Managed Futures Funds | 5 ETF Reviews | Should You Invest?
Published on November 12th, 2022
In this article we review the 5 managed futures ETFs: FMF, WTMF, DBMF, KMLM and CTA. We discuss their performance statistics, relationships to one another and show that they can act like diversifiers and complement a portfolio of stocks and bonds. We also try to decide upon the best managed futures ETF as a result of the discussion below.
What Are Managed Futures and CTAs?
Managed futures or Commodity Trading Advisors (CTA) are firms that specialize in trend following strategies in a plethora of futures contracts for commodities, rates, and equities. One of the great aspects of CTAs is that they are basically hedge funds that have flexibility to bet on the various markets going either up or down.
One problem though is that every firm uses their own proprietary model and you, as an investor, don’t really know how the model is basing its decisions. Usually the fund alludes to trend following, mean reversion, carry and break out strategies but nothing concrete like a formula is ever revealed to the public. As a result, you have some semblance about what they are doing, but this black-box framework always makes it hard to trust a process. It’s a “trust me, bro” situation and as an investor, the only thing you have to go on it their historical performance.
But like we always say, past performance is not indicative of future performance!
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There are 952 CTA funds according to BarclayHedge, an aggregator and performance tracker, but not all funds are listed and submit performance data.
Managed Futures, CTAs Performance
We can say that the key attraction to managed futures is the historical performance has been pretty good in aggregate over long periods of time.
Take the Société Générale CTA Index, for instance, which calculates the net daily rate of return for a group of 20 CTAs selected from the largest managers open to new investment. The SG CTA Index is equal-weighted and reconstituted annually and has become recognized as the key managed futures performance benchmark.
Since the inception of the index, the total return has been about 310%, which is just under the performance of the S&P500 over the same time period up until November 2022. It also did it with a volatility of 10% which is about 40% less volatility than the S&P 500.
The key thing you will notice from this chart, however, is that drawdowns are very mild and it usually has a nice smooth uptrend.
The other aspect that will bother some investors is that CTAs can go through long multi-year periods when they aren’t making new highs. You have to just trust the process and stay the course even though the S&P500 might be continuing to soar with abandon.
SG CTA Index Portfolio Performance
The important question is how much a portfolio’s performance improves when a portion of the portfolio is allocated to managed futures.
The comparison below takes the standard 60/40 stock-aggregate bond portfolio, the 60/30/10 which moves 10% from bonds to the SG CTA Index (daily returns from Bloomberg), and the 60/0/40 portfolio which replaces bonds entirely with the SG CTA Index, for exposition. The portfolio is annually rebalanced from 2004 onward (AGG‘s inception date).
As you can see from the above results, the Sharpe Ratio and the Sortino ratio, which only considers downside deviation (bad volatility), are both improved. Additionally, the maximum drawdown is reduced and a higher terminal portfolio value is reached over the 18 year backtest.
Managed futures performed well from 2000-2010 which kept up with the 60/40 portfolio, in 2014, when the 60/40 portfolio was flat for 2 years and 2021-2022 when the 60/40 portfolio had its worst performance in 50 years. CTA funds definitely can act as a diversifier when its needed the most.
But of course, you can’t invest in the index directly, so how does one invest in managed futures? There are multiple ways.
Managed Futures Firms
I have always been interested adding managed futures to my portfolio, but I was hindered by the large account minimums ($250,000 at Campbell, for instance) and wary of the high fees (2% of assets, 20% performance fee) during periods of stagnation. Plus, K-1 tax forms can be a nightmare, but worth it for businesses with lots of depreciation.
With the S&P500 bubble going straight up for 10+ years, it didn’t really seem that pressing to go the CTA route. That of course changed this year when both equities and fixed income plummeted, but commodities and managed futures funds did really well.
There are dozens of firms available.
Original Managed Futures ETFs
The first managed futures ETFs came out about ten years ago. At least two of them have already been dissolved due to low investor interest (i.e. poor performance), but two of the originals remain, FMF and WTMF, and we use them as comparisons for the newer funds.
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All of the ETFs in this article have fees just under 1%, and they don’t issue K-1 tax forms, so there is a real allure of the ETF structure if they can deliver.
I say the word “if” on purpose.
First Trust Managed Futures (FMF ETF) and Wisdom Tree Managed Futures Fund (WTMF ETF)
To put it bluntly, the performance for both of these original funds has been abysmal.
In the chart below, I plot the performance of FMF and WTMF and put in comparisons for the S&P500, an intermediate term treasury bond fund, IEF, and a long term treasury bond fund, TLT. As you can see below, since inception the Wisdom Tree fund has lost money and the First Trust fund lost money for most of the period and only recently returned some gains in 2022.
In tabular form, if you had put $10,000 into each fund since August 2013, you’d have this much today:
It’s hard to come up with anything good to say about the Wisdom Tree fund, to be frank, but the First Trust fund earned a higher return with less volatility (i.e. a higher Sharpe Ratio) than the two bond funds, so maybe if we were only looking at the terminal numbers in this table, we could say that it acts like a bond substitute.
Of course from the return chart before it, we know that is not true and we can see that the managed futures funds dramatically underperformed both bond funds and only had terminal outperformance because the bond funds have had their worst year on record coinciding with the fastest rate increase in decades (an event that shouldn’t repeat anytime soon).
In fact, the managed futures funds have a slightly negative or near zero correlation with bonds.
To be honest, both of these fund managers should have closed up shop like the other two funds that already did, but instead they decided to re-jig their strategies in 2019 and 2021, so their own historical performance isn’t even particularly relevant anymore. Will they outperform in the future? Maybe, maybe not.
I think the problem here is that First Trust and Wisdom Tree are ETF equity providers, not CTA administrators. They probably had some junior analyst come up with a simple trend following strategy and it backtested well, so they threw it into production.
Should we have confidence in a specialized strategy that doesn’t match up to their core business model? Most CTA firms only do managed futures strategies and nothing else. Their livelihood depends on having a working model.
The cynic in me says that since both funds still have $200-300 million in AUM, they left the funds open to extract some fee revenue out investors hanging onto them. There is no convincing proof that their new versions of the strategy will be any better than the old ones.
Vague Fund Strategies
It’s not like we have much to go on. The strategy description is very generic for the First Trust managed futures fund:
The Fund and the Subsidiary’s investments provide the Fund with exposure to U.S. and non-U.S. marketsSource: FMF Prospectus
(including emerging markets). The Fund and the Subsidiary may hold futures contracts on a wide range of assets, including, but not limited to, equity indexes, other financial indexes, currencies and global debt, including U.S. Treasuries. In addition, the Subsidiary may hold futures contracts on commodities.
The Wisdom Tree Managed Futures fund tells you a little bit more about what they do, but not enough to backtest it:
The Fund is managed using a quantitative, rules-based strategy designed to provide returns that correspond to the performance of the Benchmark…The Benchmark consists of listed futures contracts on 16 different tangible commodities and 8 different financial contracts. The 16 listed commodity futures contracts are: light crude oil, natural gas, RBOB gas, heating oil, soybeans, corn, wheat, gold, silver, copper, live cattle, lean hogs, coffee, cocoa, cotton and sugar. Component contracts that are similar in nature (such as gas and oil or gold and silver) are aggregated into “sectors.”
There are nine commodity sectors in the Benchmark: Energy, Grains, Precious Metals, Industrial Metals, Livestock, Coffee, Cocoa, Cotton, and Sugar. There are eight financial sectors in the Benchmark: the Australian dollar, British pound, Canadian dollar, Euro, Japanese yen, Swiss franc, U.S. Treasury Notes and U.S. Treasury bonds. Commodity sector weights are based on, but not exactly proportional to, historical world production levels. Commodity sectors that have higher historical production levels are weighted higher in the Benchmark (assuming a long position).
Weightings of the financial sectors are based on, but not directly proportional to, historical gross domestic product (“GDP”). Larger economic regions (i.e., Europe as measured by the Euro) should get a higher weighting than smaller regions (i.e., Australia as measured by the Australian dollar)(assuming a long position). The Benchmark is designed with a focus on capturing the economic benefit derived from both up and down price trends.
Systematic rules are employed to establish a “long” or “short” component position for each sector based on the price of the futures contracts relative to their moving averages. Each month, sectors (e.g., Energy, Gold) in the Benchmark are rebalanced back to a fixed weighting. Component allocations (e.g., light crude oil, gold) within this fixed weighting are allowed to fluctuate and are positioned neutral, long or short depending on the current market environment.
The sole exception to this rule is that the Energy sector and its components are never short within the Benchmark. If the Energy Sector is flat within the Benchmark then the other sectors in the Benchmark are overweighted proportionally. Sectors (e.g., Energy, Precious Metals) are rebalanced monthly and no sector will comprise more than 25% of the Benchmark at the end of each month. Components within a sector (e.g., wheat, corn and soybeans in Grains) are weighted based on individual performance during the year and are rebalanced annually to their original weights.The Wisdom Tree fund is a little more descriptive, but not sure why they single out the energy sector. Source: WTMF prospectus.
I know I am really selling you on the managed futures funds right about now, aren’t I? Luckily things are looking a little better.
New Managed Futures ETFs
Over the last three years, 3 new CTA funds have been launched, and they have had smoking performance. What we want to do is tease out if these newer funds are truly something different or they just got lucky in 2022 and are doomed to repeat the dismal performance of the FMF ETF and WTMF ETF over the next decade.
I introduce each fund one-by-one and sequentially add the newer funds into the comparison matrix. This way their performance relative to each other start out on the same dates and are directly comparable.
iMGP DBi Managed Futures Strategy ETF (DBMF)
How does DBMF work?
Dynamic Beta is a research advisory that has developed various replication funds. DBMF attempts to replicate the portfolios of the largest managed futures funds by decomposing a 60-day trailing return window.
The Fund’s managed futures strategy employs long and short positions in derivatives, primarily futures contracts and forward contracts, across the broad asset classes of equities, fixed income, currencies and, through the Subsidiary, commodities. Fund positions in those contracts are determined based on a proprietary, quantitative model – the Dynamic Beta Engine – that seeks to identify the main drivers of performance by approximating the current asset allocation of a selected pool of the largest commodity trading advisor hedge funds (“CTA hedge funds”), which are hedge funds that use futures or forward contracts to achieve their investment objectives.
The Dynamic Beta Engine analyzes recent (i.e., trailing 60-day) performance of CTA hedge funds in order to identify a portfolio of liquid financial instruments that closely reflects the estimated current asset allocation of the selected pool of CTA hedge funds, with the goal of simulating the performance, but not the underlying positions, of those funds. Based on this analysis, the Fund will invest in an optimized portfolio of long and short positions in domestically-traded, liquid derivative contracts.Emphasis mine. Source: DBMF prospectus
So basically they are trying to be a CTA replicator fund, piggybacking on top of what the pros do, kind of like what hedge fund replicator ETFs like GURU do. It’s a fully systematic process with no room for discretionary trading.
Presumably they are using regression to tease out the daily return movements, so they won’t exactly replicate what the blend of the top CTAs own at any given time, especially at turning points due to the 60 day delay window. Luckily, trend following strategies work because trends tend to last for long periods of time.
DBMF ETF Performance
The first thing that we notice when we plot the performance chart against the old guard managed futures funds is that DBMF does appear to follow the movements of FMF, but perhaps with more leverage.
Is DBMF a good investment? Well it has been, but of course we can’t know the future. However we can say that for a given level of volatility, DBMF has delivered almost double the performance of First Trust and the S&P500, as evidenced by its Sharpe Ratio and 2.5x better performance for the Sortino ratio over the same time period.
And again, the Wisdom Tree fund was a dog.
These are great numbers and this fund has really hit the ground running; they couldn’t have picked a better time to launch. It shouldn’t be a shock to find out that the assets under management has skyrocketed in the last two years. This fund started with $60 million in 2022 and now has over a billion dollars under management!
The DBMF ETF does have more similarity to FMF than it does to WTMF, as evidenced by the correlations of 0.77 and 0.37, respectively. It has a negative correlation to the S&P500 and bonds, which is good and shows that it acts as a portfolio diversifier.
Does The DBMF ETF Resemble The Top CTA Index?
Really what I wanted to know is if the fund is able to perform its mandate and replicate the largest CTA managers to perform like the SG CTA Index shown at the top of this article. If it can, we can have more confidence about its long term performance based on its short history.
Visually you can see that the DBMF fund zigs and zags at the same times the index does and in the end, the ETF outperforms the index, 66% vs. 42% over the same time period.
Next we can see from the regression to the SG CTA Index that it explains a little more than half of the weekly or monthly movement for DBMF, and both move in the same direction about 75% of the time on both time scales. We also find that the DBMF fund moves about 13% more in the same direction as the SG CTA Index, but statistically we cannot rule out that the fund movements aren’t the same (which is what we want).
In contrast, only 39% of the monthly variation in returns of the First Trust MF fund are explained by the index (not shown) and it has a beta of 0.54, meaning that the fund only moves about half as much in the direction the index goes.
While the DBMF fund has been around for only about 3 years, we can’t say much yet based on its historical performance, but because this fund does appear to mostly replicate what the SG CTA Index is doing, we can have more confidence and familiarity with what might happen in the future. For instance, we would not expect an abnormally large drawdown in the future and we expect there to be long periods without making new highs.
Does DBMF issue a k-1?
No, you get a standard 1099 at the end of the year for US investors.
KFA Mount Lucas Index Strategy ETF (KMLM)
This CTA ETF is even newer and has only been trading since December 2020. The sponsors created their own index, the KFA MLM Index.
KMLM is benchmarked to the KFA MLM Index, which consists of a portfolio of twenty-two liquid futures contracts traded on U.S. and foreign exchanges. The Index includes futures contracts on 11 commodities, 6 currencies, and 5 global bond markets. These three baskets are weighted by their relative historical volatility, and within each basket, the constituent markets are equal dollar weightedKMLM Presentation
Visually, the allocation looks like this:
And the latest holdings are shown in the factsheet. Notable is that they do not trade the equities futures markets in this fund. My best guess is that they found that it detracted from the results of their index, so they excluded it, but it could have also been a conscious decision to stick to diversifying markets.
The prospectus doesn’t say what its underlying strategy is (their website says trend following, as usual, with the presentation referring to moving averages), just that it is tracking the index that they created. But there was a useful tidbit from the prospectus:
The Index evaluates market trading signals on a daily basis and rebalances on the first day of theProspectus
month. In addition, the Index has a target average annualized volatility of 15% over time.
So already we can gather that its volatility target is about 30% more than the DBMF fund and if a sharp turnaround in a futures contract occurs early in the month, the fund will suffer for the remaining of it.
Additionally, while the KMLM ETF is benchmarked to its own index, we can still compare it to the SG CTA Index blend that averages the top managers since we are trying to uncover how it performs against the average CTA, not some custom index that doesn’t tell us anything about the strategy or performance to peers.
KFA MLM Index
This backfilled Mount Lucas index that the ETF is officially benchmarked to gives us an idea how the longer term performance might be, beyond the limited 2 year trading history of KMLM.
From the chart below, we gather that it is a pretty volatile index with sharp, sizeable drawdowns and that the index at times doesn’t make new ground for 10 years. It’s a long time to wait while the S&P500 was doubling and tripling over the same time periods, and I suspect that most investors would move on after a couple of years.
According to their presentation, the overall compounded return was 6% since inception. However, because of its negative correlation to equities, including 10% to a 60% equity / 30% bond /10% MLM portfolio improved risk adjusted returns, at least theoretically.
But let’s look at actual performance now.
KMLM ETF Performance
Starting everything from the same time period as before, we see that the KMLM fund does make the same movements as the DBMF fund, but with more volatility and therefore more return since the managed futures strategy is performing very well this year.
And naturally it has a higher CAGR, but that comes with more volatility, which you can see on the performance chart. This dings it on the Sharpe and Sortino ratios, meaning that DBMF was better at a risk-adjusted return over the same time period.
Not surprisingly the monthly correlation of DBMF and KMLM is 0.70 and the funds are negatively correlated with equities and bonds as before.
Notice that over the more limited time period, the correlation between DBMF and First Trust MF jumped to 0.88. This is probably because First Trust modified their strategy recently as mentioned earlier and now are becoming more “in line” with typical CTA strategies.
Does KMLM resemble the Top CTA index?
It’s still important to see how this fund compares to the blended top CTA index, since that is what we are using as our multi-manager benchmark with a more consistent, smoother return profile.
Over the near 2 year performance the fund returned 62% versus 42% for the SG CTA index. Since it targets about 30% more volatility, we know that the directional moves will be exaggerated; both the chart and regression below show that.
KMLM moves in the same direction an extra 33%-40% more, which is great when the strategy is working, but a potential concern when the managed futures strategy has a drawdown.
It is statistically significant that the weekly moves will be at least 10% more pronounced than the SG CTA Index, but the standard error is too large for the monthly periodicity to draw any conclusion (of course informally we know it will be more pronounced as well).
The fund’s correlation to the index is higher than DBMF, but since we are working with a different starting time period and the sample size is getting smaller, so I wouldn’t look too much into it.
Simplify Managed Futures Strategy ETF (CTA)
This is the newest of the managed futures ETFs with its inception March 2022. What makes this ETF different is that it is managed by advisor Altis Partners and employs 4 models rolled into one: price trend, mean reversion, carry, and risk-off. Other than those descriptions, I couldn’t find much about their strategy in the prospectus or fact sheets. Again, you kind of have to take their black-box word for it. They have been in business for about 20 years, so they do have experience and must be doing something right.
We get the familiar performance compared to the other funds, but Simplify CTA does seem to zig a little more when the other funds zag.
Since there is less than a year, I couldn’t run the performance table, but with such a short performance the performance and statistics would be pretty meaningless anyway.
The correlation matrix does show that CTA only has 0.53 correlation with DBMF and KMLM since inception and is negative correlated with equities and bonds.
I also skip showing the regression results because the large standard errors made the information pretty useless.
What Is The Best Managed Futures ETF
Well there you have it, the three newest managed futures ETFs that investors can buy into. So which one do I like the best?
I like the methodology that DBMF is trying to employ by attempting to average out several manager’s strategies to reduce manager risk and potentially lead to a smoother return profile. If the fund is successful at performing like the SG CTA Index as it has been during its short return history, it will have milder drawdowns than the other two funds.
So even though CTA and KMLM have had better performance (well maybe not since last week), that comes with higher volatility as you can see from the performance charts.
In the end, because of the limited trading history I ended up buying all three in equal weight since the funds do seem to add diversification to each other and its too early to tell how they will perform in different market environments in the future. If one of the funds plummets, maybe one of the other funds will pick up on that trend and perform oppositely and the total allocation will counter balance itself.
Based on everything I presented here, I do have confidence that these new CTA funds will perform better than the two original managed futures funds offered by First Trust and Wisdom Tree.
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