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One way to fight the bear market

Expensive, risky, but potentially big money-makers - managed futures funds can work like a charm, though they can also bite back

Own bonds, collect dividends and stop watching the stock market's daily drama.

Looking for more help to get through what could be troubled times ahead for financial markets? One option is a managed futures fund, an advanced portfolio-building tool that worked like a charm in 2008 but can also turn on you in a big way. Some portfolio managers won't touch them for that reason.

Managed futures is a term used to describe a strategy involving the active trading of futures contracts on commodities like gold, oil and agricultural products, as well as stock indexes, bonds, interest rates and currencies. The point is to generate returns that move to a different rhythm than the stock and bond markets.

In the investing world, they call this a non-correlated asset. The longer the stock markets keep scaring retail investors with the potential for a repeat of 2008, the more you're going to hear about these types of products.

Managed futures funds certainly delivered in 2008. The publication Canadian HedgeWatch has reported that managed futures funds averaged a return of 18.3 per cent in 2008, compared to a loss of 35 per cent for the S&P/TSX total return index and a drop of 30.4 per cent for a CHW index that functions as a benchmark for hedge funds. Managed futures is considered a hedge fund strategy, but some mutual funds are starting to use it as well.

One such fund is Man Canada AHL Diversified Program Investment, which was introduced late last year by the Canadian arm of global hedge fund giant Man Investments. The fund piggybacks onto a long-running portfolio that in 2008 made 26.5 per cent in Canadian dollars.

Managed futures funds work best when markets display a definite trend, said Keith Balmer, one of the managers of the fund. Up trends can be exploited by holding futures contracts the usual way (by "going long" in investment-speak), while down trends can be ridden by short selling these contracts.

"A prime example is 2008 - you have the super-trend of oil going up to $147 (U.S.) and back down to $35," Mr. Balmer said. "That's a trend on the way up and a trend on the way down. We can be long on one side, short on the other and make a lot of money."

There are two kinds of markets where managed futures don't thrive - those where prices zigzag along in narrow range and those that make sudden reversals.

The stock markets made a sudden reversal in March, 2009, starting a rally that now shows signs of crumbling. Meantime, other asset classes in which managed futures funds invest have been up and down. The net result has been a struggle for managed futures funds lately.

Canadian HedgeWatch numbers show an average decline of 6.6 per cent for managed futures funds in 2009, compared to gains of 30.7 per cent for the S&P/TSX total return index and 17.7 per cent for the CHW-HF composite index. The portfolio on which Man Canada AHL Diversified Program Investment is based lost 18.1 per cent last year, while the fund itself is up about 4 per cent in 2010 (the fund is the latest of a variety of hedge products to be based on the portfolio).

Making good money in a heinous year like 2008 is great, but why invest in something where you may have to give a lot of your gains back when things turn around? Mr. Balmer said there are three reasons to consider managed futures funds.

The first is that the ups can more than offset the downs. The portfolio underlying the Man Canada AHL fund averaged 15.4 per cent annually from March 26, 1996, through March 31 of this year on an after-fee basis. Another reason is the low correlation to stock and bond markets, and a third is the potential for managed futures funds to provide what Mr. Ballmer describes as a kind of insurance in stressed markets.

The potential benefit of managed futures is best illustrated in a Man Canada illustration of a traditionally constructed portfolio compared with a portfolio that has some exposure to managed futures.

The traditional portfolio - 10 per cent cash, 30 per cent Canadian bonds, 35 per cent Canadian stocks and 25 per cent world stocks - made an average 6.6 per cent annually over the past 14 years with a worst decline over any time frame of 24.2 per cent. Adding a 20-per-cent weighting to the Man AHL diversified portfolio bumped up the annual return to 8.7 per cent over the same period, and reduced the maximum loss to 18.2 per cent.

"Managed futures have wonderful qualities when you combine them with a traditional portfolio," Mr. Balmer said.

Still, the managed futures approach is rejected by some money managers.

"It doesn't interest us," said Barry Schwartz, vice-president and portfolio manager at Baskin Financial Services. "We find it extremely risky."

Mr. Schwartz said one shortcoming with managed futures funds is that they may not pay any interest or dividend income (you can buy a version of the Man AHL DP fund that does pay distributions). For him, income is a basic defence against uncertain stock markets because it means cash is flowing into your account on a regular basis, even as share prices are falling.

Still another of his criticisms is that managed futures funds are too complex for the average retail investor to fully understand. Certainly, it's a basic rule to invest only in products that are comprehensible to you. In fact, economist Nassim Taleb, author of the influential book, The Black Swan: The Impact of the Highly Improbable, touched on this point in a postscript for the book (read it at

"Do not give children sticks of dynamite, even if they come with a warning label," he writes. "Complex financial products need to be banned because nobody understands them, and few are rational enough to know it. We need to protect citizens from themselves, from bankers selling them 'hedging' products, and from gullible regulators who listen to economic theorists."

The dynamite reference is an apt one with managed futures funds. Before it was closed a few years ago, a mutual fund called AGF Managed Futures had at one point established a 10-year compound average annual loss of 21.6 per cent. Then again, this fund had a 12-month period early last decade where it gained 112.5 per cent.

Another drawback to these funds is fees. The estimated management expense ratio for Man Canada's fund is 5.25 per cent, which is more than double what you'd pay for popular conventional mutual funds (the Man fund includes performance fees). Horizons Global Contrarian, another managed futures mutual fund, has an MER of 5.15 per cent.

The standard, proven advice for worried investors is to own bonds, collect dividends and stop watching the stock market's daily drama. If you feel you need more, managed futures is an expensive, risky but potentially effective option.

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How to assess a managed futures fund

Using the Man Canada AHL DP Investment Fund as an example, let's look at some key questions

to ask when assessing a fund that uses the managed futures strategy of investing in various types

of futures contracts.

Who's offering it?The Canadian arm of Man Investments, a London-based global giant in hedge funds. Man is part of a company with origins going back more than 225 years.
Who's running it?AHL, a division of Man Investments that manages assets of $21-billion (U.S.).
What are the fees?The class A version of this fund has an estimated management expense ratio of 5.25 per cent, which is extremely high by mutual fund standards.
What do the fees include?Gains in the fund are treated as capital gains rather than interest income (gains from active trading of futures are treated like income); also, performance fees are 20 per cent of profits after fees.
What do the fees not include?The cost of currency hedging, which is variable.
What do advisers get paid for selling it?Upfront sales commission of up to 3 per cent, plus trailing commissions of up to 1.25 per cent (these are paid by the fund company).
What does the fund invest in?Futures contracts on commodities, currencies, interest rates, stock indexes and bonds. The fund can a traditional "long" position, or use short selling to benefit from price declines.
Does the fund pay income?The most widely held A class of the fund does not, but there are income-paying versions.
How much has been invested in the fund?$55-million.
How has the fund performed?This fund has only been around since November 2009, but the underlying portfolio averaged 15.4 per cent after fees from the end of March 1996 through March 2010.
What about the down side?The portfolio lost 18.1 per cent in 2009.
What's the minimum investment?$5,000.
Where can you buy it?Through advisers and online brokers.
What are some alternatives?In the mutual fund world, Horizons Global Contrarian takes a similar investing approach. Hedge funds in the sector include IMFC Managed Futures and Blackheath Futures Fund LP. Tricycle Asset Management runs several series of principal-protected notes that use a managed futures strategy.
Source: Man Investments Canada

© 2007 The Globe and Mail. All rights reserved.

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