Low-cost demands spurring managed futures evolution

Mark S. Rzepczynski said CIOs want to find strategies that generate returns in down markets but are not willing to pay high fees for them.

Demand for lower fees and customization is pushing the small cadre of institutional systematic trend-followers to offer more affordable versions of their flagship strategies.

Competition for institutional investor assets is fierce in the managed futures market — widely accepted as the most commoditized in the hedge fund industry — with intense price competition between old-school firms such as Man AHL, Winton Capital Ltd. and Aspect Capital Ltd. and banks, alternative risk premium managers and replicators offering lower-cost exposure to trend-following strategies.

“Institutional investors are forward-looking now in the face of predicted market declines and this is playing out in the managed futures space,” said Mark S. Rzepczynski, co-managing partner and CEO of AMPHI Research & Trading LLC, Boston, a global macro/managed futures advisory and brokerage firm.

“Chief investment officers are ​ looking for crisis alpha production from systematic trend strategies that will make money in down markets but they aren’t willing to pay high fees for them. Pricing is the biggest issue with these asset owners,” Mr. Rzepczynski said.

External forces are putting pressure on public plan investment fees, especially in the hedge fund arena.

“Fee sensitivity is highest for any pension fund that has to publicly disclose the fees it pays and managed futures managers are being forced to capitulate,” said Robert Christian, senior managing director and head of research for hedge funds-of-funds manager K2 Advisors LLC, Stamford, Conn.

The response from institutionally oriented trend-followers has been to break apart and reassemble their traditional strategies into cheaper, stripped-down versions without the modulating factors that adjust the systematic portfolio’s model response to real-world factors, sources said. Also on offer are new alternative risk premium strategies that replicate the beta of the core strategy’s systematic trend-following approach.

The result is a 50- to 100-basis-point flat fee range for most risk-premium strategies, sources agreed. Fees for traditional systematic trend-following strategies range between 0.75% and 1% for management fees and 10% to 20% for performance fees.

2 new options

Aspect Capital, for example, just opened two new investment options to external investors that are variations on its flagship systematic medium-term trend-following strategy. The original strategy — Aspect Diversified Fund — runs about $4 billion, with 80% of the portfolio invested in traditional momentum trends and 20% in factors that modulate the impact of external factors such as cyclical market changes and carry, said Christopher Reeve, director of product management. Fees for the full-blown trend-following program are 2% management and 20% incentive with a $100,000 minimum investment. Actual fees scale down for larger investments, Mr. Reeve said.

In response to institutional investor demand, Aspect launched the Aspect Core Trend Fund three years ago. This strategy invests only in a single-factor trend — momentum — for a flat 1% management fee. The risk-premium strategy runs about $450 million.

Clients like the core trend strategy because it offers portfolio diversification and risk mitigation by offering uncorrelated returns at a reasonable price, Mr. Reeve said. He noted that since the fund’s launch, much of the mystique surrounding systematic trend-following has dissipated and the strategy has almost become mainstream.

The success of the earlier risk-premium fund encouraged Aspect to launch the Aspect Core Trend High Volatility Fund. It offers the same pure momentum trend-following approach as the Core Diversified Fund run at 15% volatility level vs. 10% for the original version.

The fund has already attracted a total of $50 million from a U.S. institution and an Australian institution; Mr. Reeve said he could not identify the investors. The flat management fee for the high-volatility version risk-premium fund is 1.25%.

The second new fund — the Aspect Absolute Return Fund — uses a systematic multirisk-premium model to invest in 16 alternative risk premiums with a flat fee of 1.2% or a 0.75% management fee and 10% performance fee for investments meeting the $100,000 required minimum.

At the request of investors, Aspect’s research teams are providing customized solutions combining the firm’s traditional trend-following strategy with less expensive investment offerings helping investors to expand their risk-mitigation portfolios “at an affordable price,” Mr. Reeve said.

K2’s Mr. Christian noted that pressure on managers like Aspect Capital accelerated dramatically five years ago when “investors became focused on cost because returns across assets had come down.”

He added that high hedge fund management and incentive fees were an easy target and the managed futures space was the easiest place for fee cuts because the systematic, quantitative approach lent itself to “stripping out bells and whistles and paring the approach down to risk-factor exposure. You rewrite your programs, turn off some others, cut the number of markets you trade in and you can offer trend-following exposure at a much lower cost.”

Drastic change

The drastic change in managed futures pricing is creating more options for less expensive hedge fund portfolio construction, said consultants, managers and investors.

“The revolution in managed futures offerings falls into the same broad category of alternative beta and for the most part, I think this is a good thing,” said Norman Kilarjian, head of macro and quantitative strategies at hedge fund consultant Aksia LLC, New York.

“The market is waking up to the fact that many hedge funds were relying on common factor risk in making investment decisions and getting paid 2-and-20 for investment management processes that were not very differentiated,” Mr. Kilarjian said.

Some firms that consistently generate high Sharpe ratios may be worth above-average fees, he added, noting, however, that a reasonable flat fee for managers with stable volatility and Sharpe ratios of 0.6 or 0.7 should be between 50 basis points and 100 basis points.

Because prices are “down to sensible levels,” Mr. Kilarjian described one possible model hedge fund portfolio of the future as having a large core of low-cost, beta-neutral, risk-premium strategies with a much smaller allocation to more expensive alpha-generating hedge funds.

K2 is already constructing hedge fund portfolios along these lines, Mr. Christian said, especially for fee-sensitive investors.

“There is more product available that makes it possible to efficiently combine risk-premia strategies, hedge funds and perhaps co-investments, too. We have a palette now and it’s good for clients because there’s more choices at lower cost. It’s really a buyer’s market now,” Mr. Christian said.

K2 managed a total of $10.3 billion as of July 1 in hedge funds of funds, customized hedge fund portfolios and mutual funds.

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