Future thinking – Providing returns in a falling market

Managed Futures

Managed Futures trading

Of the many sub-divisions of funds offering some type of exposure to absolute returns, I have personally always been a little wary of the qualitative fund of hedge funds, primarily because there is always that element of being charged fees on top of fees and also because the individual making the investment decisions works in financial services. By nature, they are likely to be naturally optimistic about the share market resulting in a psychological bias towards the markets going up (see November’s article on the psychology of investment).

It could be argued that over time the markets are going to head in an upward trend and therefore a preposition for a rising market isn’t necessarily a bad thing. It could also be argued that fund managers are professionals and that they are in that position because they are able to detach the emotional aspect from their investment decisions.

However, hedge fund managers are amongst some of the highest paid managers in the industry, with bonuses hitting the millions when they get it right and a cynic would argue that one year of exceptional returns can set them up for retirement and therefore there is a natural predisposition to take undue risk with a portfolio in aim of providing that one year of exceptional returns.

As a result I personally have a bias towards those absolute return funds that invest directly, ie not a fund of funds, those that offer an automated investment process and finally, the larger the institution offering them the better, they have bigger and better processes in place to ensure that the psychological investment risk is mitigated. Funds such as Man Investments managed futures program or BlackRock AAA Fund.

Managed Futures Programs

Since Man Investments, arguably the most prolific retail hedge fund manager in Australia, were able to continue to provide investor returns in 2008, managed futures seems to be the new buzz phrase among the clients I have spoken to. Many who had become disheartened with falls in equity, property and now interest rates were at a loss as to where they could find investment returns.

Managed futures programs are a subset of the hedge fund universe. However, just call any of the managed futures managers out there and they will almost certainly avoid any reference to hedge funds. “We’re not a hedge fund, we’re a managed futures program” is the likely response you will hear. Although I could suggest that if you want to really confuse the issue, ask them to define the difference, Here’s my opinion:

Managed Futures aim to take advantage of trends in the market, they don’t promise absolute returns. Absolute return/hedge funds aim to produce absolute returns regardless of trends. Both aim to produce returns in a rising and falling market.

However you want to refer to them, as far as I’m concerned, it can be an excellent way to get exposure to a return in a falling market whilst also having the ability to perform in a rising market.

So what are they?

Consider them a Hedge Fund, Absolute Return Fund or the precisely named Managed Futures Investment Program, they are an automated computer program that looks to profit from trends in the investment markets. And since there is no individual fund manager, they have the added benefit of never having a personal bias or ever getting tired, allowing them to monitor and trade on over 100 investment markets worldwide.

The key to understanding these products is “profiting from trends”. You will note that in times of a flat market or very volatile swings in the market, the programs can fail to yield a return. It’s when a rising or falling trend emerges that these investment programs produce results and whilst 2008 was bad for many of the global markets, the downward trends allowed these investment programs to profit considerably.