Standard and Poors, a leading developer of indices such as the S&P 500 stock index, recently launched a managed futures index designed to be ‚Äúinvestible but also act as a benchmark for the industry,‚ÄĚ according to Jodie Gunzberg, Director of Commodities for S&P Indices.
S&P‚Äôs new managed futures product, S&P Systematic Global Macro Index (SGMI), is interesting from a number of perspectives, but also raises questions.
What is S&P‚Äôs motivation for entering the managed futures space with a new product at this moment in economic history?
Will the new index really represent broad managed futures exposure with what is essentially a singular trend following strategy? ¬†Does this “index” look like an individual CTA with a specific trend following formula? ¬† How does the new index relate to S&P’s existing managed futures index, the Diversified Trends Indicator (DTI), which is currently linked to 40% of all managed futures mutual funds assets under management and has traditionally underperformed industry benchmarks?
In this report these are the questions addressed along with a revealing look at the interesting algorithm used by S&P to create this new managed futures index.
Why Managed Futures? Why Now?
‚ÄúThe unhealthy debt situation, the general dismal jobs outlook and uncertain economic prospects all factor into why an investor might want to consider managed futures, which have traditionally held up well during past crises,‚ÄĚ said Gunzberg in her first interview on the new index.
‚ÄúThe motivation behind launching the S&P SMGI is to provide investors access to hard to reach enhanced beta,‚ÄĚ Gunzberg said, noting that access to individual managers is not as commonly available as one would expect. ‚ÄúTraditionally investors have had difficulty accessing managed futures and other alternatives uncorrelated to the performance of the stock market.‚ÄĚ
‚ÄúGlobally managed futures has had a historically low correlation to stocks, bonds, and real estate plus goes beyond commodities,‚ÄĚ she said, noting common issues investors face. ‚ÄúIf investors look over the past ten years, they notice that equity returns have essentially delivered zero return. Right now investors are wondering where to put their assets. Interest rates are at all time lows and likely only have one way to go, higher, which means bonds are likely to suffer. Real estate is generally illiquid and like stocks correlated to economic health.‚ÄĚ
As a former consultant, Gunzberg initially noticed clients were looking for exposure to commodities, but found limited choices. ‚ÄúThen we discovered managed futures, which offered significantly more choices since the funds are more well-diversified than commodity only funds, yet are still generally uncorrelated to stocks and bonds typically driven by general market environment factors, not positive economic factors.‚ÄĚ
Will This ‚ÄúIndex‚ÄĚ Represent Broad ‚ÄúManaged Futures Exposure‚ÄĚ
It will be interesting to watch how this ‚Äúindex‚ÄĚ performs relative to the managed futures industry at large. S&P‚Äôs other managed futures offering, the S&P Diversified Trends Index (DTI), has a history of typically underperforming managed futures in general. While the S&P SGMI offers a different formulaic trend following model than the S&P DTI, the question remains does the S&P SMGI represent a single trend following CTA or the broad universe of managed futures exposure?
As described in the book High Performance Managed Futures, managed futures is generally driven by three performance drivers, those macro factors that can influence returns. ¬†Ideally a diversified portfolio has a variety of uncorrelated performance drivers as constituents. ¬†Trend following is driven by the performance driver of price persistence and represents approximately 60% of the managed futures universe. ¬†This is the strategy the S&P SMGI formula follows. ¬†Price persistence occurs when the price of an asset continues trending in a consistent direction, be it trending higher or lower in price. ¬†Price dislocation, where the price of related products is temporary dislocated from other related products, is often the performance driver that influences spread arbitrage strategies. ¬†Rising and falling volatility can influence options strategies, particularly the short volatility programs. ¬†Discretionary CTA strategies, which often combine a number of strategies and typically involve human decision logic, are the fourth primary managed futures strategy and the performance driver of this category can vary depending on the trader.
How Does the SGMI Algorithm Work?
S&P SGMI has an algorithmic formula that determines a unique time trend for each constituent, or futures contract. For instance the model may indicate crude oil has a different length trend than the German bund. The formula looks back 22 days, then 5 days iteratively until it identifies a trend. The formula that determines the length of the trend for each constituent can identify changes as market conditions change for each constituent.
S&P SGMI‚Äôs approach is similar in many respects to how many individual trend following CTAs may trade, with each CTA utilizing their individual formula to determine how and when to execute trades. For instance, QIM and Winton Capital, well-known trend followers, are known to utilize 100s different algorithmic formulas to determine how and when to place trades. ¬†These computer-based models often have overlays that identify the market environment and then select what they consider the appropriate algorithm based on the nature of the market environment. ¬†From this, the computer-based “systematic” programs determine how and when to enter and exit positions. ¬†There is no human decision making or individual trade discretion in the trade decisions. ¬†Their computer formulas are constantly updated by a staff of quantitative analysts who are tasked with testing and re-engineering the formula. ¬†This is considerably more complex than the SGMI formula but highlights the fact that individual CTAs often use their own trading algorithms much like the SGMI.
How Does the S&P SGMI Compare to the S&P DTI?
Although close to 40% of managed futures mutual fund assets are tied to it, the S&P Diversified Trends Index (DTI) has generally performed below the managed futures industry as a whole. ¬†Will the S&P SGMI index generate improved performance? ¬†Time will tell, but it helps to understand some of the formulaic differences between the indexes to know what to consider. ¬†Here are the facts:
Both the S&P DTI and S&P SGMI are trend following programs.
S&P DTI utilizes 16 constituents (contracts traded) while the S&P SGMI utilizes 37, providing for additional markets traded diversification (one of five factors of correlation detailed in chapter 9 of the book High Performance Managed Futures.)
S&P DTI weighting consists of 50% commodities 50% financials, which some might considered unbalanced. ¬†S&P SGMI consists of 20% commodities, 80% financials, including currencies, equities and fixed income. ¬†Interesting to note that fixed income has the highest representation in the financial component of the index due to its low volatility. ¬†Thus, this index is utilizing a very interesting volatility skew to a certain degree. ¬†(Volatility skewing is described on page 176 of the book.)
About the Author: Mark Melin is author of three books, including High Performance Managed Futures (Wiley 2010), and has taught managed futures at Northwestern University in Chicago. Mr. Melin consults with financial advisors, pension funds, family offices and high net worth investors on developing uncorrelated investments. The author is an associated person registered with the National Futures Association NFA ID#: 0348336. For further information visit his web site at www.Go2ManagedFutures.com or via e-mail at info@Go2ManagedFutures.com
All contents copyright 2011 ¬© Mark H. Melin all rights reserved.
Risk Disclosure: Past performance is not indicative of future results. There is risk of loss when investing in futures and options. Always review a complete CTA disclosure document before investing in any Managed Futures program. Managed futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone. The opinions expressed are solely those of the author, they are not appropriate for all investors and may not have considered all risk factors.