An earlier post outlined my thoughts on the stock market at these levels… given the volatility of the past few days, I’m even less certain of near-term performance.
Anyway, I continually seek out diversification in my portfolio: strategies or asset classes which perform at different times than my core long-equity allocation. These days I’m less certain about asset-class diversification; with ultra-low interest rates, long fixed income seems a bad bet. Commodity prices have been crashing, so maybe long commodities is an option. Real estate prices have had a good run, but I’m unconvinced they can hold their own when rates rise. Option volatility has ticked up lately, but still at very low levels.
So what next? Strategy diversification. For example, if I’m reasonably sure that long fixed income is a bad idea, how about going short fixed income? If I’m unsure about when commodity prices will turn around, how about using a momentum strategy? These type of strategies are employed by managed futures funds. The upshot is the funds’ ability to diversify my long-equity portfolio: due to the strategies employed, momentum-focused managed futures funds have around zero correlation to equities. That’s about as good as diversification gets. In addition, the momentum strategies used means an opportunity to short stocks when they’re falling (e.g. in 2008, when the funds made good money while other strategies were killed) – so a bit of an offset for my long equities during a selloff.
One of the main reasons to hate managed futures funds of late was fee loads: most of these strategies charged hedge fund fees (2 and 20, or more). With the new crop of mutual funds, however, the strategies have much more palatable fee loads (more like 1% p.a.). Much easier fee hurdle to beat. So just be careful when choosing a fund – the performance of momentum managed futures funds should be highly correlated with each other, so stick with lower cost options. This often means looking in the prospectus (!) or even SAI (!!) to find out what ‘hidden fees’ are paid to the hedge fund manager. Hint: if you see a clause like the following, below the breakdown of expenses, think ‘hidden fees’:
The cost of swap(s) and structured note(s) include only the costs embedded in the swap(s) and note(s) that reduce returns of the associated reference assets (i.e., Underlying Pools), but do not include the operating expenses of those reference assets. Returns of swap(s) and note(s) will be reduced, and their losses increased, by the operating expenses of the Underlying Pools used as reference assets, and such operating expenses may include management and performance fees of a Commodity Trading Advisor (“CTA”) engaged by Underlying Pools, as well as Underlying Pool operation, administration and audit expenses One or more of the Underlying Pools used as a reference asset for a swap(s) or note(s) may pay a performance fee to a CTA, even if the return of other reference assets associated with the swap(s)/note(s) is negative. The operating expenses of reference assets, which are not reflected in the Annual Fund Operating Expenses table above, are embedded in the returns of the associated swap(s)/note(s) and represent an indirect cost of investing in the Fund. Generally, the management fees and performance fees of a CTA employed by the Underlying Pools that may be used as reference assets range from 0% to 2% of assigned trading level and 15% to 25% of the returns, respectively.
I stay away from these funds. There are managers/funds out there worth the fee loads, but I’m too small an investor to access them!