Building Futures Mutual Funds
After the experience of 2008, investors became interested in liquid and
transparent investment vehicles. Managed accounts have received a lot of
attention as one way of achieving these goals. Regulated formats, such as
European UCITS III and American mutual funds, are another way of ensuring
liquidity and transparency.
For a manager, these structures potentially offer a much larger and
diverse investor base. However, whether futures strategies can make it in the
many-trillion dollar US mutual fund market is a big question. This is a market
dominated by huge fund complexes and regulated by laws that date to the early
We were very interested to learn that Rydex /SGI has had some success with
its managed futures mutual fund, which was launched in 2007. By the end of 2009,
assets under management rose to $2.33 billion.
The growth in assets happened despite a 2009 loss of 4.25% (in Class-A
shares). This performance is in line with managed futures indexes.
The Rydex managers we talked with are part of a group responsible for
developing alternative products. Sanjay Yodh is managing director for
alternative strategies. Before he joined Rydex / SGI, he was a managing director
at Deutsche Bank. Ryan Harder is portfolio manager in the quantitative team.
Previously he worked at West LB Asset Management and CIBC World Markets.
Rydex /SGI is a $22 billion mutual and exchange-traded fund manager owned
by Security Benefit Corp., which was recently acquired by Guggenheim Partners
LLC. Guggenheim, with $100 billion in assets, is a big player in alternatives.
Alpha Financial Technologies developed the indicator and quantitative
method used by the Rydex / SGI Managed Futures Strategy Fund—see the April 7th,
2009, issue of Opalesque Futures for an interview with Victor Sperandeo, founder
of Alpha Financial. On the related topic of UCITS III managed futures and macro
funds, we’ve presented a number of examples in the past, for example in our June
16, 2009, issue.
Sanjay Yodh “(This) is a low-risk way to go long volatility and have a
safety net in your portfolio.”
Opalesque Futures Intelligence: What is the strategy of the managed
Ryan Harder: The fund seeks to match Standard & Poor’s Diversified Trends
Indicator, which uses seven months of data to determine long and short positions
on the basis of trends. By using an exponential moving average, the latest data
is weighted more heavily than previous months.
OFI: Which markets does it trade?
RH: The benchmark is designed to be a 50/50 mix of financial futures and
commodity futures, covering eight financials and 16 commodities. The commodity
portion is weighted by global production estimates and the financial part by
countries’ gross domestic products. Small weighting adjustments are made to
account for the liquidity of the underlying futures contracts. Having both
financial and commodity futures gives you another layer of diversification and
leads to low volatility over time.
OFI: Does it correlate with managed futures indexes?
RH: It is not designed to track any group of managers but the strategy
uses a trend-following signal that many commodity trading advisors use as well.
It makes sense that there will be a fair degree of correlation between S&P DTI
and managed futures, given that most CTAs use trend-following systems.
OFI: Does the strategy include discretionary adjustments?
RH: No. If the indicators says long copper, we will be long copper. We do
not over- or under-weight any component.
OFI: What effect do mutual fund regulations have on the strategy?
Sanjay Yodh: Rydex /SGI was built on executing alternative investment
strategies within the 1940 Act mutual fund format. We launched the first mutual
funds with leveraged and inverse index strategies in 1993, acquiring the special
skills necessary to deliver such strategies. Our trading desk and quantitative
team have substantial experience. However, this type of legal structure could
hinder other managers in executing their strategy.
RH: Mutual fund rules do not prevent us from pursuing our objective of
matching the S&P DTI.
Ryan Harder “With this fund, there is no question about manager
selection. You don’t take that risk.”
OFI: What is the time horizon of the trades?
RH: The fund has a medium-term time frame. We do not trade in and out of
positions daily. The portfolio is re-balanced every month. We hold some
positions for a month but hold others longer because the trends continue for
OFI: Do you go long and short all markets?
RH: Energy is the only sector that is never short. It is either long or
neutral When it is neutral the weighting that goes to energy is spread out
proportionately among the other futures contracts. The fund maintains 100% gross
exposure long or short.
OFI: How does the strategy differ from a trend-following CTA?
RH: It has lower volatility than most CTAs because we do not use any
leverage to get returns. By contrast, a typical CTA may be leveraged three or
four times. Our fund is re-balanced each month to get back to 100% gross
exposure. We hold a lot of cash. Because you put up only a small amount for
capital for margin with futures contracts, typically only 5% to 10% of the fund
is used for margin.
SY: So this is a very low-risk way to get exposure to futures. It tends
not to have major drawdowns. It is a low-risk way to go long volatility and have
a safety net in your portfolio. This fund provides a buffer against significant
drawdowns in the S&P 500. When equity markets are doing well, typically it does
not make a big loss and can provide positive returns. Last year was the biggest
loss in a calendar year that the benchmark has had.
OFI: Why did the strategy make a loss in 2009?
SY: There was unprecedented market activity last year. After volatility
spiked in the fourth quarter of 2008, it decelerated persistently though 2009.
We had not experienced anything like that before. What drove equity returns was
investor psychology, not economic fundamentals—those pointed to high
unemployment, distressed real estate and significant illiquidity. By contrast,
in currencies and commodities there was a lot of shifting between long and short
positions which did not create discernable trends in the market, so many trend
following strategies had a very difficult time.
OFI: Why should an investor choose a managed futures fund that will
likely make lower returns than many CTAs?
RH: When you invest with CTAs, you may get a manager who will make 20% or
a manager who will lose 20%. With this fund, there is no question about manager
You don’t take that risk.
SY: This fund gives you core exposure to an asset class that diversifies
your portfolio, in particular against difficult equity markets. As a mutual fund
investor, you get transparency and daily liquidity. You can get different
exposures and take idiosyncratic risk with other managers who employ leverage
and may make higher returns. But we believe this fund is a pretty strong
solution for asset allocation at the strategic level.
OFI: What do you mean by strategic asset allocation?
SY: The way you build wealth is by preserving your capital and looking
for risk-managed ways to grow it. To do that, you always want some allocation to
this type of strategy. When times are good for the rest of your portfolio,
managed futures has a zero to slightly negative correlation to other
investments. When things go really bad in the rest of the portfolio, it tends to
have a very negative correlation to other investments. This fund is best used as
a strategic allocation that can be increased or reduced, depending on overall
OFI: Isn’t the 2.2% expense ratio (for class-A shares) high for a mutual
RH: For a typical mutual fund, yes. But you really should compare it not with
other mutual funds but with managed futures investments. Compared with a CTA,
the fund is very reasonable, since CTAs typically charge a 20% performance fee
that adds up over time in addition to a 2% management fee.
OFI: Does the Rydex /SGI Long/Short commodities fund work the same way?
RH: That fund also uses trend-following signals. It makes sense that most
long/short commodity indexes follow trends because commodity prices tend to move
in line with the business cycle. As the economy expands, they tend to go up and
as it contracts, they go down.
OFI: Would you describe the model that generates signals?
RH: The goal is to match the performance of the JP Morgan Core Commodity-Investable
Global Asset Rotator Sigma Long-Short Total Return Index, which determines long,
short or neutral positions for each commodity using 12 months of data. If there
is no consistent trend, we won’t have a position is that market. As with the
managed futures fund, we implement the strategy with futures and structures
OFI: Does the long/short commodities fund differ from the managed
futures fund in other ways, besides trading only commodities?
RH: The two indexes are different. For instance, each commodity has a
separate signal in the JP Morgan Core Commodity-Investable Index whereas S&P DTI
uses sector-level signals. Also, the commodity fund can short energy futures.
OFI: How would a investor decide between these two funds?
SY: The risk/return profiles are different. Let’s consider the commodity
fund first. There are investors who want only commodities. Our long/short
commodities fund can be used as a replacement or a complementary addition to a
long-only commodity allocation. It allows you to take advantage of situations
where it is better to be, say, long oil and short natural gas. If it is best not
to be exposed to a certain commodity, that part of the portfolio can go to cash.
So it has advantages over long-only commodity funds, while providing the same
transparency and liquidity. The managed futures fund is a volatility dampener
for your overall portfolio; it is a defensive position for capital preservation
in difficult environments. By contrast, the commodity fund is an offensive
position with much higher volatility, more in line with traditional equities. It
can be used to get higher returns.
OFI: How do you deal with the volatility in commodity markets?
RH: The fund has a reversion test to avoid over-bought or over-sold
situations and a volatility cap that scales back positions when historical
volatility is high. The positions are equally weighted. The 14 commodity futures
that are components of the index are highly liquid instruments. Commodities that
are thinly traded are not part of the index.
Gross exposure typically ranges from 70% to 130%. It could go as low as zero if
no commodity market trended or as high as 200% in the extreme case of seven
commodities trending downwards and seven trending upwards. But those situations
are very rare.
OFI: Commodity index investments have faced negative rolling returns
because of contango situations in futures contracts. Does this have an impact on
the Rydex /SGI futures funds?
RH: We’re not totally immune to the contango effect but not as affected
as long-only index investments. If we’re short a commodity that is in contango,
we benefit from it!