This is a critique to an article (Using Managed Futures to Diversify a Portfolio by Jeffrey L. Stouffer) that professes the benefits of managed futures, and a response to some misguided statements.
“Any financial advisor could present an Ibbottson chart showing the long-term performance of equities and cite the expected 10% return from investing in equities.”
This does not take into account the volatility in the sequence of returns and the survivorship bias that plagues an index that tries to track a group of stocks. For example, of the 500 largest U.S. companies in 1957, only 74 were still part of the S&P 500 forty years later in 1997. I can’t locate the statistics, but I know it’s become even more dire for the survivors if you consider the loss of the dotcoms, Enron, Worldcom, Bear Stearns, AIG, General Motors (before bankruptcy), Lehman Brothers, etc. just to name a few. This is survivor ship bias, and this should make just about every investor highly suspicious of anyone (e.g. an “expert” financial advisor) showing long-term index returns. It should also make most investors queasy about taking large amounts of risk.
“The problem with this is that a chart showing a track record since the end of the eighteenth century just did not match the client’s life span.”
This is the least of the investors’ problems. Any index that could track such a span would be severely plagued with survivorship bias (see above). And thus, the index would greatly overstate the true returns and greatly understate the true risk experience by investors.
“One asset class has been the savior of several institutional and high-net-worth individuals. Managed futures, as a group, have clearly outperformed equities and fixed income investments, especially during 2008.”
Read the fine print: Most managed futures prospectuses have a disclaimer that states the spectacular returns that are being shown over the last, say, ten years were not achieved with any significant amount of capital, and the fund only started accepting outside investors in the most recent month (e.g. October 2010). In other words, We started a bunch of funds (maybe 100′s or even 1,000′s) with a small amount of seed capital. When we found the lucky one that showed great performance, we capitalized that one and sold it to investors misleading them to believe the fund managers risked a larger amount of capital than they actually did during the preceding 10 to 20 years. This is more alchemy than sound strategy, which is disingenuous to say the least. Even scarier, investors are starting to flock to these arguably fraudulent investment arrangements. Anyone who would recommend these products are either misinformed or a fraud.
