We can’t blame people for being confused by the narrative out of the managed futures space in 2011. Here was an asset class that had made its name by thriving during volatile times, now struggling in the midst of seemingly high volatility and blaming volatility (of all things) for their poor performance. A performative contradiction of sorts? Perhaps… but, with the VIX sinking to its lowest levels since August of 2011, and because we’re obstinate and enjoy challenging commonly held beliefs, we decided to take a look at the numbers to find out who was right- those claiming volatility killed the radio star, or those claiming volatility should have been bolstering returns.
To dig a little deeper, we took a look at VIX daily changes back to 2003, and then looked at the average performance of the Newedge CTA index for certain VIX percentage change ‘buckets’. Meaning, how did managed futures perform (on average) during the top 20 daily gains for the VIX, in the worst 20 daily losses for the VIX, and so on for different groupings of percentage gains/losses for the VIX.
The results were initially surprising. Is that an annualized performance of -60% on the first line for those days when the VIX had the largest spikes upwards? It sure is, calling into question the widely held belief that managed futures are long volatility investments (meaning – they typically perform well in times of increased volatility).
So what does this mean, exactly? To answer our initial question- those assuming volatility should be an all or nothing game for managed futures- whether as a boon or bane- are all wrong. Is managed futures a long volatility investment? Yes, but that classification should come with a big caveat – because it does not mean that managed futures are going to perform on the day of a spike in volatility. Counter intuitive, yes; but let us explain.
A volatility spike, while signaling a higher volatility environment, is usually an indication of a significant and sudden change in the current market environment. This makes a lot of sense when you think about it. If the VIX moving sharply up represents a spike in fear and uncertainty, it’s likely going hand in hand with a major trend reversal (from up to down), and when most managed futures programs are classified as trend following, that kind of development is far from desirable. February 2nd of last year was a solid example of this.
What is more interesting to us is that this pattern is mirrored when the VIX decreases. If volatility suddenly contracts, there’s a good chance the move will be accompanied by a reversal elsewhere in the markets as well, and as the data indicates, those kinds of moves can also be detrimental for managed futures. As it turns out – the bulk of managed futures gains (as far as the Newedge index is concerned) came into play when the VIX was making smaller moves (a sign that the current market atmosphere was being maintained). Bottom line? Managed futures is a long volatility play, but can also be hurt by sharp changes in volatility as they impact the consistency of market trends.
Big Caveat – the VIX is an imperfect measure of volatility as far as managed futures are concerned – because it measures implied volatility in S&P 500 options (in layman’s terms – stock market volatility), while CTAs trade a much more diverse amount of markets than just stocks. In short, this analysis ignores the fact that the VIX could spike while volatility in another market like Coffee or Soybeans could fall on that day. But, in our experience the VIX still provides a good reflection of general volatility as well (per the risk on/risk off mentality).