Key Takeaways
- • Managed-futures funds are experiencing their largest drawdown in recent history, with 36 funds in the Morningstar Category averaging a maximum drawdown of 13.4% over the three-year period through April 2017.
- • The asset class's core strategy—momentum trading across multiple time horizons in futures and forwards markets across equities, bonds, currencies, and commodities—has been undermined by rangebound market behavior rather than sustained directional trends.
- • Currency markets entered rangebound behavior starting in March 2016 after trending upward for approximately one year (2014-2015), characterized by frequent reversals every couple of weeks or months that penalize trend-following strategies.
- • Crude oil shifted from a strong downward trend spanning Q2 2014 through Q1 2016 into a rangebound environment during 2016 that has persisted into May 2017, directly impacting commodity-focused managed-futures performance.
- • The structural challenge facing the asset class is that its historical edge—low correlation to traditional long-only equities and bonds through trend-capture strategies—depends on sustained directional moves that have become increasingly rare in major asset classes.
Summary
Managed-futures funds are confronting their most severe performance headwinds in years, raising fundamental questions about the viability of trend-following strategies in current market conditions. Through April 2017, the 36 managed-futures funds tracked by Morningstar with sufficient performance history experienced an average maximum drawdown of 13.4% over the preceding three years—a significant test of investor confidence in the strategy.
The underperformance stems directly from the operational mechanics of managed-futures investing. These funds employ systematic trend-following models that buy momentum on strength and sell into weakness across futures and forwards markets spanning equities, bonds, currencies, and commodities. Since their inception in the 1970s, this approach has theoretically generated returns with low correlations to traditional equity and bond portfolios, making them attractive portfolio diversifiers. However, this advantage depends entirely on the presence of sustained directional trends across asset classes.
Recent market behavior has eliminated the conditions necessary for trend-following success. In currency markets, the U.S. dollar index demonstrated a nearly straight-line uptrend from 2014 through mid-2015, but beginning in March 2016, the dollar entered a rangebound pattern characterized by frequent reversals occurring every few weeks to months. Crude oil followed a similar trajectory, exhibiting a pronounced downtrend from Q2 2014 through Q1 2016 before transitioning into a choppy, rangebound environment that persisted through May 2017. These frequent reversals in both major asset classes directly undermine momentum-based trading models, which profit from persistence in price direction, not mean reversion.
For a strategy class that has anchored institutional portfolios as non-correlated return drivers for decades, this shift represents a material challenge. The managed-futures industry must now contend with a market environment that punishes the very characteristics upon which its performance thesis was built.
The underperformance stems directly from the operational mechanics of managed-futures investing. These funds employ systematic trend-following models that buy momentum on strength and sell into weakness across futures and forwards markets spanning equities, bonds, currencies, and commodities. Since their inception in the 1970s, this approach has theoretically generated returns with low correlations to traditional equity and bond portfolios, making them attractive portfolio diversifiers. However, this advantage depends entirely on the presence of sustained directional trends across asset classes.
Recent market behavior has eliminated the conditions necessary for trend-following success. In currency markets, the U.S. dollar index demonstrated a nearly straight-line uptrend from 2014 through mid-2015, but beginning in March 2016, the dollar entered a rangebound pattern characterized by frequent reversals occurring every few weeks to months. Crude oil followed a similar trajectory, exhibiting a pronounced downtrend from Q2 2014 through Q1 2016 before transitioning into a choppy, rangebound environment that persisted through May 2017. These frequent reversals in both major asset classes directly undermine momentum-based trading models, which profit from persistence in price direction, not mean reversion.
For a strategy class that has anchored institutional portfolios as non-correlated return drivers for decades, this shift represents a material challenge. The managed-futures industry must now contend with a market environment that punishes the very characteristics upon which its performance thesis was built.
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