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Wednesday, September 8, 2010

No This is Not an Asset Class

The WSJ reported  on the exodus of investors ((looking firmly into that rear view mirror) from managed futures funds in ligfht of their disapoinint performance. As the article notes some other factors contribute to that sentiment as well, although I am sure they were overlooked when performance looked goods:

A slew of new "managed futures" mutual funds purport to offer small investors a sophisticated strategy that held up well during the financial crisis.
But the approach, previously limited mostly to institutions and wealthy individuals, has proved an awkward fit for the mom-and-pop mutual-fund world.
The new funds' complex structure, which can leave investors in the dark about fees and portfolio holdings, already has prompted regulators to push for stricter oversight of the products. And so far, performance has been lackluster.
Managed-futures funds aim to profit from both positive and negative trends in commodities, currencies, bonds and other markets. The funds trade futures contracts tied to these investments, sometimes taking "short" positions to bet on price declines.
The idea (or precisely product) of a managed futures account for individual investors is not new previously they had been done as managed futures accounts run by commodity trading advisors regulated by the CFTC.
These products were/are sold with the argument that these managed futures are an "asset class". Apparently simply because they trade currency, bond and commodity futures they constitute and asset class. Of course nothing of the kind is the case, since they can be long or short and uninvested at times they share no characteristics of those asset classes. They are simply a bet on manager skill something which is by its very nature inconsistent and an unreliable basis to invest.

If these funds correlate to anything it is the existence or non existence of trends in markets (and the managers skill in timing and identifying these). The article notes:

The new funds are arriving amid market conditions that are generally unfavorable to the managed-futures approach. While strong positive or negative market trends tend to benefit these funds, markets lately have generally been choppy with many shorter-term reversals. "If you're trying to invest based on a trend-following strategy and there is no trend, that is not a helpful environment," says Lasse Pedersen, principal at AQR.
And the fees on these funds are massive. If the inestor of actively managed stock  fund with an average fee of over 1%  is analogou to starting out 10 yards behind in a hundred yard dash compared to an index investor with fees of .20% or less, then the investor in these funds starts at least 30 yards behind:

Equinox's MutualHedge Frontier Legends Fund, launched at the end of last year. The fund's website and prospectus fee table list an expense ratio of 2.2% for A shares, fairly typical for a hedge-like mutual fund. But that doesn't tell the whole fee story. A fund prospectus filed in early January said the fund may invest as much as a quarter of assets in a subsidiary, which could in turn invest in various private investment vehicles or commodity pools. In a lengthy section on "principal risks," the prospectus said the vehicles "are typically subject to relatively high management fees and often include performance-based fees" that can reduce fund returns.
Equinox divulged more details in a prospectus supplement filed in late April, after the fund had been on the market for nearly four months. That document said the pools would be subject to anticipated management fees of up to 2% of assets and performance-based fees ranging from 15% to 30% of new-high net trading profits—fees far more typical of hedge funds than mutual funds.
And the often rapid fire short term trading in these funds means the after tax returns will look even worse.

But I have no doubt the industry will be back marketing these funds hard and that investors will return if there is a short period of strong performance.

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