Aon Investment Research and Insights. Managed Futures. March 2018

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1 Aon Investment Research and Insights Managed Futures March 2018

2 Table of Contents Executive summary....1 Introduction what is managed futures?....2 Why invest in managed futures?...3 Suitability and portfolio construction...5 Potential drawbacks and considerations....6 Conclusion...7 About Aon Investment Research and Insights Aon s robust portfolio of ideas, tools and researched solutions support trustees and sponsors to anticipate their future investment requirements. By beginning to identify investment research and communicate ideas before they are needed we can shorten the implementation times for our clients and act in a timely way when opportunities are correctly priced. To learn more and to access other research and insights from Aon s investment experts, visit aonhewitt.com/investment 2 Name of study or publication

3 Executive summary Investors looking to improve the quality of returns in their portfolio often look to make an allocation that has a low correlation to their other holdings as part of their long-term strategy. One such answer is to invest in a managed futures strategy. A managed futures strategy: Takes advantage of trends in prices across a variety of markets Generates a diversifying return stream that may improve portfolio returns Can perform well in times of market stress Generally provides good liquidity and require small minimum investment sizes Has reasonable fee terms relative to its value Managed future strategies have many different names all used interchangeably. Common descriptors include CTAs (commodity trading advisors) and trend followers. For consistency, we refer to these strategies as managed futures throughout this paper. Managed Futures 1

4 Introduction what is managed futures? Managed futures is a strategy within the hedge fund universe that profits from momentum,bor trends, in prices. The phenomenon of momentum is driven by many factors, including investors cognitive biases (such as herding), and the behaviour of hedgers and speculators in the markets. Portfolios are unconstrained and diversified, with a broad opportunity set encompassing global equity, fixed income, commodity, and currency markets. Managed futures portfolios also tend to be very liquid as the securities used to implement the strategy are primarily exchange-traded derivatives contracts. Key features Features Characteristics Volatility target Managed futures managers typically target a specific volatility level (usually between 10% and 18% per annum) rather than a return target. Risk-return profile Over the long-term, managed futures funds have returned a Sharpe ratio of around Liquidity Managed futures is at the liquid end of the spectrum of hedge fund strategies, with funds being traded anything from daily to monthly with two days notice. Fees Fees can generally range from 1% management with 20% performance fees, to more simplistic strategies that offer lower rates at a 50bps flat fee. Managed Futures 2

5 Why invest in managed futures? Diversification Managed futures has historically provided a differentiated return stream, with a very low correlation to traditional asset classes and other hedge fund strategies when viewed over a sufficient time period. Market opportunity Managed futures does not face headwinds due to high valuations like other traditional risk assets (e.g. long-only equities, investment-grade bonds, and high-yield bonds). Downside protection Managed futures funds have protected capital in times when traditional markets have taken downturns. Returns Managed futures has delivered strong absolute and risk-adjusted returns over the long-term. Small minimum account sizes Minimum investment amount is typically around $1m. Liquidity profile Liquidity is high, as typical implementation is via extremely liquid derivatives markets. Competitive fees Fees are typically lower than other hedge fund strategies. Investors have a wide range of choice when it comes to employing a managed futures mandate, and can choose between simple and more complex managed futures mandates. Diversification Downside protection Market opportunity Returns Managed futures differentiated return profile has acted as a diversifier in volatile periods, often providing positive returns during bear markets. However, the strategy works best in providing return in a sustained market trend upward or downward, as trend followers will buy the market when it trends up and short sell the market when it trends down. Inclusion of a managed futures strategy within an investors portfolio increases the ability to generate returns within a wider range of scenarios and economic environments. Small minimum investment Features Global equities IG fixed income High yield Managed futures Liquidity profile Global equities IG fixed income High yield Competitive fees Managed futures Managed Futures 3

6 Over time, managed futures strategies tend to have a correlation of around zero with traditional markets like equities. In a period where you might see an extended equity market drawdown, one would expect a managed futures strategy to be short equities and profit from this movement, and vice versa if the market is heading in the opposite direction. It is also important to note that managed futures are able to provide diversification and positive performance during crisis periods in other asset classes such as fixed income or commodities. Because equity, bond and commodity markets have typically been recurring but unpredictable in the past, we see the ability to perform well in both bull and bear markets as valuable. Performance during ten worst months for global equities 20% 15% 10% 5% 0% -5% -10% -15% -20% Global equities Recovery plan 10/2008 8/1998 9/2008 9/2002 9/1990 2/2009 5/2010 9/2011 8/1990 9/2001 Source: AHIC, Investment Metrics Managed Futures 4

7 Suitability and portfolio construction Investor objectives Overall risk and return considerations influence the sizing; investors with significant negative cash flows that would be adversely impacted by a market drawdown may benefit from larger allocations. Total portfolio composition Portfolios with limited diversification into other less macrosensitive assets and strategies can benefit more from a larger allocation. Managed futures can be a standalone allocation within a traditional portfolio or a component of a broader hedge fund/opportunistic segment of the portfolio. Volatility target Less capital needs to be allocated to highervolatility managed futures strategies to achieve the same effective risk allocation. Source of funds Allocations to managed futures are typically sourced from other return-seeking asset classes, but could be sourced from fixed income depending on market views or other factors. Governance There is limited additional governance, particularly relative to implementing a direct, broad hedge fund mandate. Managed Futures 5

8 Potential drawbacks and considerations Like any investment, managed futures strategies offer certain risks and rewards. Investors should be fully informed before making an investment. The table below lists a number of considerations for investors as they think about an allocation to managed futures. Potential drawback Considerations Episodic return profile Performance generally comes in spurts and is subject to periodic negative drawdowns (drawdowns of greater than two times the volatility target are possible) Tend to underperform in range-bound markets or in trending markets that are choppy and prone to quick reversals. May increase governance / complexity The level of increase is modest relative to implementing most other diversifying strategies Can be a stepping stone to a broader hedge fund or opportunistic allocation Require comfort with the use of derivatives Leverage is embedded in the derivatives used to implement the trading strategies Importance of manager selection Large variance in performance across managers Managers typically use trends of 1 12 month, and so correlations between managers can be high Potentially slow reaction to the market It takes models different amounts of time to realise the market is in a down trend and adjust positioning accordingly they will not be short as soon as markets begin to fall Short, medium, and long term trend followers are differentiated by their reaction time to trends and changes in direction of trends Managed Futures 6

9 Conclusion Managed futures strategies take advantage of a fundamental and lasting market phenomenon (trends); can generate diversifying return streams that are additive to portfolio returns; have tended to perform well in times of market stress; generally provide good liquidity; and have reasonable fee terms relative their value added. We feel that an allocation to hedge funds, including strategies such as managed futures, is appropriate for investors looking for an alternative source of return with the intention of improving portfolio efficiency. An investor may choose to invest in a standalone managed futures hedge fund strategy, or an allocation to a fund of hedge funds strategy. If you wish to learn more about managed futures or how to implement a managed futures strategy, please contact your consultant. We re here to empower results For more information visit aonhewitt.com/investment or contact your Aon representative. Managed Futures 7

10 Contacts John Belgrove Senior Partner +44 (0) Kate Charsley Partner +44 (0) With thanks to our author Lewis Fowler Hedge Fund Researcher Max Meikle Analyst Sion Cole Senior Partner and Head of Client Solutions +44 (0) Follow me on Tim Giles Head of UK Investment Consulting +44 (0) Managed Futures 8

11 About Aon Aon plc (NYSE:AON) is a leading global professional services firm providing a broad range of risk, retirement and health solutions. Our 50,000 colleagues in 120 countries empower results for clients by using proprietary data and analytics to deliver insights that reduce volatility and improve performance. For further information on our capabilities and to learn how we empower results for clients, please visit Aon plc All rights reserved. This document and any enclosures or attachments are prepared on the understanding that it is solely for the benefit of the addressee(s). Unless we provide express prior written consent, no part of this document should be reproduced, distributed or communicated to anyone else and, in providing this document, we do not accept or assume any responsibility for any other purpose or to anyone other than the addressee(s) of this document. Notwithstanding the level of skill and care used in conducting due diligence into any organisation that is the subject of a rating in this document, it is not always possible to detect the negligence, fraud, or other misconduct of the organisation being assessed or any weaknesses in that organisation s systems and controls or operations. This document and any due diligence conducted is based upon information available to us at the date of this document and takes no account of subsequent developments. In preparing this document we may have relied upon data supplied to us by third parties (including those that are the subject of due diligence) and therefore no warranty or guarantee of accuracy or completeness is provided. We cannot be held accountable for any error, omission or misrepresentation of any data provided to us by third parties (including those that are the subject of due diligence). This document is not intended by us to form a basis of any decision by any third party to do or omit to do anything. Any opinions or assumptions in this document have been derived by us through a blend of economic theory, historical analysis and/or other sources. Any opinion or assumption may contain elements of subjective judgement and are not intended to imply, nor should be interpreted as conveying, any form of guarantee or assurance by us of any future performance. Views are derived from our research process and it should be noted in particular that we can not research legal, regulatory, administrative or accounting procedures and accordingly make no warranty and accept no responsibility for consequences arising from relying on this document in this regard. Calculations may be derived from our proprietary models in use at that time. Models may be based on historical analysis of data and other methodologies and we may have incorporated their subjective judgement to complement such data as is available. It should be noted that models may change over time and they should not be relied upon to capture future uncertainty or events. Aon Hewitt Limited is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales. Registered No: Registered Office: The Aon Centre The Leadenhall Building 122 Leadenhall Street London EC3V 4AN Copyright 2018 Aon plc aon.com