KATHRYN KAMINSKI

Last week we were jazzed to have Dr. Kathryn Kaminski deliver a comprehensive presentation on Managed Futures Trend Following: The Ultimate Diversifier, where she covered the role of convergent and divergent strategies, and introduced other important themes like:

• The role of managed futures in institutional portfolios
  • Diversifiers vs. crisis alpha
• Return based style analysis to differentiate between managed futures funds, and build optimal portfolios
  • Identifying and managing the drivers of managed futures returns
• Sources of “craftsmanship alpha” in managed futures
  • The qualities to look for and what to avoid

The webinar prompted several questions from attendees, and Dr. Kaminski was kind enough to answer every one. We present her answers in Q&A format below:

Yes, post 2008 hasn’t been an easy period for Managed Futures. In all fairness, it has also been one of the easiest periods for Equity investors in the past 100 years or more.

There are several things to consider:

• Low interest rates are a drag for Managed Futures.If 80% or more of your assets are in T-bills and cash management accounts, this doesn’t help. In the 70s and even in the 80s Managed Futures had an 8% tail wind from interest on collateral. That would be nice right now.Put simply, low rates aren’t good for Managed Futures in pure carry terms. In addition, low rates may also create less movement in futures prices (Remember – the futures price includes the time value of money). Alex Greyserman and I examined this issue in our book. We considered the amount of market divergence in recent years and couldn’t find any evidence that prices are more efficient and less divergent than before. (See Chapter 5)
• No-crisis equals less divergence in prices equals less trend to capture. Hutchinson and O’Brien (2014) examine this issue in a paper entitled “Is this time different? Trend Following and Financial Crises” https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2375733

They show that when there is a sustained period without crises things are not so easy for Trend Following. I also have a whitepaper on “Crisis Alpha Everywhere” discussed in PIOnline that shows that it is the amount of crisis in different assets, not just equities, that matters. Equity crisis is a bigger driver, but it is crisis in general that drives divergence/dislocation that creates tradable trends.
http://www.pionline.com/article/20170330/ONLINE/170329884/crisis-alpha-everywhere

To put it more simply, there has been less crisis since 2008. There are some exceptions: 2014 was a rough year in commodities and currencies, CTAs did very well as we would expect. If there are no more serious crises in the next 10 years, I would expect this to be a headwind for Managed Futures returns.

Take the example of oil in 2014. No macro trader wanted to short oil because it seemed impossible that the price could keep going down. A trend system should short oil because it is going down. If the manager is willing to come in and make a discretionary decision, this is going against the approach – put in the words of the talk – adding convergent to the divergent approach. This often can backfire.

Another red flag is style drift – if the manager is moving their strategy around too much they are most likely suffering from hindsight bias. A simple example would be speeding up or slowing down the trend system due to recent performance. When slow trend systems have worked, if they move their system to be slower they are chasing past performance, which is not a great plan.

Carry is a good fit for trend – as long as it isn’t too big and as long as it is multi-asset class. Macro strategies are also good because they have similar positions but they tend to get into positions at different times.

For a global perspective, CRO is not really a new concept but in the US the term and concept is new. In 2012, one of the largest Swedish Pension funds discussed a similar objective and they built what they called a “protection portfolio” which has a similar mandate to the CRO mandates in the US. Pension funds in Europe, the Middle East, and Japan have been investing in Managed Futures with a similar objective for many years. US pensions have been somewhat newer to investing in Managed Futures.

How does CRO shift the conversation about Managed Futures? Historically Managed Futures has been bucketed in with “convergent” strategies in hedge funds. In this case, when compared with these strategies they came up short as a stand-alone investment. The Sharpe ratios are lower than the typical hedge fund.

On the other hand, from a “global” portfolio perspective they are one of the best global risk reducers. Hedge funds tend to have higher Sharpe ratios, but while they are generally uncorrelated they tend to correlate during periods of crisis, or when credit or liquidity risk are an issue. In this case, they are “locally optimal” in a hedge fund portfolio but not always globally optimal from the entire portfolio perspective.

A CRO strategic class is meant to put strategies like managed futures (in particular trend following) into a different bucket with a different strategic objective than hedge funds. Given this, investors have understand that if they are looking for risk mitigation they may make different choices than if they are looking for something that is just uncorrelated.

No offence, but trend following on equity indexes is not good at all as a stand-alone.

I would estimate the Sharpe ratio about 0.08 over long horizons (see our book on trend). This doesn’t mean you shouldn’t do it but it’s not generally that fun to do. It is a part of a trend system but I wouldn’t advise doing it alone. Timing seems to be more difficult in equities, traditionally trends on short rates and fixed income have had the best Sharpe ratios.

If the S&P goes down, CTAs will tend to short the S&P, but it will depend on how quickly the S&P goes down and what happened prior to the S&P going down.

Most CTAs who focus on longer-term trends may reduce their long positions but not start shorting until some time after the S&P goes down. This is why Q1 has been hard for CTAs even in an equity correction. Since the long term trend in equities was up up up, they were  long equities, but when this trend reverted they lost on the correction and had to reduce equity positions.

A key thing to remember is that CTAs tend to have long term signals it can take some time for them to go from long to short in any asset.

Great question, I would suggest a 20% allocation but I do agree that it requires the right framing for an investor. The investor needs to see the investment as complementary to the remainder of the portfolio, not necessarily just crisis alpha. This is precisely why a CRO or strategic class for pensions is a big step for understanding managed futures. If they are less comfortable with hugging their peers or a benchmark, a lower allocation may be more appropriate. I often focus on also telling them with this investment it is important to not buy high and sell low. Many investors invest after a big “divergent event” and then they get frustrated that it doesn’t repeat. If they want to reduce an allocation, reduce after, not at the bottom. This is why framing the investment is so important.

Historically shorts do not preform as well as longs. This is simply because over the long run many assets with a risk premium tend to up-trend.

But since most investors hold long assets, being able to be short from time to time can have great complimentary properties. Without doing any analysis, I would suggest that the contribution is 80/20 or 70/30.

In our book, Alex and I look at the long bias in equities in Chapter 13 of our book using the equity bias factor. You can see there that most of the time it is better to have more long bias, but sometimes when it really matters being short can really add value.

I would suggest Robert Carver’s book “Systematic Trading” and Andreas Clenow’s book “Following the Trend.”

Thanks Kathryn!