How Managed Funds Managed To Do So Poorly

Commodity fund managers are a swashbuckling lot. Unlike the folks who run stock and bond portfolios, commodity traders thrive on market chaos. Their computerized trading systems are designed to exploit volatility in the futures and options markets, no matter which way the market goes. Well, the world currency and interest-rate markets are moving, all right--yet the commodity funds have been left in the lurch.

Their poor showing in a crucial period raises questions about the ability of commodity funds to deliver the high rewards that their high-risk profile would seem to promise. True, some of the largest funds achieved double-digit gains through Sept. 30, largely on the strength of currency and interest-rate bets earlier in the summer. But when those markets really went wild in September, the funds failed to cash in (table). On average, managed futures funds lost 2% in September and posted only slight improvement in October. Through Sept. 30, the funds are down 1.8%.

Their dreary performance contrasts sharply with the gains racked up by hedge-fund manager George Soros and supertrader Paul Tudor Jones, who recorded huge profits by trading currencies and European interest-rate futures. "This has not been a banner year for managed futures," says George E. Crapple, co-chief executive officer of Millburn Ridgefield Corp., which runs $650 million in futures portfolios.

`WHIPSAW PERIOD.' Indeed, commodity funds have suffered through nearly two years of poor performance. In 1991, while equity investors were thriving, commodity funds eked out a 4.8% gain, according to Managed Account Reports, a New York-based newsletter that tracks futures funds. But throughout 1991 and much of this year, the markets were listless, giving traders few opportunities for profits.

What went wrong in September? For the most part, the losers were "trend-following" traders who use computer programs, not "discretionary" traders such as Jones, who make decisions depending on their view of market fundamentals. The trend followers got caught because their computers can't foresee earth-shattering fundamental factors--in this case, the collapse of Europe's system of linked exchange rates, the Bundesbank's sudden interest-rate cut, and the devaluation of the pound. "This has been a whipsaw period for people who try to follow trends," says Jim Little, director of development for Campbell & Co., a trend-follower.

A good example of the traders' troubles came on Sept. 9, when reports abounded of an imminent collapse of Europe's exchange-rate mechanism. At Hawksbill Management Co. in Santa Rosa, Calif., the computers were blindly following the trend set forth by the market's previous action and were continuing to issue buy orders. But Hawksbill President Thomas Shanks overrode the computers, selling the pound and buying the mark. Within days, the British devalued the pound and the Germans cut interest rates, and Shanks pocketed a $2.6 million profit, accounting for much of his firm's 19% gain in September.

Most trend followers obeyed their computers and got creamed. The losers included some of the largest commodity trading firms. Demeter Management, which handles nearly $800 million in commodity fund assets for Dean Witter Financial Services Group Inc., saw its portfolio decline more than 3.2% in September. Dunn Capital Management, which handles $200 million in futures assets, posted a 7% loss. And the commodity trading giant John W. Henry & Co. lost more than 4.4% on $725 million of its funds that trade heavily in currency and interest-rate markets.

NARROW ESCAPE. Fund managers who avoided the slaughter either made correct bets, like Shanks, or were out of the market entirely. At Millburn Ridgefield, for example, a risk-control program signaled traders to exit or drastically trim most of its current positions in early September. In an hour of hectic trading, Millburn unloaded more than $1.5 billion in marks, yen, Swiss francs, and pounds, narrowly escaping their collapse against the dollar. Millburn's tally for the month: a hard-earned 0.24% gain. "We would have had horrendous losses if we hadn't cut our size," says Crapple.

Trend followers are trying to make sense out of their dismal recent returns. "When you look past the superficial question of how we did, you look under the hood and see immense change in the global markets," says Kenneth G. Tropin, John W. Henry's president. "Volatility is just a harbinger of new trends to come."

Maybe. But futures traders are supposed to make money by exploiting volatility. Performance isn't a "superficial question" if you were among the thousands of commodity-fund customers who lost money when the currency markets went bonkers.

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