Blog

PIMCO Considers Managed Futures vs. Multi-Strategy Funds

24 November 2016
Managed futures and multi-strategy funds have both become increasingly popular over the past several years. Both provide investors with a  potential to diversify their returns, and to outperform during equity-market downturns – but which one is better? That’s the question considered by PIMCO’s Justin Blesy, Ashish Tiwari, and Chris Santore in their July 2016  paper Managed Futures and Multi-Strategy Funds: The Search for Diversification.

Equity Beta
Most managed futures and multi-strategy managers had low three-year trailing equity betas for the period ending May 31, 2016. But if a low correlation to the stock market was investor’s chief concern, then managed futures were the better option: Over 40% of managed-futures managers had equity betas of less than zero, while just a tiny fraction of multi-strategy managers had the same result.
Hedge fund

Performance During Downturns
Moreover, authors Blesy, Tiwari, and Santore point out that, since most managed-futures and multi-strategy investors hold their investments in the context of a broad portfolio, their betas matter most during equity-market downturns. Due to the  evidence from the graph below, managed-futures and multi-strategy funds with higher equity betas had the worst performance during the recent 10% selloffs in the S&P 500, August-September 2015 and January-February 2016:
alternative investments

Dispersion of Returns
But not all of the  managed-futures (or multi-strategy) managers are equal: For the three-year period ending May 31, the gap between the returns of managed-futures managers in the top 20%  and managers in the bottom 20% was 6.7%. By comparison, the gap between the top and bottom quintiles of the multi-strategy category was just 3.7%.
Thus, it’s evident that manager selection – and the due-diligence process inherent therein – is more important when choosing a managed-futures fund than selecting a multi-strategy fund.
dispersion return

Dispersion During Downturns
Returning to those recent equity-market selloffs in August-September 2015 and January-February 2016, Blesy and others found that funds in both categories fared better in the second downturn, which lasted longer  (28 days versus 10). This is explained by the authors as a case of “whipsawing” in the earlier downturn, wherein managers lost on short bets.
dispersion during downturns

Conclusion
Blesy, Tiwari, and Santore conclude by contrasting the ends and means of managed-futures and multi-strategy approaches: While their objectives may be the same, their paths to getting there are not. This requires a “closer evaluation of the considerations identified” in the white paper for investors who are interested in either managed futures or multi-strategy investing.
Ultimately, selection of a manager is the key. In the authors’ closing words: “Overall, pairing a small number of these complementary managers may smooth the journey and increase the chance of realizing desired outcomes.”

For more information, read a copy of the white paper:

Managed futures and multi-strategy mutual funds have soared in popularity over the past few years as investors are searching for the strategies designed to provide reliable portfolio diversification and attractive returns. In total, investors poured $37 billion into these funds from December 2014 through May 2016 alone, according to Morningstar. However, investors considering these categories should  take a closer look at how specifics of the  funds have performed. The past three years show a significant variation in style across managers. While some delivered attractive returns, only a subset delivered when it counted most – during sharp sell-offs in equity markets. We think the traditional playbook for evaluating managers needs to be altered when picking funds in these categories. Assessing philosophy, process, people and performance remains important, but investors also need to ask a different set of questions to ensure they not only select the right managers, but also have an optimal pairing. Furthermore, wide variation in performance implies “over-diversification” is a key risk – having too many managers increases the chances results will likely be subpar. Below, we offer a simple framework to help identify the right managers for investors who seek diversification benefits from these strategies.

STATE OF PLAY Managed futures, also known as trend-following or momentum funds, are gaining popularity as a portfolio diversifier and a potent antidote to equity market sell-offs. Multi-strategy funds, which provide access to multiple strategies and/or managers in a single fund, continue to gain traction as a perceived “onestop” solution for investors looking to allocate assets to liquid alternatives (see Figure 1). Combined, these categories have captured the majority of flows into liquid alternative mutual funds since December 2014. Given relatively short track records, many of these funds can be difficult to evaluate. However, a review of the past three years’ performance, which encompasses track records for a sizable segment of funds in each category, provides valuable insights. 
hedge funds

WHAT IS MY MANAGER’S EQUITY BETA? Equity beta, which measures the magnitude and direction of a fund’s movement with the equity markets, is a useful metric to gauge how sensitive a fund’s performance is to equity market gyrations. On average, funds with low or negative equity beta tend to be better equity diversifiers. Looking at the last three years, overall diversification provided by most managers is good – the majority of managed futures and multi-strategy managers have low equity betas, as shown in Figure 2. However, investors still need to be careful. For example, one out of five multi-strategy managers has an equity beta higher than 0.4; i.e., a 10% decline in equities is likely to cause the fund to lose around 4%. 
Hedge fund

ALONG WITH LOW EQUITY BETA, DID THE MANAGER DELIVER ATTRACTIVE RETURNS? Low equity beta is important, but not sufficient. There’s little benefit if the diversification potential comes at the cost of paltry, or worse, negative returns. As Figure 3 shows, performance dispersion across managers in both categories can be large. For example, returns delivered by the 20th and 80th percentile managers for multistrategy funds differed by close to four percentage points. For managed futures funds, the difference was even higher, close to seven percentage points. Put simply, investors are getting paid to diversify with only a subset of managers, and some managers delivered far superior performance. 
dispersion return

DOES THE MANAGER PROVIDE DIVERSIFICATION WHEN IT COUNTS THE MOST? While most managers provided diversification on average, they differed in their ability to provide diversification during equity market downturns. For example, although the last three years’ performance of multi-strategy managers didn’t reveal a strong relationship between returns and equity beta (i.e., managers with higher returns didn’t necessarily exhibit higher equity beta), there was a strong relationship during sharp market sell-offs. As shown in Figure 4, multi-strategy managers with high equity betas delivered the worst performance during August-September 2015 and January-February 2016. While this could be a result of poor timing decisions, the relationship seems to be quite persistent. In fact, we find there is almost a perfect correlation between average equity beta over the past three years and performance during down markets. 
alternative investments

DO SELECTED MANAGERS FOLLOW COMPLEMENTARY APPROACHES? It is also important to consider whether selected managers follow complementary approaches.  Assessing whether managers are substitutes or complements requires a combination of qualitative and quantitative analysis. As an example, the responsiveness of signals1 used by managed futures managers can help in discerning whether they are good complements.  In both August-September 2015 and January-February 2016, the S&P 500 declined by over 10% before recovering in October and March, respectively. The sell-off path was different in each episode. 
In August-September 2015, the sell-off happened over just six trading days; the January-February 2016 sell-off transpired over 28 trading days. Managed futures funds tended to do well in both these periods, but there was quite a bit of variation in performance across managers. A closer analysis shows much of this variation was driven by the level of responsiveness to market moves. In August 2015, managed futures funds that used short-term signals to go long or short the markets got “whipsawed” as they went short the market only to see it bounce right back, underperforming managers using longer-term signals. In contrast, these more responsive funds outperformed their slower-moving counterparts during the January-February 2016 market sell-off as the gradual nature of the market decline and subsequent recovery posed limited whipsaw risk (see Figure 5). This illustrates a central point: Pairing managed futures managers with different levels of responsiveness would have provided a more consistent outcome across these two episodes. 
dispersion during downturns

OTHER CONSIDERATIONS FOR MANAGER SELECTION Although average equity beta in multi-strategy funds and responsiveness of managed futures strategies can help explain the direction of returns during recent market drawdowns, these factors still don’t fully explain the wide variation in returns across managers. As we’ve argued previously, manager selection is critical to investing in liquid alternative strategies, as broad investment guidelines and manager discretion can result in wide dispersion in returns across funds. However, even when selecting managers backed by an experienced team, sound process and deep resources, among other considerations, we still expect consistently high dispersion in manager performance to continue. 
In managed futures funds, this dispersion reflects differences in algorithm, risk constraints and investment universe. Some strategies more rigidly target total volatility levels and contributions by asset class while others focus on the strongest trends, resulting in more variable levels of risk and more concentrated positions. With multi-strategy funds, the overall fund structure, opportunity set and target level of risk and equity beta differ significantly across funds. For example, focusing allocations on multiple equity long/ short and credit managers has the potential to generate meaningful equity risk, particularly during more volatile markets. In sum, while overall objectives across managers may be similar within a category, the paths to those outcomes vary widely. Therefore, a closer evaluation of the considerations identified in this article can help investors identify managers with differentiated approaches. Overall, pairing a small number of these complementary managers may smooth the journey and increase the chance of realizing desired outcomes.

Information for investors

This website is provided by Eganov Asset Management Partners (the “Investment Adviser”) and is for information purposes only. No guarantee, representation, undertaking or warranty, express or implied, is given by the Investment Advisor, Emerging Asset Management Ltd (the “Investment Manager”),  Cayman Emerging Manager Platform SPC (the “Company”), Eganov Asset Management Stocks & Derivatives Strategies S.P. (the "Sub-Fund"), Apex Fund Services Ltd (the “Administrator”) or their respective directors, officers, partners, shareholders or members as to the accuracy or completeness of the information or opinions contained on this website and no liability is accepted by such persons for the accuracy or completeness of any such information or opinions.

The Sub-Fund is a Segregated Account constituted as a distinct class of shares in the Company, an exempted segregated portfolio company incorporated in May 2011 for an unlimited duration and is registered as a mutual fund with the Cayman Islands Monetary Authority.

This website does not constitute or form any part of a prospectus, offer, invitation or solicitation for the sale of shares in the Company or the Sub-Fund, nor should it be construed to constitute any investment, legal or tax advice.

It should not be used or considered for the purpose of any offer to sell or solicitation to buy shares in the Company or the Sub-Fund in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or not authorized. This website is not aimed at persons who are residents of any country in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make any offer to sell or solicitation to buy shares in the Company or the Sub-Fund.

Users of this website who intend to subscribe for shares in the Company or the Sub-Fund are reminded that any subscription for any class of shares in the Company or the Sub-Fund can only be made by completing the subscription agreement for the relevant shares and shall be made solely on the basis of the information contained in the private placement memorandum of the Company and the supplement thereto of the Sub-Fund.  

Persons interested in making a subscription into the shares of the Company or the Sub-Fund should contact the Investment Advisor for the necessary documentation.

In making an investment decision, investors must rely on their own examination of the Company and the Sub-Fund and the terms of the offering, including the merits and risks involved. No assurance can be given that the Company’s or the Sub-Fund’s investment objectives will be achieved.

The shares of the Company or the Sub-Fund have not been filed with or approved or disapproved by any regulatory authority of any country or other jurisdiction, nor has any such regulatory authority passed upon or endorsed the merits of the Company or the Sub-Fund.

The directors of the Company (the "Directors") do not expect that an active secondary market will develop in the Company’s or the Sub-Fund’s shares. No listing or other dealing facility is at present being sought for any part of the Company’s or the Sub-Fund’s shares, although the Directors may reserve the right to seek a listing in the future.

Information for investors in the Russian Federation

Users of this website are reminded that no approval has been sought in relation to the Company or the Sub-Fund from any regulatory body in the Russian Federation. In the RF, the shares of the Company or the Sub-Fund can only be sold after obtaining the approval of the Federal Commission of the Security Market, which has not been obtained, and then only subject to requirements provided in law.

Information for investors in the Republic of Cyprus

Users of this website are reminded that no approval has been sought in relation to the Company or the Sub-Fund from any regulatory body in the Republic of Cyprus. In the Republic of Cyprus, the shares of the Company or the Sub-Fund can only be sold after obtaining the approval of the CySEC, which has not been obtained, and then only subject to requirements provided in law.

Information for investors in the United Arab Emirates

Users of this website are reminded that no approval has been sought in relation to the Company or the Sub-Fund from any regulatory body in the UAE. In the UAE, the shares of the Company or the Sub-Fund can only be sold after obtaining the approval of the Emirates Securities and Commodities Authority, which has not been obtained, and then only subject to requirements provided in law.

Information for investors in the United Kingdom

Users of this website are reminded that the Company or the Sub-Fund is not authorized or regulated under the provisions of the Financial Services and Market Act 2000. Accordingly, the shares of the Company or the Sub-Fund cannot be promoted or sold in the United Kingdom, other than under the exemptions permitted by the Act, in particular, the Financial Services and Market Act 2000 (Participation of Collective Investment Schemes) (Exemptions) Order 2001. In the UK, the shares of the Company or the Sub-Fund can only be sold to professional clients and/or self certified sophisticated high net worth individuals by an FSA Regulated Investment Advisor who has carried out a suitability test, as this is classified as an Unregulated Collective Investment Scheme ("UCIS") and is not regulated or recognized by the FSA in the United Kingdom.

Information for investors in the United States of America

Users of this website are reminded that the shares of the Company or the Sub-Fund may not be offered or sold in the United States or to U.S. persons at any time (as defined in Regulation S under the U.S. Securities Act of 1933 or the U.S. Internal Revenue Code). The shares of the Company or the Sub-Fund have not been and will not be registered under the U.S. Securities Act of 1933, as amended, or the securities laws of any state in the United States, and is subject to U.S. tax requirements. The shares of the Company or the Sub-Fund may not be offered, sold, transferred or delivered without compliance with all applicable securities laws and regulations.

Information for investors in Cayman Islands

Users of this website are reminded that the Company or the Sub-Fund may not make an invitation to the public in Cayman Islands to subscribe for the shares of the Company or the Sub-Fund.

No investment, legal or tax advice

Nothing contained in this website constitutes investment, legal, tax or other advice, nor is it to be relied upon when making investment or other decisions. The information on this website is available for information purposes only. You should obtain relevant and specific professional and legal advice before making any decision to enter into an investment transaction.

Liability for use of this website

Access to this website is permitted on a temporary basis and the Investment Advisor reserves the right to withdraw or amend the service it provides on this website without notice. The material and information displayed on this website are provided without any guarantees, conditions or warranties as to accuracy or completeness and are not intended to amount to advice on which reliance should be placed. The Investment Advisor, the Investment Manager, the Administrator, the Company and the Sub-Fund disclaim all liability and responsibility arising from any reliance placed on such materials and information contained on this website, or by anyone informed of any of this website's contents.

The internet is not a completely reliable transmission medium and none of the Investment Advisor, the Investment Manager, the Administrator, the Company and the Sub-Fund accept any liability for any data transmission errors such as data loss or damage or alteration of any kind or for the security or confidentiality of information transmitted across the internet to or from the Investment Advisor, the Investment Manager, the Administrator, the Company, the Sub-Fund or their respective directors, officers, partners, shareholders or members. Any such transmission of information is entirely at the website user's own risk.

Intellectual property rights

The Investment Advisor is the owner or the licensee of all intellectual property rights in this website, and in the materials published on it. Those works are protected by laws and treaties around the world. All such rights are reserved. Information found on this website may not be reproduced, distributed, stored in a data retrieval system, linked to modified or transmitted, in any forms or by any means (electronic, mechanical, photocopying, recording, or otherwise) without the prior written consent of the Investment Advisor. Nothing on this website can be construed as granting any license or right in relation to any of the Investment Advisors trademarks or those of a third party.

Law and variation

The terms and use of this website are governed by and shall be construed in accordance with the laws of Cayman Island. The courts of Cayman Island will have jurisdiction over any dispute arising from, or related to this website and by using this website each user agrees that the courts of Cayman Island are the most appropriate and convenient courts to settle disputes. Accordingly, each user agrees not to argue to the contrary or object to proceedings in such courts on the grounds of venue or that the proceedings have been brought in an inconvenient forum. The Investment Advisor retains the right to bring, in its sole discretion, proceedings against any user for any breach of these terms in the user's country of residence or any other relevant country.