Strategy Spotlight

PIMCO Managed Futures Strategy: Seeking a Smoother Ride in an Uncertain World

Today, the heightened possibility of increased volatility coupled with the prospect of lower returns going forward, suggests that the time may be right to consider the potential benefits of managed futures strategies.

Trend-following, the primary approach used in managed futures strategies, has generally delivered strong returns over multiple decades.1 Today, the heightened possibility of increased volatility coupled with the prospect of lower returns going forward, suggests that the time may be right to consider the potential benefits of trend-following strategies.

Portfolio manager Matt Dorsten and product manager Michael Connor discuss the mechanics of trend-following strategies, and how PIMCO GIS TRENDS Managed Futures Strategy Fund (TRENDS) is differentiated in the marketplace.

Q: What are managed futures and how do they work?

Michael Connor: Managed futures funds – also known as trend-following or momentum strategies – have been around since the 1980s. Historically, investors have been drawn to these strategies mainly for their diversification benefits and their potential for equity-like returns. Because of their low-to-negative correlation with many risk assets, they may help to lower overall portfolio volatility and contain drawdowns. Ideally, they should demonstrate their best performance during equity sell-offs, when investors need returns the most. In choppier markets without clear trends, performance may be down or muted.

Q: Why have investors been allocating to managed futures strategies?

Connor: With low annual returns expected for mainstream stocks and bonds over the next decade, and asset prices in both the equity and bond markets near all-time highs, investors are looking to alternative strategies for return and diversification potential. As such, investors have been allocating to managed futures strategies, which offer the potential for both.

Q: How have managed future strategies performed during market shocks?

Connor: The sell-offs of 2015 - 2016 provide a good test case for trend-following strategies as equity markets experienced a number of notable sell-offs. A natural question for investors to ask is: During these sell-offs, did trend-following funds do what they’re supposed to do? For true managed futures strategies, we believe the answer is yes.

Have Managed Futures Strategies Performed as Expected?

A closer look at these three drawdowns – the China devaluation scare in August of 2015, the negative rate scare in early 2016, and Brexit in mid-2016 – helps provide insight into the potential benefits, and limitations, of trend-following strategies. Trend following strategies may not always outperform the broader market as displayed in Figure 1, but the chart above examines how managed futures strategies fared during these market sell-offs, noting some key distinctions in the three different episodes.

  1. China Devaluation: This downdraft occurred very quickly and somewhat unexpectedly over the course of four days. Trend-following strategies that were particularly fast-moving, like PIMCO’s strategy, were able to identify the trend and then take appropriate positions. However, note that the diversification effect here (trend-followers rally as the equity market sells off) is somewhat muted due to the speed of the move.
  2. Negative Rate Scare: The January-February 2016 selloff took several weeks and the rebound in risk market assets was slower which allowed trend-following strategies to provide a much stronger diversifying effect with particularly strong performance from strategies, like TRENDS, which are designed to react more quickly.
  3. Brexit: The sell-off in June 2016, like the China devaluation scare, also occurred very quickly, taking place over two days. However, the performance of trend followers was stronger this time, because, given previous market moves, trend-followers generally were well positioned for the event. PIMCO TRENDS, for example, was up 3.84% on the day following the Brexit vote.

Q: How do you expect managed futures to perform in different market environments going forward?

Matt Dorsten: Managed futures strategies are all designed differently so there is considerable disparity among these funds. Trend horizons, portfolio construction and risk management criteria are three main factors that determine the nature of a managed futures fund.

At PIMCO, we focus on shorter-term trend windows because we believe this makes our strategy more responsive in an equity market selloff, and also that it positions us to trade ahead of other managers who track longer time horizons. This seeks to increase the likelihood that investors will benefit during surprise market shocks but does expose the fund to risk in choppier markets. Investors should educate themselves on specific strategies to understand how performance can vary in different environments.

Q: What is PIMCO’s managed futures investment philosophy?

Dorsten: PIMCO TRENDS specializes in capitalizing on shorter-term trends and is characterized as a faster moving, adaptive strategy that limits long equity exposure. With 14 years of dedicated quantitative expertise, PIMCO integrates macroeconomic insight and bottom-up microeconomic (i.e. security-level) considerations to create a strategy that is designed to maximize diversification potential without sacrificing return. The fund possesses several distinct characteristics relative to competitors:

  • Fast moving: By focusing on shorter moving-average windows, TRENDS seeks to enter newly formed market trends quickly and potentially exit completely once trends have reversed, often ahead of other slower-moving trend followers.
  • Adaptive: Over the short term, TRENDS aims to scale up or down quickly in response to strong or weak market trends. This allows us to focus allocation to the strongest trend signals which may outperform.
  • Limits long equity exposure: Short equity exposure in the fund can reach -100%, but TRENDS limits long equity exposure to +50% to emphasize diversification characteristics of the strategy.

Q: What is PIMCO’s managed futures investment process?

Dorsten: PIMCO’s approach to trend-following is to refine the standard models using both macro- and micro-level insights informed by PIMCO’s investment process, such as:

  • Active collateral management: In an era of low returns, maximizing the potential from investing collateral through PIMCO’s active fixed income management may add a significant boost.
  • Drag reduction: We use PIMCO’s carry forecasts in an effort to avoid a significant portfolio drag from negative carry and roll-down.
  • Scaling rules: We do not target a constant risk level, but rather scale up volatility as opportunities develop and scale down when market trends are few.
  • Cross-market trends: Robust macroeconomic insights provide the ability to look both within and across markets to identify trend signals.
  • Risk management bias: TRENDS is designed to maximize its risk management role by constraining exposures that may overlap with traditional portfolio risks.

New strategy ideas are vetted by the Trends Research Advisory Group, which is comprised of senior portfolio managers across a variety of specialist desks.

PIMCO’s derivatives execution is conducted by specialist portfolio managers on our global derivatives execution platform. Futures rolls are determined and executed by the appropriate specialist desk. Collateral is managed by our specialist Short Term Portfolio Managers. And, an appropriate liquidity buffer is mandated and monitored by our Risk Management Desk. Through this robust process, our TRENDS strategy harnesses the scope of PIMCO’s industry-leading global resources, which we believe provides a competitive advantage.

1 Measured by Eurekahedge CTA/Managed Futures Hedge Fund Index
2 The Unified Management fee takes account of a fee waiver in the amount of 0.25% p.a. until 31 July 2018. The fee waiver will expire from 01 August 2018.
The Author

Matt Dorsten

Portfolio Manager, Quantitative Strategy

Michael Connor

Derivatives Strategist, Quantitative Strategies



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A word about risk:

Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. The fund will seek exposure to commodities through commodity-linked derivatives and through the PIMCO Cayman Commodity Fund VIII Ltd., a wholly-owned subsidiary of the Fund organized under the laws of the Cayman Islands (the “Subsidiary”). The Subsidiary is advised by PIMCO, and has the same investment objective as the Fund. The Subsidiary (unlike the Fund) may invest without limitation in commodity-linked swap agreements and other commodity- linked derivative instruments. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. Investing in foreign denominated and/ or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. The strategy may utilize quantitative models as part of implementing its investment strategies. The models evaluate securities or securities markets based on certain assumptions concerning the interplay of market factors. Models used may not adequately take into account certain factors, may not perform as intended, and may result in a decline in the value of your investment, which could be substantial. The Fund is non-diversified, which means that it may concentrate its assets in a smaller number of issuers than a diversified fund.

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