Patrick Welton doesn't care which way markets move. The doctor-turned-trader, who manages some $500 million, rode the commodities rally for months, banking huge profits as oil soared past $145. When prices reversed, he shifted gears and used futures to bet against black gold. Welton also trades futures on stocks, bonds, and currencies, and he's thriving in the current chaos.
Anyone who tracks the portfolios of big institutions, such as pension funds and college endowments, knows how dreadful 2008 was. It might have been worse if not for so-called managed futures funds, which as a group soared last year. Welton's Global Directional Portfolio, for instance, notched a 23% gain. Such performance is a reminder to investors big and small that diversification pays. "We do tend to make money...during difficult times," says Brent Hankins, a senior portfolio manager at Welton Investment in Carmel, Calif. Adds Welton: "Most portfolios are vastly underdiversified."
Catering chiefly to wealthy investors and big institutions, managed futures funds use computer models to suss out market trends that may last a few days or several months. Trying to capitalize on both the upside and the down, the funds then buy and sell futures and other derivatives. Although there are scores of managed futures funds, including ones run by John W. Henry & Co. (whose founder also owns the Boston Red Sox), many are small: Few have more than $1 billion in assets. "Whether prices move fast or slow, in the U.S. or abroad, we are watching, perennially watching," says Welton, whose returns last year outpaced similar funds by nearly 10 percentage points.
The key for Welton and other so-called trend followers is volatility. If price swings are small, trading opportunities tend to be minimal. In 2005 and 2006, when stocks were steadily rising, the Chicago Board Options Exchange Volatility Index—the infamous VIX "fear index" that measures whether fluctuations in equities are weak or wild—dipped to a low of around 10. During those two years, managed futures funds overall eked out gains of just 1.7% and 3.5%, according to research firm BarclayHedge, compared with 10.7% and 12.4% for hedge funds.
But since the financial crisis hit, the volatility index has soared, topping 80 in the fall before settling to around 39 today. The tumult has been a boon for managed futures funds, which climbed more than 13% last year. Hedge funds, by comparison, were off around 21%. Managed futures funds have "had a really good run," says Sol Waksman, president of BarclayHedge.
Welton first dabbled in the markets to help pay for medical school at the University of California at Los Angeles in the mid-1980s. Later, during his postdoctoral training at Stanford University, he honed his financial skills at Commodities Corp., the Princeton (N.J.) trading shop where legendary investor Paul Tudor Jones cut his teeth. In 1998 Welton decided to give up medicine to start his own firm. "The challenges of global trading captured me," he says.
Welton and his 19-member team now keep tabs on more than 100 different markets around the world. The group's rapid-fire trading in and out of positions has produced annualized, double-digit gains every year since the fund's inception in mid-2004.