Faced with the prospect of potential declines in both bonds and equities, an allocation to managed futures may serve as an appealing diversifier to traditional strategies. HIGHLIGHTS Managed Futures have historically performed well in both falling and rising interest rate environments. 2015 INSIGHTS Interest Rates and Inflation: How They Might Affect Managed Futures Over the last six months, the yield on 10-year US Treasury Bonds has slowly risen from about 1.4% to almost 2.0%, re-igniting concerns about a bear bond market and an accompanying increase in inflation. Meanwhile, the continuing uncertainty of global economic prospects also raises questions regarding the sustainability of the bull market in equities. As shown in the figure below, the S&P 500 Total Return Index has more than doubled from its low in early 2009. FIGURE 1 Markets that have exhibited lower volatility characteristics during the prevailing interest rate environment could potential see an increase in volatility, which in turn, may result in added profit potential for managed futures. S&P 500 Total Return Index (2007-2014) Growth 2000 1600 1200 800 400 0 07 08 09 10 11 12 13 14 Years S&P 500 Total Return Index INVESTOR MATERIALS PREPARED BY EQUINOX GROUP DISTRIBUTORS, LLC, MEMBER FINRA. EQUINOX GROUP DISTRIBUTORS, LLC PROVIDES WHOLESALING SERVICES TO OTHER BROKER-DEALERS AND INDEPENDENT FINANCIAL ADVISORS. EQUINOX GROUP DISTRIBUTORS, LLC, IS NOT AFFILIATED WITH THE FINANCIAL ADVISOR WHO HAS PROVIDED THIS MATERIAL TO INVESTORS AND IS NOT RESPONSIBLE FOR ANY MODIFICATIONS OR ATTACHMENTS MADE TO THESE MATERIALS. INVESTORS WHO HAVE QUESTIONS SHOULD CONTACT THEIR FINANCIAL ADVISOR PRIOR TO INVESTING.
1 There is no guarantee that these return characteristics will persist in the future. Against this backdrop, faced with the prospect of potential declines in both bonds and equities, an allocation to managed futures may serve as an appealing diversifier to traditional strategies. Despite the relative underperformance of managed futures over the past 18 to 24 months, the salient features of this asset class are worth repeating. Managed futures represent a universe of non-traditional strategies where Commodity Trading Advisors ( CTAs ) seek to generate returns by taking long and/or short positions in futures contracts on financial instruments and physical commodities. Managed futures have historically provided attractive risk-adjusted returns that have desirable properties: They tend to be uncorrelated with those of most other asset classes, both traditional (equities and bonds) and non-traditional (real estate, commodities, absolute return, and other hedge fund strategies); They tend to be positively skewed; They tend to display shorter and shallower drawdowns. 1 TABLE 1 Comparing Returns and Risk Across Multiple Asset Classes 2000-2014 BARCLAY BTOP 50 HFRX GLOBAL HEDGE FUND FTSE NATREIT U.S. REAL ESTATE S&P GSCI TOTAL RETURN S&P 500 TOTAL RETURN ANNUALIZED RATE OF RETURN 5.02% 3.28% 12.13% 1.04% 4.24% VOLATILITY 8.28% 5.75% 21.26% 23.40% 15.26% ANNUALIZED SHARPE RATIO (RF = 0%) 0.63 0.59 0.65 0.16 0.35 DOWNSIDE VOLATILITY (<0%) 4.63% 4.14% 15.00% 16.78% 10.83% ANNUALIZED SORTINO RATIO (MAR = 0%) 1.06 0.78 0.77 0.06 0.38 SKEW 0.49-1.43-1.02-0.46-0.58 KURTOSIS 1.42 8.01 6.68 1.30 1.01 MAXIMUM DRAWDOWN -11.63% -25.21% -68.14% -69.38% -50.95% CORRELATION TO BTOP50 1.00 0.25-0.04 0.13-0.17 2 INSIGHTS
FIGURE 2 Managed Futures vs. Other Asset Classes (2000-2014) Barclay BTOP50 Total Return Index HFRX Global Hedge Fund Index Dow Jones REIT Composite Index SM S&P GSCI Total Return Index S&P 500 Total Return Index $60,000 $45,000 $30,000 $15,000 0 12/1999 6/2000 6/2001 6/2002 6/2003 6/2004 6/2005 6/2006 6/2007 6/2008 6/2009 6/2010 6/2011 6/2012 12/2000 12/2001 12/2002 12/2003 12/2004 12/2005 12/2006 12/2007 12/2008 12/2009 12/2010 12/2011 12/2012 6/2013 6/2014 12/2013 12/2014 We begin by noting that the falling interest rate environment of the last several years, shown below, has generally benefited managed futures. Many, if not most, trend-following CTA programs have held long positions in bonds over this period, which have proved profitable. Bonds and interest rates are included in one of the six sectors traded by most CTAs, but their exposure in most CTA programs tends to be significant. FIGURE 3 US 10-Year Treasury Bond Yield (1990-2014) 10 8 Falling Interest Rates Yield (%) 6 4 2 0 1/1990 1/1992 1/1994 1/1996 1/1998 1/1991 1/1993 1/1995 1/1997 1/1999 1/2000 1/2002 1/2004 1/2006 1/2008 1/2010 1/2012 1/2013 1/2001 1/2003 Years 1/2005 1/2007 1/2009 1/2011 1/2013 1/2014 INSIGHTS 3
However, the prevailing climate of low short-term rates has meant that the interest earned by CTA programs on their fixed-income investments is lower than a few years ago. Most managed futures investment vehicles use less than 25% of their capital to post margin against the futures contracts they trade, while the balance is held in cash or fixed-income investments. For most CTA programs, particularly in the prevailing low-rate environment, the return earned from interest income has tended to be small compared to the returns generated from futures trading. How will managed futures fare if the recent increase in rates is not a head fake but the start of a trend, rooted in fears of increasing deficits and rising inflation? Perhaps surprisingly, the answer is that managed futures have historically performed well in both falling and rising interest rate environments. 2 For CTAs, the trend in rates is important, not its direction. Unlike bond funds, whose mandate is to hold long positions, CTAs can establish short positions in bonds, which may add to their profitability if trends persist and rates continue to rise. In addition, if interest rates stabilize at higher levels, the income earned by managed futures strategies on their fixed-income investments may be higher, potentially helping overall returns. Another dimension to the shift away from a benign rate environment is the potential for managed futures strategies to profit from an expansion in market volatility. Strategies in this non-traditional asset class have the potential to generate profits by being long and/or short both financial and commodity markets. Markets that have exhibited lower volatility characteristics during the prevailing interest rate environment could potentially see an increase in volatility, which in turn may result in added profit potential for managed futures. Finally, a note on rising inflation, an environment in which both bond markets and broad equity markets have historically tended to underperform. 3 CTAs, particularly ones who trade futures on physical commodities (energy, base and precious metals, grains, livestock, and soft commodities), can potentially earn positive returns from long positions in commodities if their prices trend upward in an inflationary environment. Note that investing in long-only commodity products, which may seem appealing during such times, has in the past proved to be extremely volatile and has not delivered risk-adjusted returns that are comparable to managed futures, as shown in Table 1, Comparing Returns and Risk Across Multiple Asset Classes, and Figure 2, Managed Futures vs. Other Asset Classes 2000-2012, of pages 2 and 3 on the previous page. 2 Prospects for CTAs in a Rising Interest Rate Environment, Campbell White Paper Series, January 2013. 3 Stocks in certain sectors (e.g., natural resources) may benefit from inflation, but equity markets overall tend to underperform. It should also be noted that the effects of unexpected inflation can differ from those of normal or expected inflation. We do not address those issues. 4 INSIGHTS
APPENDIX DEFINITIONS Annualized rate of return (AROR) is the geometric average return for a period greater than or equal to one year, expressed on an annual basis or as a return per year. Annualized standard deviation (volatility) measures the degree of variation of monthly returns around the mean (average) return. The higher the volatility of the investment returns, the higher the annualized standard deviation will be. Correlation is a measure of the degree to which the value of different investment types move in the same direction; if they perform independently of one another, they are non-correlated, such as managed futures vs. stocks and bonds. Downside Volatility is a measure of risk, defined as volatility below MAR (minimum acceptance excess rate). Maximum drawdown: Measure of risk (also known as worst historical loss) that illustrates the largest peak-to-valley decline, based on monthly rates of return, during a given time period. The worst historical loss depicted in this Investor Insight is not the maximum loss that can occur in an individual s account. Kurtosis is a statistical measure used to describe the distribution of observed data around the mean. Long Position refers to the buying of a security such as a stock, commodity or currency, with the expectation that the asset will rise in value. Sharpe ratio: A risk-adjusted measure developed by William F. Sharpe, calculated using annualized standard deviation and excess return to determine reward per unit of risk. The higher the Sharpe ratio, the better the fund s historical risk-adjusted performance.* Short Position refers to the sale of a borrowed security, commodity or currency with the expectation that the asset will fall in value. Skew describes the asymmetry from the normal distribution in a set of statistical data. Skewness can come in the form of negative skewness or positive skewness, depending on whether data points are skewed to the left (negative skew) or to the right (positive skew) of the data average. Sortino Ratio is a ratio developed by Frank A. Sortino to differentiate between good and bad volatility in the Sharpe ratio. This differentiation of upwards and downwards volatility allows the calculation to provide a risk-adjusted measure of a security or fund s performance without penalizing it for upward price changes. A minimum acceptable return of 0% has been used in the calculation. A Trend-Following Strategy generally seeks to identify the general direction of one or more global market segments (either up or down) using indicators such as current market prices and moving average prices, and buy or sell investments based on the assessment of these trade signals as determined before a trade is made. Trend-following generally focuses on the direction an investment or global market segment already has gone and not on the direction it may go. Volatility is a measure of fluctuation in the value of an asset or investment. Lower volatility improves the stability and lowers the risk of an investment portfolio. Including managed futures as part of a diversified portfolio helps to stabilize the overall ups and downs of your investments. DESCRIPTIONS The Barclay BTOP50 Index (BTOP50) seeks to replicate the overall composition of the managed futures industry with regard to trading style and overall market exposure. The BTOP50 employs a top-down approach in selecting its constituents. The largest investable trading advisor programs, as measured by assets under management, are selected for inclusion in the BTOP50. In each calendar year the selected trading advisors represent, in aggregate, no less than 50% of the investable assets of the Barclay CTA Universe. To be included in the BTOP50, the following criteria must be met: Program must be open for investment. Manager must be willing to provide daily returns. Program must have at least two years of trading activity. Program s advisor must have at least three years of operating history. The BTOP50 s portfolio will be equally weighted among the selected programs at the beginning of each calendar year and will be rebalanced annually. The index does not encompass the whole universe of CTAs. The CTAs that comprise the index have submitted their information voluntarily. Investors cannot directly invest in an index and unmanaged index returns do not reflect any fees, expenses or sales charges. Managed Futures programs in the Barclay BTOP50 Index may be subject to leverage risk, volatility and risk of loss that may magnify with the use of leverage. Source: barclayhedge.com. The purchase of a managed futures investment involves a high degree of risk. Specifically, you should be aware that, in addition to normal investment risks, managed futures investments entail certain risks, including, in all or some cases: Managed futures often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. Managed futures can be highly illiquid. Managed futures are not required to provide periodic pricing or valuation information to investors. Managed futures may involve complex tax structures and delays in distributing important tax information. Managed futures are not subject to the same regulatory requirements as mutual funds. Managed futures often charge high fees. Definitions continued on back. INSIGHTS 5
APPENDIX CONTINUED DESCRIPTIONS FTSE NATREIT US Real Estate Index provides investors with a comprehensive REIT performance benchmark that spans the commercial real estate space across the US economy. Source: PerTrac Financial Solutions. The HFRX Global Hedge Fund Index is designed to be representative of the overall composition of the hedge fund universe. It is composed of all eligible hedge fund strategies, including but not limited to convertible arbitrage, distressed securities, equity hedge, equity market neutral, event driven, macro, merger arbitrage, and relative value arbitrage. The strategies are asset weighted based on the distribution of assets in the hedge fund industry. Source: hedgefundresearch.com. The S&P 500 Total Return Index is widely regarded as the best single gauge of the U.S. equities market. This world-renowned Index includes 500 leading companies in leading industries of the U.S. economy. Although the S&P 500 focuses on the large cap segment of the market, with approximately 75% coverage of U.S. equities, it is also an ideal proxy for the total market. Total return provides investors with a price-plus-gross cash dividend return. Gross cash dividends are applied on the ex-date of the dividend. Source: standardandpoors.com. The S&P GSCI Total Return Index is widely recognized as a leading measure of general price movements and inflation in the world economy. It provides investors with a reliable and publicly available benchmark for investment performance in the commodity markets, and is designed to be a tradable index. The index is calculated primarily on a world production-weighted basis and is comprised of the principal physical commodities that are the subject of active, liquid futures markets. Source: standardandpoors.com. EXCEPT FOR THE HISTORICAL INFORMATION AND DISCUSSIONS CONTAINED HEREIN, STATEMENTS CONTAINED WITHIN CONSTITUTE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH STATEMENTS ARE BASED ON OUR REASONABLE EXPECTATIONS, ESTIMATES AND ASSUMPTIONS. THESE STATEMENTS MAY INVOLVE A NUMBER OF RISKS, UNCERTAINTIES, AND OTHER FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY, INCLUDING, BUT NOT LIMITED TO, THE PERFORMANCE OF FINANCIAL MARKETS, THE INVESTMENT PERFORMANCE OF PRODUCTS SPONSORED BY EQUINOX FUND MANAGEMENT, LLC, GENERAL ECONOMIC CONDITIONS, COMPETITIVE CONDITIONS, AND REGULATORY ACTIONS, INCLUDING CHANGES IN TAX LAWS. READERS SHOULD CAREFULLY CONSIDER SUCH FACTORS. FURTHERMORE, SUCH FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE ON WHICH THEY ARE MADE, AND NEITHER THE AUTHOR NOR EQUINOX UNDERTAKES ANY OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF SUCH STATEMENT. THIS MATERIAL DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY UNITS IN ANY SECURITY. INVESTMENTS IN MANAGED FUTURES ARE SPECULATIVE, INVOLVE SUBSTANTIAL RISK, AND ARE NOT SUITABLE FOR ALL INVESTORS. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. THERE IS RISK OF LOSS. YOU CAN LOSE MONEY IN A MANAGED FUTURES PROGRAM. THERE IS NO ASSURANCE THAT ANY INVESTMENT STRATEGY WILL BE PROFITABLE, OR THAT THEY WILL BE ABLE TO AVOID LOSSES. NO LEVEL OF DIVERSIFICATION OR NON- CORRELATION CAN ENSURE PROFITS OR GUARANTEE AGAINST LOSSES. EQUINOX FUND MANAGEMENT, LLC IS A REGISTERED INVESTMENT ADVISOR AND COMMODITY POOL OPERATOR SPECIALIZING IN THE DEVELOPMENT OF INNOVATIVE ALTERNATIVE INVESTMENT PRODUCTS FOR PRIVATE/INDIVIDUAL INVESTORS. THE MATERIAL PROVIDED HEREIN HAS BEEN PROVIDED BY EQUINOX FUND MANAGEMENT, LLC AND IS FOR INFORMATIONAL PURPOSES ONLY. EQUINOX FUND MANAGEMENT, LLC IS THE ADVISOR TO ONE OR MORE MUTUAL FUNDS DISTRIBUTED THROUGH NORTHERN LIGHTS DISTRIBUTORS, LLC MEMBER FINRA/SIPC. NORTHERN LIGHTS DISTRIBUTORS, LLC AND EQUINOX FUND MANAGEMENT, LLC ARE NOT AFFILIATED ENTITIES. Securities offered through Equinox Group Distributors, LLC, Member FINRA. 47 Hulfish Street, Suite 510 Princeton, NJ 08542 T 1.877.837.0600 equinoxfunds.com EFM660 0645-NLD-03/11/2013