A Fast-Paced Trading Game

After a stellar 2008, the hedge fund strategy is taking a beating. Is it time to bail?

In 2008 few hedge fund strategies performed better than managed futures, which attempt to profit from short-term moves in commodity, currency, and other markets. And in 2009 few have performed worse. Does that mean it's time to bail out on managed futures?

If one looks simply at returns, it might seem so. The category is down 7.8% through the end of July (the most recent data available), according to Altegris Investments, a broker-dealer based in La Jolla, Calif. That's lousy compared with the Standard & Poor's (MHP) 500-stock index's 9.3% gain over the same period—and with the 15.5% return that managed futures posted in the midst of last year's market meltdown. Such stellar performance in 2008 had some proponents calling managed futures "the new diversifier." And while this year's numbers aren't pretty, the fact that the category hasn't moved in lockstep with the market is actually better for your portfolio. "The funds are doing what you'd expect them to do," says Adam Erickson, chief operating officer at Brewer Investment Group, a Chicago wealth management firm. "They're not following the stock market."

The funds' managers, who are also referred to as commodity trading advisers, buy and sell futures contracts in everything from oil and natural gas to currencies and interest rates. They hope to profit from large price moves, up or down, over a few weeks or months, and they usually do so with the help of complicated computer programs that help identify trends. "They're good at capturing large price movements in commodities and currencies," says David Bailin, president of alternative investments at Merrill Lynch Wealth Management (BAC).

But this year has been noticeable for its lack of pronounced—and sustained—market movements. Until it recently spiked above $1,000 an ounce, gold had spent much of the year trading in the 900s. The euro has been stuck in a 6 cents range against the dollar since May. And even when there have been moves—oil's bounce from $45.20 to a recent $71.10 is a good example—they've been sudden, uneven, and short-lived. "There's been talk of double dips and green shoots, inflation and deflation, and plenty of stutter steps and reversals," says Altegris President Jon Sundt, referring to the market's mixed signals. "It's the choppiness of the market that's responsible for the performance."

So investors in managed futures shouldn't expect a smooth ride. Managers often lose small amounts of money as their computer models identify possible trends that fail to materialize. But when the trends do emerge, they can often make up for the losses. In every year since 2000, Altegris' managed futures index has had periods in which it fell 6% or more yet still finished up for the year. Last year's gains came despite a 7% loss during the summer. Says James Shelton, chief investment officer at Kanaly Trust: "The investment itself has a little bit higher volatility than people are aware of." Merrill Lynch says managed futures make up about 2% of its high-net-worth investors' portfolios. Some advisers recommend going as high as 15%.


Once available only to accredited investors—those who make $250,000 a year or have $1 million in investable assets—managed futures are now an option for everyday investors. In recent years, mutual funds have emerged that seek to track the strategies of managed futures. Rydex/SGI Managed Futures Fund, which came out in 2007, mirrors the performance of the S&P Diversified Trends Indicator, an index that uses a seven-month moving average (the average daily price of an asset over a seven-month period) to decide when to buy or sell any of six commodities, six currencies, and Treasury bonds or notes. Direxion Commodity Trends Strategy Fund (DXCTX) and Direxion Financial Trends Strategy Fund (DXFTX), introduced last year, take the Rydex fund but separate the commodity and currency components. Other firms, including WisdomTree Investment and (WSDT) AQR Funds, have recently applied to the Securities & Exchange Commission to launch their own managed futures funds.

The Rydex fund was up nearly 9% in 2008 and is down 3.9% so far in 2009—not as stellar as some managed futures funds, but not too shabby, either. To comply with SEC regulations the funds place trades based on a set of simple, unchanging rules once a month rather than using the complex, constantly adjusting mathematical models of the best-managed futures programs—making them a sort of "managed futures lite" option. They're also designed not to short energy futures, which are more sensitive to economic and political events. While that decision reduces overall volatility, it also means the mutual funds don't profit when oil crashes, as it did in 2008. "The difference between the two types of funds is like a Ford Pinto and a new Lexus," says Ken Steben, president of managed futures adviser Steben & Co. in Rockville, Md. "They both run on combustion engines, but the cars are very, very different."

For investors interested in more traditional managed futures, some commodity trading advisers make their funds available to investors who make at least $70,000 a year and have $70,000 in investable assets. But choosing a manager isn't easy—each has his own proprietary computer program and favored strategies, and the difference in performance among managers can be huge. In 2008 the best managed futures funds were up more than 30%, while the worst were down around 20%. And the funds may come with the high fees associated with hedge funds—it's not uncommon for 20% of the profits to go to the manager—and do not have daily liquidity. Focus on experienced managers and try to get a feel for how much risk they take on to generate their returns. Says Altegris' Sundt: "Do your homework."

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