcomer is barely
one-tenth the size of WDTI.
FTGC acts like a long-only fund. That's because it is long-only,
at least for now. Its r
coefficient versus DJUBS is .67, a much tighter fit than exhibited
by the other two portfolios. (See Table 2.) In contrast, FTGC's
coefficient against the short-enabled CSMF is nil.
Mostly, FTGC has benefited from a "winter" strategy, namely long
positions in coffee, natural gas and soybean meal.
Short Track Records
It's early days for managed futures ETFs, so it's dangerous to
make too many generalizations regarding their behavior. Still,
there are indications of their relative utility as portfolio
adjuncts. Compare the recent performance of a model portfolio (60
percent equities, 40 percent fixed income) against constructions
with a managed futures overlay (50 percent equities, 35 percent
bonds and 15 percent managed futures).
As detailed in Table 3, adding FTGC both augmented returns and
dampened volatility to yield a significantly higher Sharpe ratio.
The question before investors and advisors now is whether there's
any permanence to this outperformance. Of the three extant ETFs,
FTGC has the longest leash: It's not tethered to a mechanical
strategy like DTI or DFI. FTGC managers have recently opted to go
"all long" and, by doing so, have extracted a big dollop of alpha.
FMF and WDTI portfolio runners don't have that latitude. Not yet,
While the cold winter has driven some commodity prices skyward,
weather has not been the sole reason for a widespread futures
rebound. The expansive rally may be a warning sign of incipient
inflation. If so, the long-only approach adopted by FTGC may have
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