ETF Wrapped Managed Futures
WisdomTree, an exchange-traded fund manager with about $10.5 billion in assets, launched a diversified futures ETF this January. One of the people involved in bringing the product to the market was Luciano Siracusano, chief investment strategist at WisdomTree and a co-founder. Here he discusses what the ETF format means for a managed futures strategy.
WisdomTree Managed Futures Strategy Fund is listed on the NYSE Arca and has about $100 million in assets. It is based on the Diversified Trends Indicator developed by veteran trader Victor Sperandeo and his Alpha Financial Technologies. The DTI is a trend-following strategy on 24 commodity and financial futures, with a track record that starts in 2004. Insider Talk with "Trader Vic" Sperandeo can be found in Opalesque Futures Intelligence April 7, 2009.
Since March 2007, the mutual fund company Rydex has been running a mutual fund that also uses the DTI. The Rydex fund has over $2.5 billion in assets (as of the end of March). For more on the Rydex fund, see Opalesque Futures Intelligence February 24, 2010. In addition, there is an exchange-traded note that applies the commodities component of the same methodology, from ELEMENTS.
A recent report from Attain Capital sharply criticized the DTI and the Rydex and WisdomTree funds based on it, mainly on the ground that they underperform the commodity trading advisors tracked by the Newedge CTA Index. Below is Mr. Siracusano's reply to the question of performance.
Opalesque Futures Intelligence: What made you decide to bring out this ETF?
Luciano Siracusano: The ETF industry has grown tremendously over the past decade to more than $1 trillion in assets, but the alternatives part of it just started to take off recently. Some ETF providers are starting to focus on strategies that were formerly available only through hedge funds or commodity trading advisors. We looked for a way to create an ETF that is not correlated with US stocks and US bonds (see table below). Many financial advisers use managed futures for diversification in asset allocation. But it had not been commercialized in an ETF structure, so we filled this gap.
"Even some CTAs may be interested in our ETF as a way to put their cash to work when they're in between rolling positions"
OFI: How would you describe the investment objective?
LS: The investment program seeks to achieve positive total returns in both rising and falling markets. The quantitative rules-based strategy goes long or short to capture price trends in commodity, currency and US Treasury futures.
OFI: Doesn't it follow trends in stock index futures?
LS: It has no equity exposure. This is in order to keep the correlation to stocks low.
OFI: Does the ETF structure affect the implementation of the strategy?
LS: An ETF is just an open-ended fund that trades on the exchange continuously through the day. It incorporates many of the benefits of traditional mutual funds. In addition, it has intra-day liquidity, you see what's in the portfolio and in many cases the cost of the fund is lower than traditional mutual funds in the same strategy. For example this ETF is priced at 95 basis points. The same strategy is available in a mutual fund structure at much higher price points.
OFI: How does the ETF format lower the cost?
LS: There are some embedded costs that ETFs don't have to bear. Being an ETF wrapper sometimes allows you to bring down the expense ratio of the exposure.
OFI: Is this an index fund?
LS: Technically this is not an index fund, even though it targets an underlying benchmark. It is actively managed in the sense that there is flexibility to use different instruments to get the benchmark return. For instance we use a swap to get the return on the commodity portion of the indicator, which is an efficient way of getting that return but would not be possible if the fund were a passive index fund.
OFI: Industry people say this strategy does not perform well. What is your response?
LS: There will always be some great active managers that can do things we can not do in an ETF structure. Whether you can identify them in advance and whether they will continue making strong returns over time are open questions. The nice thing about our strategy is that it has a long-term track record. In the past eight years the DTI benchmark has outperformed US stocks, US bonds and some of the long-only commodity indexes including the Goldman Sachs index. Everybody can draw their own conclusions about DTI's track record â€“ 6.1% annualized â€“ and our fund's ability to get that return over time. Our low fees give us a better ability to track the benchmark. The fund started in January and was up 5.67% through April 30th. The ETF is the best structure for this purpose, an easy and inexpensive way to get exposure.
OFI: With ETF holdings being transparent, isn't there concern that somebody might replicate the trades?
LS: If someone buys the same contracts, it adds to the herding behavior that pushes the trends the program is following. So I don't think it has any impact once you implement the position. If people bought the same contracts before we implemented the trades, then it could be a problem. But that risk is mitigated because the program does not generate new positions until the end of each month We implement at the end of the month as soon as we become aware what the changes are.
Source: Zephyr StyleAdvisor, Bloomberg
OFI: Commodity index funds can have prices move against them because others anticipate the rolling of contracts and trade ahead of the index. Doesn't your fund face the same issue?
LS: Many commodity index funds roll into just one contract every month and everybody knows that's the contract they're going to roll into. By contrast, this rolls into 24 different contracts and never into the near-month contractâ€”it always goes out a few months, which gives it much more diversification across the spectrum. Plus this is diversified across very liquid futures contracts. It is hard to have market impact on highly traded contracts.
OFI: How does it do when commodities go down, as they have in past weeks?
LS: The DTI is designed to capture price trends when prices are rising and also when they are declining. Long-only commodity indexes are very vulnerable to the cyclical quality of commodity prices over time. Our fund makes money by following the down trend when commodities sell off.
OFI: Who are the fund's intended customers?
LS: The product has very wide application. Financial advisers look for managed futures for the alternatives portion of their asset allocation. With CTAs or hedge funds, you have to meet a minimum investment requirement, which is sometimes difficult. An ETF has no minimum. It could potentially have very broad use, particularly for investors that are fee conscious, don't want any lock-up to their alternatives and want transparency as to what they own. Even some CTAs may be interested in our ETF as a way to put their cash to work when they're in between rolling positions and want to get the returns that correspond to trend following strategies. They could use the ETF on a short term basis.
OFI: What if other products are launched using the same benchmark?
LS: Alpha Financial Technologies assured us there is ample investment capacity in the DTI strategy. It can have many billions of dollars benchmarked to it because it is highly diversified across most liquid contracts and does not hold a concentrated position in any one contract. That said, there aren't too many ETF sponsors that could offer this strategy. It takes regulatory exemption from the SEC, which we worked to get, to offer this actively managed ETF.