Deconstructing Alpha

EP 17: What are managed futures anyway? Yung-Shin Kung – Credit Suisse

June 22, 2022 Geremy van Arkel, CFA® and Shannen Carroll Season 1 Episode 17
EP 17: What are managed futures anyway? Yung-Shin Kung – Credit Suisse
Deconstructing Alpha
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Deconstructing Alpha
EP 17: What are managed futures anyway? Yung-Shin Kung – Credit Suisse
Jun 22, 2022 Season 1 Episode 17
Geremy van Arkel, CFA® and Shannen Carroll

Stocks down, bonds down, managed futures up!  What are managed futures, how do they work, and why are they performing so well in this “everything down” environment?  To answer these questions, we go right to the source - Yung-Shin Kung, Head of Quantitative Strategies, & Portfolio Manager of the Credit Suisse Managed Futures fund.  Tune in and listen up, this is something totally different! 

Show Notes Transcript

Stocks down, bonds down, managed futures up!  What are managed futures, how do they work, and why are they performing so well in this “everything down” environment?  To answer these questions, we go right to the source - Yung-Shin Kung, Head of Quantitative Strategies, & Portfolio Manager of the Credit Suisse Managed Futures fund.  Tune in and listen up, this is something totally different! 


Managed Futures_01

Fri, 6/10 10:16AM • 27:12


managed futures, portfolio, trend, commodities, investors, futures, positioning, view, assets, equities, stocks, program, credit suisse, rates, question, return, market, invested, environment, inflation


Welcome to another edition of deconstructing Alpha. I am your host Jeremy van Arkel. And we have a really interesting show today we're gonna be talking about something that I think a lot of the financial advisory community doesn't really understand very well. And, and I would guess that maybe even some analysts and portfolio managers don't understand this subject very well. We are going to be talking about managed futures, and their role in portfolios and how they can be used as a hedge or even a growth asset class in your portfolios. And so today's guest is Yung Shin Kung, and he is coming to us from Credit Suisse, where he is the portfolio manager of the Credit Suisse managed futures fund. Before we dive in, I have to give you our standard disclaimer that please stay on the end of the call on the end of the interview here for important notes and disclosures about this podcast. Those are important so that we can deliver this podcast to you and make sure all of our compliance officers are happy. So Yung. Welcome to the call. I'm so glad that you're here. Thanks, Jeremy. So where are you located right now, where are you videoing in from?


Our team is based in New York. I'm in the New York office, as we speak. 




It's another nice sunny day here.


I love New York. I was just up there. And I just it's just you know, they they talk about that vibe, that New York vibe and you just can't explain it and then you forget about it. And then you show up and it's back. Right. So okay, so what in your words? What's your role at Credit Suisse?


So I look after the quantitative investment strategies group within Credit Suisse Asset Management. I've been at Credit Suisse for over 20 years now. I think we're a bit unique in that over this period. In fact, since 1999, we've gained a lot of insight by indexing and analyzing the hedge fund industry, including the Managed futures space, through our proprietary Credit Suisse hedge fund index.


Right. And Credit Suisse has become known for this quantitative hedge fund replication type strategies, right?


Yeah, we've been involved in in replication and index tracking in the alternative space. Really, since before 2010, we sort of got into it in terms of a fully evolved program at the beginning of 2010. So we have certainly a pretty decent history in this space.


Alright, so we're currently in an inflationary environment and commodity prices are up and then stocks and bonds are down. And so this is an interesting environment. In that coming into this environment, most investors had both stocks and bonds, and they did not have very much exposure at all to commodities, and or managed futures. So let's talk specifically about managed futures today. And can you can you explain simply what a Managed futures strategy is?


I'll try. So when we're talking about managed futures, we're focusing on capturing price trends, up or down across major asset classes through the deeply liquid futures market, the bulk of the three to $400 billion invested in managed futures, is focused on trend following and I think a critical aspect of managed futures and why the name is that we focus on the deeply liquid futures market. There are other trend following methodologies out there. Some of them focus on more esoteric, less liquid places, but managed futures is really using futures to be able to take advantage of price trends up or down.


So what kind of markets are we talking about here? What so if so, what you're saying is if a market is going up or down, you could be long or short. So what can you give us an example of what those markets are?


Yeah, we, we've found the trends exist across all major asset classes, stocks, bonds, currencies, and commodities. So all are represented in the program. We also focus on covering all major regions in the program, so long as the markets of those regions have the have the necessary liquidity to implement the trend programs. So it's really across the board asset class wise and quite regionally diverse as well.


Okay, so you mentioned that the majority of the assets in the industry are trend following assets. So can you explain the trend factor? And then can you explain why the returns of managed futures this year are performing so well?


Yeah. Great, very topical question. We think trends exist, because asset prices don't discount new information instantaneously. We think that there are lead lag effects in decision making. Investors differ in the rate at which they process and digest new information and implement investment decisions. If you think about, you know, one extreme being hedge funds, hedge funds tend to be very fluid and dynamic in their positioning. If you think about the other end of the spectrum being institutional investors, many institutional investors work with consultants, they may have complex governance processes. And so there's a range of governance structures at play, and many investors react to the decisions of other investors creating certain feedback loops. So Trends tend to be most pronounced exactly when asset class rotations occur. That's when investors are repricing the key macroeconomic variables such as growth and inflation, such as we know what we've seen fairly recently. It's really during those periods, that they're selling certain assets in order to increase allocations to other assets. And that dynamic gives rise to actually both a downtrend and whatever they're selling and an uptrend and whatever they're, they're buying. And we try to take advantage of both of those.


So trend, the trend factor performs well at points of change.


points have changed rotations, I would say it tries to take advantage of repositioning, of portfolios, not necessarily the rebalancing back to target but the shifting and the targets of a portfolio.


So that's very interesting, because I think most people would think a trend factor would perform very well say, if the US market went up, say consistently for 12 years, that that will be a trend, but that's more a momentum factor. Right.


Yeah, I mean, I think you could also consider that to be a trend and some of these longer term secular types of trends are profitable trend following programs tend to benefit from those. But that is not when you see the concentrated, really impactful performance that creates perhaps a bit of a, a, a more consistent performance through time. I think trend following certainly has benefited from a you know long period of of declining interest rates. So that has been a positive and a tailwind during that period of time. But if we're going through a period where interest rates are consistently rising, we should also benefit from that. But I think when you see trends being particularly acute is when investors are rapidly reacting to information and repositioning portfolios, and that typically occurs when people are repricing growth expectations or repricing inflation expectations.


And that change point we that we experienced this year was the in in the, you know, outsized inflation, caused investors to reassess both their stocks and bonds, which is the majority of their portfolio. And a lot of the assets that they didn't own now have to be bought, like, come on.


Absolutely. Absolutely. Right. And so we also saw actually, commodities being a significant beneficiary in terms of the uptrends. This year, currencies as well, the dollar has been very strong for a good amount of the year. And I think that reflects a number of these dynamics as well as perhaps the view that the dollar is maybe a safer currency than some of the other currencies in the marketplace. So that's, that's that that description is spot on.


Okay, so when you when you invest in a managed futures strategy, you know, typically, when you invest in a stock strategy, if you were just had one stock and you invested $100, in into Microsoft, you would buy $100 worth of Microsoft stock, and you'd be 100% invested, do the dollars in a managed futures strategy all go to the futures? Or or is this the component to fixed income involved here?


That's another excellent question. So in general, trend following programs, and I'll speaking for ourselves, but also, you know, we do look at there about three dozen managers that constitute our hedge fund index. So we're looking at a broad range of programs. And what we see is that the typical volatility of a risk profile or volatility of a Managed futures program is somewhere between that of stocks and bonds. 10% is the volatility we target and our usage of the capital in the fund is really a function of how much risk we want to take. And so, when we look at our program, we typically have a decent amount of cash that we don't need to post in terms of trading the futures in the program, which does create a good amount of cash in the program. So there's both the futures exposures as well as the cash which is not necessary to support those futures exposures.


So, you can you can be you can change the you can change the direction of the, of your of your trends. You can be long or short any of these asset classes, but you can also change the amplitude by how what percentage of your total portfolio you have Investing in futures because futures are leveraged, leveraged instrument, right?


That's right. That's right. We're not borrowing but futures by themselves are in of themselves are levered instruments. And so we're able to generate enough exposure to get to our 10% risk target, without using up all the capital that exists in the fund, in terms of margin. So it's, it generally we see a decent amount of cash in these programs, and we tend to be very conservative with that cash. You know, we don't we're not looking to take significant investment risk with that we're trying to provide investors with exposure to trends not really credit or something like this. Yeah. So so there is a lot of cash we typically invest it. And in shorter term instruments, which generates some some type of return.


So what approximate percentage of the portfolio is held in cash? For


it varies through time. Yeah, it varies through time, I'd say for somebody like ourselves, it could be, it could be the majority, I mean, it could be over 50% of the portfolio is even even even beyond that would be in cash equivalents. For us.


So that's very unique in this environment, because what comes hand in hand with inflation is fed tightening. So with the short end of the yield curve looking like it has to rise, or is it is expected to rise, the rates on the short end with the Fed controls is expected to rise. Does that give you sort of an a little advantage, or extra return in environments when the Fed is tightening?


Yeah, absolutely. Higher, front end rates are certainly a tailwind for the program, purely. As you point out, Jeremy, from the standpoint of just generating a yield, which we pass directly through to investors through higher returns on on, you know, essentially cash equivalents. I think in addition to that, this type of environment and rising short term rates provide opportunities elsewhere, and they provide obviously opportunities in the in the interest rate space, but also effects, you know, precious metals probably has some linkage to what's happening in in shorter term rates. And so there's a propagation of trends as well into various places, which, which the program is trying to take advantage of. So I think there are multiple levels on which a move upward in in front end rates is potentially beneficial to a trend following program.


So if if most investors are invested in stocks and bonds, this type of investment could serve as a diversifier for those kinds of portfolios because you're able to capture trends in all assets, but in also in particular, in the ones that are changing the most like commodities, as well as you you could maybe benefit from rising or higher for longer interest rates.


Yeah, absolutely. I think managed futures is in our experience, you know, one of the only investment strategies that tends to do best when stocks are struggling the most. So I think it's a very interesting period for managed futures. And we're getting a lot more interest in it probably, I guess, right now,


right? I'm sure. I'm sure. And I think one of the one of the maybe you can comment on this, but maybe one of the problems leading up to, you know, the pre the prior market environment, one of the problems was interest rates were near zero, so you didn't have the tailwind of your short term investments earning money. But does that mean that managed futures are not necessarily like so? So when I look at this environment, I say, well, inflation is here, and the most linear way to respond to inflation, is to buy commodities. But I but I at least my data shows that commodities don't have really a lot of long term return, maybe just slightly above cash as their long term expected return. But they have huge volatility, therefore, I have to be good at timing. So does manage futures is managed futures, something that investors have to time or is this more of a long term portfolio position?


This is a question that comes up a lot. We tend to guide investors, both institutional investors and retail investors to look at managed futures with a long term perspective. We know that, you know, empirically, over the long term, they've improved the quality of portfolio assurance, particularly through mitigating drawdowns and reducing volatility. Obviously, that's not a guarantee but that's that's been the experience. You I would argue, you need to be less right in managed futures than perhaps commodities with respect to your view. You know, I would expect managed futures if we went through a much more deflationary episode could potentially profit inflation as long as that's significant, creating lasting durable trends that's also profitable. So I think there's a little bit more scope to win in a broader range of potential outcomes, perhaps with a Managed futures strategy than just an outright commodity exposure. So just to answer specifically, your question about timing, you know, if an investor believes that they can add value timing the market, then it may be appropriate to think about being more active and timing managed futures. I guess we all know that, you know, market cycle timing is not easy, but some people do add value there.


Yeah. And I think that quite the point of that question, for me, at least was more when I look at, you know, saying, although we have this inflationary environment, we should probably have, you know, a healthy chunk of exposure to commodities. But, you know, in the long run, if you're, you know, if you, you know, I know what, I don't know, and I've been doing this, you know, the longer you do this, the less you feel certain about and so the more you want assets in your portfolio that least are appropriate if you're not right. And and and, you know, commodities feel like I have to get the timing right, because the volatility is so off the chart and, you know, they take the, take the escalator up and the elevator down. And, and managed futures seem to be more of more of a driver have more consistent returns, and they seem to be more risk managed, and they seem to be have really their own unique performance patterns are different than stocks and bonds. So


yeah, I fully agree. I mean, I think you also want multiple arrows in the quiver, if your view is right, and for whatever reason, there's a particular event or situation which causes your expression of that view not to be successful, it's nice to have another expression of that view in the portfolio so that hopefully, that other expression doesn't suffer from the same. You know, whatever, particularity that causes, you know, yeah, your, your, your base case, version, your base case implementation not to function as like, it's terrible. To be right, and to express the view, and then for that view, not to be profitable, right. Well, we


all we all know that that can happen, which is I don't think investors, then I think there's two layers of this expressing your view in a portfolio that investors don't think about. The first is, you could be right on the on what is going to happen, but wrong on your implementation. Right. And, and, and you know, that that's the first side of it. But the second side of it is, if you do have an opinion, it's easy for that to bleed into all of your assets, and therefore your whole portfolio is tilted in one direction, and you don't realize it.


Right. That's a very good point. Yeah. So


okay, so in this current market environment, I mean, without giving away the book, are there any sort of positioning points that you could talk about with your portfolio? How, you know, on sort of, on average, or, in general, how the portfolio is positioned right now?


We're very transparent, we're happy to give away the book. So no problem answering that question. The portfolio has been very flexible and adapting to the series of macroeconomic events, hyperinflation supply chain shocks, differences regionally in terms of the response to the pandemic. So current positioning, or long were broadly long commodities. With, with energy being, you know, a pretty significant position at the moment. We're modestly short equities. That short bias has been a little bit more biased towards Asia than the rest of the world. But right now, we're consistently short equities. And that's been a more flexible position. That's that's evolved a bit. As markets have evolved, more broadly long, the US dollar, really across the board versus other currencies. So I think the portfolio is, and we're short, we're short rates in general. So I think it's if I if I infer what the positioning is, at the moment, I would describe it as positioned for higher inflation, perhaps lower growth. And that's current positioning that that certainly can evolve. The expectation in a program like this is that there's responsiveness and so that's something which, you know, may change next week and may change several months out.


Well, it sounds like all of those positions are working in your favor so far this year. So So


I guess equities have been the most tricky, but in terms of, in terms of the year we've seen, you know, we see good profitability in the commodity space, we've seen very strong profitability, being short rates and FX has also contributed.


Yeah, so the major drivers this year, probably long commodity short treasuries.


Yeah, that's that's been a pretty consistent theme as you can imagine, and that's the nice thing about trend as well as you know, sometimes we get called the black box and I don't like that, when you think about the position that exists in which we just went through, it's very intuitive positioning, like if you if you've watched markets for the last six months, you wouldn't be surprised that the positioning of some type of program, which is designed to reflect the evolution of prices is positioned exactly as we just talked about. So I hope our goal is for the positioning to be quite intuitive.


Excellent. So to further onto that, what kind of environments do you have any examples of environments where managed futures have historically in the past, performed well suited to make this sort of this idea of, of how they were a little more tangible for investors?


Yeah, it's an important question. I mean, managed futures is not something which is always going to give you tremendously attractive performance. I think, you know, trendless range bound markets, you know, by definition, are not good for trend following. And I think what we've seen is that, you know, periods where we've extended periods of very low interest rates, you know, maybe suppressed interest rates have tended to coincide with markets that have been pretty, pretty range bound, and fairly trendless. And so, you know, what's good is this repricing of expectations around the core macro variables, if if nobody has any views on that, there's just very, it's very stable, very static. And then you sort of bounce around. That's not a particularly good environment for trend. Right,


right. Okay, so can manage futures protect against really large downsides? I mean, it so far this year, we've had, you know, repricing and changes, and everybody's repositioning their portfolios, and which is creating trends in areas where there weren't trends. You know, if if things get worse here, or like, I mean, the way I look at risk is, is it's kind of two kinds of sort of like, this is normal. And And wow, this is this is big, too. So does it the Manage features help in large scale? Downside? price changes?


Yeah, I think you know, one of the first of all, there's obviously no guarantees. But we certainly think there's a good there's a good chance. Yeah, I think the nice thing about managed futures, and you're sort of going back to the last question about when will they potentially underperform? The good news is that in that environment, most people have pretty good experiences with the rest of their portfolio. And so I think the nice thing about trend is that it, it tends to do best when the other parts of the portfolio may be struggling. So some of the some of the periods we're trying to see the biggest returns have been, you know, sort of the tech meltdown. In the early 2000s, the global financial crisis, there was a, you know, sort of a decent profile. When the intensity of the COVID event back in 2020, was extremely high. This year with the repricing that we've talked about, it's also been pretty good. So the the program, not the program, but trend following more generally, managed futures, more generally. does tend to benefit from from shocks, which often coincide with pretty steep losses in in equities or cyclically sensitive assets. So I, you know, we certainly think that there's a good chance of protection, but it's, you know, it's probabilistic, it's not a you're not buying a certainly not buying a put option on equities.


So I'm gonna summarize, I think what we all talked about right here, and tell me if I'm kind of right on. So as a as a portfolio allocator, where we build portfolios and multi assets and multi managers, and we try to create consistent risk managed outcomes for people, we are always looking for diversification. And the best kind of diversifiers for us, are ones that have a positive expected return a unique performance pattern, and then the ability to provide returns when nobody else is that sort of, and often those assets, when you look at them in isolation, they don't look that attractive. But when you combine them with other assets, that can really make the overall performance pattern to the client a lot more consistent.


That's very well described. Yep, I would I would certainly agree. I mean, I think the you know, really, what you want to do with portfolio construction is guard against unexpected outcomes, you know, your base case may come to be and hopefully you make a good amount of money. But you also want to have components of that portfolio, which are going to protect you or have a good chance of protecting you. If your base case doesn't come to fruition, you want to guard against a range of outcomes. And I think you've described a number of the features of the types of strategies you want in a portfolio that gets you there, so I couldn't describe it better at all.


I think you described it all pretty good. And we started with this idea. hear that there's these mythical instruments called Managed futures portfolios. And I think we boil down what they are and how they act and how to use them in a portfolio. So so before we wrap this up, is there anything else you want to add? I always like to offer back in case we think we miss something here. Anything, anything, any last thing? Any last comments here for the listeners? Oh, Jeremy,


thanks so much for the questions. I think we've covered all the bases.


Yeah. Well, this has been very informative for me, hopefully, for the audience. And hopefully, I respected everybody's time a little bit better this time around. So I appreciate you all listening. And we'll have plenty more of these podcasts to come in the future. And Young, thank you so much for your time. Really appreciate it. And all your work over there at Credit Suisse. Thank you. Thank you.


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