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Investor Guide AN INVESTOR’S GUIDE Managed Futures A DIVERSIFYING SOURCE OF RETURNS OPPORTUNITY TO PERFORM IN BULL AND BEAR MARKETS POTENTIAL TO MANAGE DOWNSIDE RISK The AQR Investor Guides are designed to help investors develop a clearer understanding of how certain investment strategies work, and how AQR’s distinctive approach to managing them may help investors achieve their long-term investment objectives. What is Managed Futures? Buy (“Go Long”) Contracts that Equity Indices have been Managed Futures involves trading futures contracts — increasing Fixed Income agreements to buy or sell a particular asset in the future at in price a price set in advance. The assets could be equity indices, Currencies Sell (“Go Short”) fixed income, currencies or commodities, all of which are Contracts that traded on liquid markets around the world. Investors who have been Commodities decreasing pursue Managed Futures generally buy (“go long”) assets in price that have been rising in price and sell (“go short”) assets Source: AQR. Past performance is not indicative of future results. that have been falling in price, betting that these trends will continue. Managed Futures relies on a systematic, This approach, also referred to as trend following, is not rules-based process to identify trends as they new. Hedge funds and Commodity Trading Advisors develop. In doing so, the strategy eliminates (CTAs)1 have been pursuing trends in futures markets human emotion from the decision-making since the 1970s. process of when to buy and sell. 1 A commodity trading advisor (CTA) is an individual or firm who provides individualized advice regarding the buying and selling of futures contracts, options on futures or certain foreign exchange contracts. The CTA registration is required by the National Futures Association, the self-regulatory organization for the industry. AN INVESTOR’S GUIDE | MANAGED FUTURES 3 How does Managed Lifecycle of a trend End of Trend Futures work? Market Price Return to fair value Fair Value Continuation of Trend Herding and overreaction Managed Futures seeks to capitalize on price trends, or the tendency of markets to Start of Trend move in the same direction (either up or Price Anchoring and underreaction down) for a sustained period of time. There Catalyst New information are a number of theories as to why this happens, but studies in behavioral finance suggest that certain biases may explain the Time start and continuation of trends. Source: AQR. The chart above is an illustration and not representative of an actual investment. The cycle of investor under- and overreaction, Start of Trend depicted to the right, is what sustains price Anchoring: Investors focus too heavily on historical data and underreact trends in markets and creates an opportunity to new information, causing prices to move more slowly towards fair value. for investors who spot them early. Ultimately, Disposition Effect: Investors may sell winners too early in an attempt to trends come to an end as prices tend not to realize gains, or may hold onto losers too long in an attempt to avoid losses. deviate from fair value indefinitely. Continuation of Trend Having the flexibility to hold long and short Herding: After prices have trended for a while, some investors jump on positions enables Managed Futures to the bandwagon, prolonging trends and potentially pushing prices past the potentially benefit from both positive and point of fair value. negative price trends. Confirmation Bias: Investors tend to look for information that confirms what they already believe and view recent price moves as representative of the future. 4 AN INVESTOR’S GUIDE | MANAGED FUTURES When does it work? When does Because the strategy relies on the presence of sustained price trends in markets, it struggle? Managed Futures has historically performed best when markets go from good Conversely, in choppy or to great or bad to worse. Below are two examples of favorable environments range-bound markets, or for Managed Futures; these periods were marked by steadily rising or falling during trend reversals, prices. Managed Futures tends to struggle. Over the long term, however, Managed Futures Good to Great Bad to Worse has a proven track record of Commodity markets mid-2000s Global financial crisis October 1, 2006 – May 31, 2008 September 30, 2007 – December 31, 2008 delivering positive returns. Bloomberg Commodity Index S&P 500 Index What makes it potentially $150 $110 valuable to investors is its tendency to perform well when other asset classes $125 $85 are struggling. $100 $60 $75 $35 Oct 2006 Apr 2007 Oct 2007 Apr 2008 Sept 2007 Jan 2008 May 2008 Sept 2008 Source: Bloomberg. For illustrative purposes only. Past performance is not indicative of future results. AN INVESTOR’S GUIDE | MANAGED FUTURES 5 What are the benefits of Managed Futures? A DIVERSIFYING SOURCE OF RETURNS Many investors’ portfolios have traditionally Managed Futures has delivered attractive historical returns. relied on two sources of returns: stocks and January 1, 2000 – December 31, 2020 bonds. Alternative strategies, such as Managed Global 60/40 Portfolio Managed Futures Futures, provide investors an additional $350 Dot-Com Global opportunity for positive returns that may come Bubble Financial $300 Burst Crisis at a time when traditional assets, such as stocks $250 and bonds, are struggling. Adding diversifying $200 sources of returns may help to reduce a portfolio’s $150 overall volatility as well as improve returns. $100 $50 In the chart on the right, we show the returns of $0 a 60% stock/40% bond portfolio versus the SG 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Trend Index, which tracks the performance (net Source: AQR, Bloomberg. Global 60/40 Portfolio is 60% MSCI World Index and 40% Bloomberg of fees) of the ten largest managers of trend- Barclays Global Aggregate Bond Index, rebalanced monthly. Managed Futures is represented by the SG Trend Index. Note: Individual managers in the SG Trend Index may have significantly higher or following strategies. While the cumulative lower levels of volatility and or returns. Past performance is not indicative of future results. returns are similar, what is important to note are the highlighted periods which demonstrate the strategy’s historical ability to perform well when stocks and bonds have struggled. 6 AN INVESTOR’S GUIDE | MANAGED FUTURES OPPORTUNITY TO PERFORM IN BULL AND BEAR MARKETS Another compelling attribute of Managed Futures is its tendency Managed Futures has historically to do well in both strong (“bull”) and weak (“bear”) markets. This is performed well in bull and bear markets. largely explained by the fact that most extreme down or up markets Average Quarterly Returns have not happened overnight, but are the result of continued January 1, 2000 – December 31, 2020 deterioration or improvement in economic conditions. 5% 4% In prolonged down markets, Managed Futures tends to position 3% 2% itself “short” — that is, the strategy sells assets — as markets begin to 1% decline and seeks to profi t if markets continue to fall. Similarly, in 0% -1% sustained up markets, Managed Futures tends to position itself “long” -2% Managed Futures Managed Futures Managed Futures — the strategy buys assets — and aims to profi t if the rise continues. in Bear Markets in Normal Markets in Bull Markets When the returns of Managed Futures are compared to the returns Source: AQR, Bloomberg. Note: Individual managers in the SG Trend Index may have signifi cantly higher or lower levels of returns. of the global stock market to the right, the strategy has performed “Bear Markets” represents the worst 30% of the MSCI World Index’s quarterly returns, “Bull Markets” represents the best 30% of best during extremely strong or weak markets. quarterly returns, and “Normal Markets” represents the middle 40% of quarterly returns. Past performance is not indicative of future results. AN INVESTOR’S GUIDE | MANAGED FUTURES 7 POTENTIAL TO MANAGE DOWNSIDE RISK The global financial crisis represents a classic Managed Futures provided protection during the global example of how Managed Futures may perform in financial crisis. troubled markets. Going into the fourth quarter of October 1, 2008 – December 31, 2008 2008, equity and energy prices had been declining; 20% government bond prices had been rising. This led to Managed Futures being positioned short equities, 10% short energy commodities, and long government 0% bonds. These positions profited as the same trends continued throughout the quarter, while the stock -10% market and other strategies suffered. -20% On average, Managed Futures has helped when -30% investors needed it the most, during those very Global Equities Managed Futures difficult equity bear markets. Source: AQR, Bloomberg. “Managed Futures” is represented by the SG Trend Index. “Global Equities” is represented by the MSCI World Index. Note: Individual managers in the SG Trend Index may have significantly higher or lower levels of returns. Please see page 7 for more details on the average performance of Managed Futures during equity bear markets. Past performance is not indicative of future results. 8 AN INVESTOR’S GUIDE | MANAGED FUTURES How does Managed Futures fit into a portfolio? Investors seek alternative investments — that is, alternatives to buying and holding traditional assets like stocks and bonds — in order to increase the expected return of their portfolios while improving diversification and reducing the magnitude of losses if global markets suffer. We believe Managed
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