Managed futures funds have fared poorly, but could shine in a market downturn

, Managed futures funds have fared poorly, but could shine in a market downturn

The funds can bet on rising or falling prices, and have a low correlation with stocks or bonds

Taken as a group, managed futures mutual funds have been wretched over the past five years. But the category has some strong performers, and if you’re looking for an unloved area due for a turn, managed futures might be the place to go.

The average managed futures fund has gained an average 1.24% in the past five years, according to Morningstar. That is only slightly better than the average intermediate-term US government bond fund. Within that average annual return is a lot of variation, and not all of it the good variety.

Why invest in commodities at all? A 1983 paper by the late Harvard professor John Lintner, “The Potential Role of Managed Commodity-Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds,” showed that managed futures had substantial diversification benefits for stock portfolios. This makes sense: Managed futures funds can bet on rising or falling prices, and have a low correlation with stocks or bonds.

And limited data shows that Lintner’s findings had merit. Guggenheim Managed Futures Strategy A (RYMFX), the oldest open-end managed futures fund, gained an annualized 12.4% during the 2007-2009 bear market, vs. an annualized loss of 42.95% for the Standard and Poor’s 500 stock index and a 48.26% for the MSCI Europe, Australasia and Far East index.

If you’re worried about a stock market downturn, then, a managed futures fund might make sense, especially since the funds have had such a wretched performance recently. Recent reaerch show that periods of really bad performance from managed futures often leads to relatively short bursts of outperformance — in other words, reversion to the mean.

The research also raises some interesting points. The first is that performance for managed futures has been unusually awful, particularly when looked at in terms of their Sharpe ratios, which measures return in relation to risk. The Barclay’s CTA Index, which represents the equally weighted average net returns of a large set of managed futures programs, had a 12-month Sharpe ratio of -1.99 in the 12 months ended June 30, its worst 12-month period ever. The research notes that those Sharpe ratios tend to revert to the mean. If the mean reversion pattern continues, this indicator could bode well for managed futures.

From the research:

The consistent result across our tests is that there does appear to be historical mean reversion in managed futures Sharpe ratios, with weaker 12-month periods being followed by stronger 12-month periods, and vice versa. This result would justify a strategy of buying the dips in managed futures and moderating positions after a strong period of performance.

Managed futures’ outperformance tends to be in short, sharp bursts. Waiting for a confirmation of the uptrend can mean you would miss a significant portion — up to 40% — of positive returns. Since the bulk of returns in managed futures were concentrated in relatively short windows of time, a return-chasing approach such as this can miss the early returns in a run-up and may incur a large opportunity cost.

The takeaway: It is good to buy low, but, as star manager Peter Lynch was fond of saying, it is always darkest just before its pitch black. However, searching for those funds that have been doing the worst, and dripping money in over several months is a great strategy.