Diversified Futures Fund

The traditional investment classes are equities, bonds and cash. Alternative investments are anything that falls outside of these categories, from real estate and fine art to venture capital and absolute return funds.

Alternatives offer different return profiles to the traditional asset classes. Since the inception of the MSCI World Index at the end of 1969 until the end of 2018, equities have delivered an annualised return of 9.3% with a maximum drawdown of 57.46%. The returns on bonds and cash are currently at all time lows. Alternatives can offer return profiles with higher returns and/or lower drawdowns, which may be more suited the needs of particular investors.

In addition, alternatives can have no or low correlation to traditional asset classes, so they can reduce an investors overall systematic risk.

There are many tasks in which computers are capable of outperforming humans. For instance, the autopilot on a commercial aircraft provides a safer, smoother flight than a human pilot – even during take-off and landing and in extreme weather conditions.

Systematic investing means following algorithms – rule-based approaches which mean that investment decisions are made deterministically. Systematic investing is thus readily replicable and testable.

Computer systems are reliable, immune from emotion, fatigue and behavioural biases.

Absolute returns are returns which are defined without reference to a benchmark. Absolute return funds do not seek to outperform say, an equity benchmark, but rather to achieve positive returns over a given timeframe.

To deliver absolute returns with low correlation to traditional asset classes over rolling three-year periods.

Correlation is a measure of how much two things move in sync with each other. Strongly positive-correlated variables will tend to move in tandem – they move up together and down together. Strongly negative-correlated variables will tend to have the opposite behaviour, when one moves up the other moves down, and vice versa. Variables with no correlation will have no relationship, if one moves up the other could move in either direction.

When categorising correlations as low, moderate or strong, the interpretation we use is given below.

An important consideration when thinking about correlation is the timeframe over which it is being measured. Variables which are uncorrelated or with low correlation in the long term can frequently to be strongly negatively or positively correlated in the short term.

For more about correlation, see Is your liquid alternate investment correlation, negatively correlated or uncorrelated?

Money invested in the Diversified Futures Fund is invested in a long-only value equity portfolio, which is used as collateral to trade futures contracts around the world through our proprietary systematic managed futures strategy.

We are a systematic value investor. Our models filter and rank stocks listed in countries in the MSCI World to select those with the characteristics most likely to generate strong performance. We invest long only (we don’t short sell) and we have a long holding period. We hold 25 to 50 equities at any given time.

Value investing was pioneered by Benjamin Graham (Warren Buffett’s mentor) and David Dodd in their 1934 book Security Analysis which was published shortly after the boom and subsequent bust of the stock market that led to the Great Depression. This in part was their reaction to how to invest to protect oneself. Value investors use various metrics to identify stocks which they perceive to be trading at a discount.

Our process of filtering and ranking stocks can, and often does, create portfolios with uneven distributions across countries and sectors. We would be worried if our portfolio didn’t do this, as we think it’s pretty unlikely that every country and every sector will have exactly the same opportunities for value. Because of our filtering and ranking, we are confident with our stock selection. If we are overweight a particular country or sector, it’s because it’s where there is the most opportunity.

Exchange traded funds (ETFs) are an example of systematic investing, where equities are weighted by market cap (or the relevant index methodology). As such, they can be thought of as a one factor model. This is a pretty simplistic systematic model, and we have a long-term track record of doing better.

The premises behind our Diversified Futures algorithm are (1) futures markets exhibit trends, (2) you should cut your losses quickly and let your profits run and (3) diversification across uncorrelated instruments helps to smooth returns.

We are constantly monitoring futures instruments from a range of asset classes and countries to identify potential trends. When a new trend emerges, we add that instrument to our current portfolio. We employ moving stop losses to let our profits run while constraining the downside risk.

The futures will struggle to make money when a market or markets are moving sideways or range bound and when there are sharp rising or falling market trend reversals.