Finding Stable, Predictable Returns in Times
         of Extreme Stress


Roland P. Austrup
President & Chief Investment O...
Important Information
Past Performance is not indicative of future results

This communication is not and under no circums...
AIC 2003

              •Hedge funds do not provide protection in periods of equity market stress

                       ...
AIC 2003 – Conclusions Revisited

Managed Futures are a better stand-alone diversifier than hedge funds
over all timeframe...
AIC 2006

              Passive long-only commodity indices do not necessarily profit in
              periods of equity m...
AIC 2006 – Conclusions Revisited
Long commodity indices are uncorrelated to equities, but …

Passive long only commodity f...
The Recent Environment




                         7
The Recent Environment




                         8
The Recent Environment




                         9
The Recent Environment




                         10
Returns from October 2007 (S&P 500 Peak) to
Present


  Asset Class Index                          ROR


  S&P 500 Total R...
2008 Returns




               12
Updating ‘Profits Under Stress’ Data




                                       13
Stable & Predictable Returns in General




                                          14
The Source of Stability and Predictability


Broad Diversification

    Managed Futures trade futures on multiple uncorrel...
The Source of Stability and Predictability


Controlled Volatility

    Focus on managing as opposed to accepting market r...
Controlled Volatility


Managed futures focused on targeting volatility as opposed to blindly
accepting market volatility
...
Correlation when you don’t want it


Hedge funds exhibit high tail risk dependency with equity markets




               ...
Uncorrelated but Bifurcated


Commodities hedge periods of inflation (negative correlation)
Commodities are correlated to ...
Uncorrelated and Negative Correlation when
Needed


Managed futures are negatively correlated to equities in periods of
eq...
Sources of Return


Source of return to managed futures is market pricing of risk premia


    Risk premia structures tend...
Risk Premia and Managed Futures

Managed futures strategies capture risk premia and shifts in risk
premia

    Need to und...
Pricing Risk Premia
Commodity markets price risk premia (convenience yield) in the
futures market

Unlike futures, spot pr...
Risk Premia in Commodities

Convenience yield of holding or not holding commodity inventories

   Shows up in the ‘Basis’ ...
Sources of Managed Futures Return

    Capturing Roll Yield


                                                Rolling long...
Risk Premia in Currencies
Covered interest parity

Forward price is based on yield differentials

Higher yielding currenci...
Risk Premia in Currencies



 Unlike the case in commodities though, momentum and managed
 futures strategies in currencie...
Pricing Risk Premia

Currencies also price risk premia in the spot market

Forward prices directly priced off of known car...
Risk Premia in Fixed Income

Fixed Income Markets

    Risk premia is cost of capital


    Yield curve (shape, slope) det...
Risk Premia in Equities
Equities

    Risk premia is cost of capital


    Discounted stream of expected future cash flows...
Managed Futures Implementation
Professional managers known as Commodity Trading Advisors
(CTAs)

CTAs invest in futures on...
Summary
Managed Futures hedge periods of economic and equity market
stress

   Commodities indices are uncorrelated to equ...
What to Do ?

     Learn


     Understand


     Commit


     Invest


     Enjoy the reward




                       ...
Selected Sources
    Gary Gorton, and K. Geert Rouwenhorst (2007), “The Fundamentals of
•
    Commodity Futures Returns”, ...
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Managed Futures Presentation

  1. 1. Finding Stable, Predictable Returns in Times of Extreme Stress Roland P. Austrup President & Chief Investment Officer Integrated Managed Futures
  2. 2. Important Information Past Performance is not indicative of future results This communication is not and under no circumstances is to be construed as an invitation to make an investment in the IMFC Global Investment Program nor does it constitute a public offering to sell the program. Applications for IMFC Global Investment Program will only be considered on the terms set out in the Disclosure Document (for U.S. resident investors ) or Offering Documents (for Canada-resident investors). Terms defined in the Disclosure Document and Offering Documents shall have the same meaning in this material. Potential investors should note that alternative investments can involve significant risks and the value of the investment may go down as well as up. There is no guarantee of trading performance and past performance is not indicative of future results. Investors should review the Disclosure Document and Offering Documents in their entirety for a complete description of IMFC Global Investment Program. An investment should only be made after consultation with independent qualified sources of investment and tax advice. The information contained in this material is subject to change without notice and IMFC will not be held liable for any inaccuracies or misprints. Risks of Investing There are risks associated with an investment in the Program, as a result of, among other considerations, the proposed nature and operations of the Program. An investment in the Program should only be made after consultation with independent qualified sources of investment and tax advice. An investment in the Program is speculative and involves a high degree of risk and is not intended as a complete investment program. It should be borne in mind that risks involved in this type of investment are greater than those normally associated with other types of investments. There is a risk that an investment in the Program will be lost entirely or in part. Only investors who do not require immediate liquidity of their investment and who can reasonably afford a substantial impairment or loss of their entire investment should consider investment in the Program. Capitalized terms not defined in this document are defined as set forth in the Disclosure Documents and Offering Documents. 2
  3. 3. AIC 2003 •Hedge funds do not provide protection in periods of equity market stress S& P 500 B a r c la y C T A In d e x C S F B /T r e m o n t 1 7 .2 4 % 1 5 .0 2 % 1 3 .7 7 % 2 0 .0 0 % 1 1 .7 6 % 8 .9 5 % 1 5 .0 0 % 1 0 .0 0 % 0 .7 0 % 0 .1 8 % 5 .0 0 % 0 .0 0 % -5 .0 0 % -1 0 .0 0 % -8 .8 7 % -9 .9 3 % -1 5 .0 0 % -1 4 .3 1 % -2 0 .0 0 % -2 1 .6 6 % -2 5 .0 0 % -2 2 .5 3 % -2 6 .8 5 % -3 0 .0 0 % 4 th Q u a rte r Ir a q In v a d e s LTC M M ess NASDAQ M a r k e t S e llo ff 1987 K u w a it (J u n e - J u ly - S e p '9 8 M e ltd o w n O c t M a r '0 2 -S e p S e p '9 0 ) '0 0 - M a r '0 1 '0 2 3
  4. 4. AIC 2003 – Conclusions Revisited Managed Futures are a better stand-alone diversifier than hedge funds over all timeframes Managed Futures are a significantly better diversifier when S&P 500 monthly returns are up or down more than 3% Hedge funds are a slightly better diversifier when S&P monthly returns are between –3% and +3% Managed Futures and hedge funds together are a better diversifier than either asset class alone Managed Futures are a regulated industry offering high liquidity, full transparency, minimal credit risk and daily mark-to-market 4
  5. 5. AIC 2006 Passive long-only commodity indices do not necessarily profit in periods of equity market stress Barclay CTA I ndex S&P 5 0 0 Total Return I ndex Gorton & Rouwenhorst 30.00% 20.00% 10.00% 0.00% -10.00% -20.00% -30.00% -40.00% -50.00% 4 th Quarter 1 9 8 7 I raq I nvades Kuwait LTCM Mess July- South East Asian $ Market Selloff Oct (June-Sep'9 0 ) Sep '9 8 Crisis Aug'9 7 - '0 0 -Sep '0 2 Aug9 8 5
  6. 6. AIC 2006 – Conclusions Revisited Long commodity indices are uncorrelated to equities, but … Passive long only commodity futures are not a good source of uncorrelated return • Limited protection against major market downturns • Undesirable Skewness Managed Futures have demonstrated alpha over long commodity indices for over 25 years • Over 500 bp per annum • History of solid protection against major market downturns • Desirable Skewness • Elimination of negative commodity skew 6 Commodity exposure better achieved through Managed Futures
  7. 7. The Recent Environment 7
  8. 8. The Recent Environment 8
  9. 9. The Recent Environment 9
  10. 10. The Recent Environment 10
  11. 11. Returns from October 2007 (S&P 500 Peak) to Present Asset Class Index ROR S&P 500 Total Return Index - 36.1% HFR Global Hedge Fund Index - 21.8% Goldman Sachs Commodity Index (S&P GSCI) - 26.2% Barclay CTA Index + 11.2% 11
  12. 12. 2008 Returns 12
  13. 13. Updating ‘Profits Under Stress’ Data 13
  14. 14. Stable & Predictable Returns in General 14
  15. 15. The Source of Stability and Predictability Broad Diversification Managed Futures trade futures on multiple uncorrelated asset classes Industrial and agricultural commodities, currencies, fixed income instruments and equity indices Average correlation of assets and markets traded is less than 0.10. Active Long and Short Strategies Potential for profit in both rising and falling markets Managed futures managers have generally been long fixed income, USD and Yen, and short equities and, since August, commodities. 15
  16. 16. The Source of Stability and Predictability Controlled Volatility Focus on managing as opposed to accepting market risk Position sizes dynamically calibrated based on portfolio volatility and VaR targets, market correlations and market volatilities Truly Uncorrelated Returns Uncorrelated in general Negative correlation to equity market returns during periods of equity market stress 16
  17. 17. Controlled Volatility Managed futures focused on targeting volatility as opposed to blindly accepting market volatility 17
  18. 18. Correlation when you don’t want it Hedge funds exhibit high tail risk dependency with equity markets 18
  19. 19. Uncorrelated but Bifurcated Commodities hedge periods of inflation (negative correlation) Commodities are correlated to equities in periods of slowdown 19
  20. 20. Uncorrelated and Negative Correlation when Needed Managed futures are negatively correlated to equities in periods of equity market stress 20
  21. 21. Sources of Return Source of return to managed futures is market pricing of risk premia Risk premia structures tend to persist Causes autocorrelation of basis, carry and spot currency data Risk premia by definition positive in fixed income and equity markets 21
  22. 22. Risk Premia and Managed Futures Managed futures strategies capture risk premia and shifts in risk premia Need to understand how and where various assets price risk premia Generally systematic, quantifiable and diversified Objective is to capture persistent risk premiums and manage spot volatility across a diversified portfolio of asset classes and markets, and NOT to speculate on specific markets Often momentum or trend-based strategies because of underlying autocorrelation in and from the pricing of risk premia 22
  23. 23. Pricing Risk Premia Commodity markets price risk premia (convenience yield) in the futures market Unlike futures, spot prices exhibit no autocorrelation or trending tendencies Futures prices are rarely equal to spot prices plus known and quantifiable carry factors (cost of capital, storage and transportation costs) The ‘convenience yield’ of holding or not holding commodity inventories is also priced into futures prices Difficult for investors to transact in spot commodity markets 23
  24. 24. Risk Premia in Commodities Convenience yield of holding or not holding commodity inventories Shows up in the ‘Basis’ or shape/slope of spot-futures price curve. A measure of risk of supply shock (or glut) versus cost of carrying inventory Existence of Basis creates ‘Roll Yield’ and autocorrelation in futures prices Excess returns from owning a portfolio of low inventory commodity futures and shorting a portfolio of high inventory commodity futures Excess returns from owing a portfolio of high basis commodity futures and shorting a portfolio of low basis commodity futures Excess returns from owing a portfolio of high momentum commodity futures and shorting a portfolio of low momentum commodity futures Return Correlations of these strategies is 0.87 24
  25. 25. Sources of Managed Futures Return Capturing Roll Yield Rolling long futures contracts in backwardated markets continually locks in Backwardation – Positive Roll Yield profit by selling the higher expiring contract and buying Sell the cheaper forward contract. Buy Rolling long futures Price contracts in contangoed markets continually locks in loss by selling the cheaper Sell expiring contract and buying the more expensive forward Buy contract. Contango –Negative Roll Yield Rolling short futures contracts in contangoed markets continually locks in Time profit by buying the cheaper expiring contract and selling the more expensive forward contract. 25
  26. 26. Risk Premia in Currencies Covered interest parity Forward price is based on yield differentials Higher yielding currencies trade at a forward discount to lower yielding currencies equal based on the yield differential Assumes absence of riskless arbitrage The carry-trade Forward and futures prices do not accurately forecast future spot price Significant empirical evidence for autocorrelation of interest rate differentials Excess returns from investing in the direction of the carry Risk of carry-trade is that spot moves against the trade by more than the interest-rate differential. 26
  27. 27. Risk Premia in Currencies Unlike the case in commodities though, momentum and managed futures strategies in currencies bear little correlation to carry strategies. Why? 27
  28. 28. Pricing Risk Premia Currencies also price risk premia in the spot market Forward prices directly priced off of known carry factor … interest rate differentials Spot currency prices exhibit autocorrelation Implies evidence of additional risk premium priced into cash markets. Some evidence of time-varying risk premia associated with sovereign macro-economic risk factors (measured by equity dividend yield, bond default and term spreads) No barriers for investors to transact in spot currency markets 28
  29. 29. Risk Premia in Fixed Income Fixed Income Markets Risk premia is cost of capital Yield curve (shape, slope) determines risk premia over time horizons Most opportunities are, as with traditional strategies, on the long side Short opportunities in longer duration instruments generally based on on inverted yield curves and rising interest rate environment ( increase in required risk premia by investors) 29
  30. 30. Risk Premia in Equities Equities Risk premia is cost of capital Discounted stream of expected future cash flows Required equity risk premium assumed in discount rate Most opportunities are, as with traditional strategies, on the long side Existence of Negative skew (fat left tails) in equities creates short opportunities 30
  31. 31. Managed Futures Implementation Professional managers known as Commodity Trading Advisors (CTAs) CTAs invest in futures on multiple asset classes that trade globally Equity indices, fixed income instruments, currencies and physical commodities Average correlation of asset classes less than .1 Active long and short strategies ; no long or shot bias in many markets Source of return varies by asset class Common source of return of all asset classes is market pricing of risk premia A set of strategies for systematically capturing risk premia priced into various asset classes and managing spot risk and volatility 31
  32. 32. Summary Managed Futures hedge periods of economic and equity market stress Commodities indices are uncorrelated to equities but only hedge inflation Hedge funds and commodity indices become highly correlated to equities during periods of economic slowdown or recession Managed futures hedge both inflationary and deflationary economic environments Managed futures have provided stable and predictable returns for over 25 years and across many market environments Source of managed futures returns is market mechanism of pricing risk premia into all asset classes CTAs generally use systematic strategies to identify and capture risk premia across a diversified portfolio of assets and markets, and to manage spot price risk. 32
  33. 33. What to Do ? Learn Understand Commit Invest Enjoy the reward 33
  34. 34. Selected Sources Gary Gorton, and K. Geert Rouwenhorst (2007), “The Fundamentals of • Commodity Futures Returns”, Yale ICF Working Paper No. 0708 Hilary Till (2007), “Term Structure Properties of Commodity Investments”, • Presentation to Opal Financial Group FX & Commodity Summit for Institutional Investors, Chicago Derek Bond, Michael J. Harrison, Niall Hession, and Edward J. O’Brien • (2007), “Some Empirical Observations on the Forward Exchange Rate Anomaly”, Working Paper Christopher F. Baum and John Barkoulas (1996), “Time-Varying Risk • Premia in the Foreign Currency Futures Basis” Boston College Working Papers in Economics Nikiforos T. Laopodis (2007), “Noise Trading and Autocorrelation • Interactions in the Foreign Exchange Market: Evidence from Developed and Emerging Economies”, Journal of Economics and Finance 34

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