AQR: It’s Not Too Late to Bet on Managed Futures

Next year will be marked by economic volatility and big market moves, exactly the conditions that favor trend following.

Illustration by II

Illustration by II

Managed futures, one of the best performing hedge fund strategies this year, will continue to generate top returns in 2023, argues AQR.

Trend-following, which involves taking long and short positions in predominantly liquid futures contracts across currencies, commodities, fixed income, and equities, had a strong comeback after a decade of delivering little in gains. The SG Trend Index, which tracks the ten largest funds managed futures funds, gained 36 percent in the first three quarters, according to the latest paper from AQR. Meanwhile, the traditional 60-40 stock and bond portfolio lost 20 percent as macroeconomic conditions worsened.

AQR’s paper comes as some investors question whether managed futures will continue to outperform. Some worry that it’s both too late to get into the strategy and that its history shows some significant underperformance, notably during the 2010s.

But AQR argues that next year will be marked by economic volatility and large market moves, exactly the conditions that favor trend following. That’s why investors can expect continued outperformance from the strategy in 2023.

“There are several key challenges impeding a return to a calm economic environment, making it improbable that economic conditions will settle into anything resembling their pre-pandemic stability within the next year or two at a minimum.” Challenges include inflation and growing fears of a recession in the U.S. and Europe.

Yao Hua Ooi, principal at AQR, said investors often fear they are investing at the top of the market. But when it comes to managed futures, they don’t need to worry about that for two reasons. First, trend-following tends to do best when there’s high macroeconomic volatility. And when vol is high, it tends to persist. Second, the performance of trend following doesn’t have the mean-reversion property, meaning there’s no evidence suggesting that a year of good performance would be followed by a year of bad returns.

“For those two reasons, we are trying to help investors focus more on the long-term diversification benefit of adding managed futures to their portfolio and not be so worried about timing,” Ooi said.

Jon Caplis, CEO of PivotalPath, said that rising interest rates can be a catalyst for trend-following. Collateral posted as margin for managed futures is primarily held in cash-like securities, such as Treasury bills. With rising yields, investors receive more passive income. “I would call that a tailwind in favor of managed futures strategies,” he said. “[Even] if strategies end up returning zero, they are still going to return the risk-free rate.”

The core of the trend-following strategy is to “capture the tendency of markets to gradually incorporate new information,” which works best when the price trends prevail for a long time, according to the AQR paper. That’s why the strategy produced exceptional returns during prolonged market drawdowns. During the dot-com bubble, the SG Trend index returned 51 percent, compared to a loss of 25 percent by the traditional 60-40 portfolio. The index gained another 24 percent during the Global Financial Crisis, while the 60-40 portfolio went down 35 percent.

From 2010 to 2019, the average annual return of the SG Trend index stood at 1.8 percent, while the 60-40 portfolio gained 7.5 percent, according to the AQR paper. “The 2010s featured a unique set of fundamental macroeconomic forces that created an unfavorable environment for persistent price trends,” according to AQR.

But AQR admits it’s not easy to stick with the strategy through a flat period like the 2010s. It suggests investors take a diversified approach in trend-following strategies, which might include the traditional price trend, economic trend, and alternative markets.