John W. Henry: Commodity Trader uses Long Term Trend Following Techniques
May 1996, Page 10
Adapt and grow
By Oliver Conway
One great prize has so far eluded futures managers. But Oliver Conway looks at a firm that believes it is set to win a place in the institutional market. The managed futures industry has long been trying to tap the huge pools of money held by pension and insurance funds, but has failed to make significant progress because it is perceived to be too risky, expensive and volatile. However, one of the worlds largest futures managers is now targeting the institutional market with a series of funds aimed at overcoming these concerns.
Connecticut-based John W. Henry, which has around $1.4 billion under management, launched JWH Risk Management to bridge the gap between managed futures and mainstream fund management. Company chairman John Henry says the launch "marks the beginning of a new era for JWH". Institutions will eventually become the firms major business, he says.
Although JWH already manages money for some institutions, the new firm has been created to try to gain a long-term presence in the US institutional market. JWH Risk Management will initially offer three types of fund. The first set of portfolios is based on JWHs original trading system, but with less leverage. It comprises two unleveraged programs - one financial, the other diversified - which are uncorrelated to bonds, but aim for similar returns in the long run; and one with a slight gearing that is correlated to neither stocks nor bonds and which hopes to provide a return of up to 15% a year. The second set consists of 12 funds covering the worlds six main stock indexes - in the US, the UK, Japan, Germany, France and Australia - in both efficient and enhanced format. The efficient series offers a high correlation to the underlying but with less volatility and an annual return of 200-500 basis points over the index; the enhanced series aims to give a return of 300bp above the index while keeping tracking error below 300bp. The third set of products tracks two other indexes - the Goldman Sachs Commodity Index and one comprising US fixed-income instruments, which will initially use Lehman Brothers Long-Term Government Bond Index as a benchmark - in both efficient and enhanced form.
Some institutional money has already been invested in the US to be traded alongside proprietary capital, but the programs have yet to be marketed. The firm plans to offer the same products to European institutions. The three core funds are currently being filed for regulatory approval prior to trading proprietary capital. They will be domiciled in Luxembourg and denominated in US dollars and other major currencies. The other programs will follow.
The funds prospective appeal to institutions is based on their low gearing and low fees. "Our non-leveraged programs have management fees of less than 50bp and no incentive," says Henry, adding that many of those outside managed futures do not appreciate that high fees derive from high leverage and that the less a program is geared, the more money it can manage.
"Leverage is non-existent in traditional investment," he says. The firm is also developing a swap mechanism that will allow investors who are not allowed to open a futures account to gain exposure to the programs, add JWH executive vice-president David Bailin. Investors would pay Libor and receive 80% of an index based on JWHs programs.
Managed futures are currently ranked behind stock, bonds, overseas exposure and other mainstream markets in institutional preferences, Bailin says. However, he believes interest will pick up when investors start to study seriously the various alternative investments, as managed futures are among the most liquid and provide a great deal of diversification. He says the greatest problem afflicting institutional investors is that "they are all doing the same thing". Their performances are all evaluated against their peers, he adds. Henry says JWH funds have zero correlation with traditional investments.
JWH Risk Management is in its infancy, with much recruitment and legal and administrative work still to be done. "We have no CEO, no infrastructure and we are not even in our office space yet," says Henry. He envisages an initial staff tally of "a couple of dozen". Senior strategist Jules Staniewicz says the company is still looking into the legality of sharing employees. The details of how best the programs can be offered are also being worked out, but JWH Risk Management hopes to be fully operational early in the second half of this year. Staniewicz believes the new company could attract as much as $1 billion in a relatively short time. But equally, he says, it may take time to become accepted.
It is developing a series of products to be launched in the next few months, giving it a third style of trading. It now uses two systems, both of them long-term trend following. One is always fully invested in the market, the other can withdraw if there is no trend.
JWH trades almost 60 markets worldwide. Its 24-hour trading operation allows it to control all positions. Henry says JWH does not use options for investment management for reasons of cost. "We have made our business managing risk," he says. "We are comfortable with risk and we get our reward from risk."
"Positions held for two to four months are not unusual, and some have been held for more than one year," says a spokesman. Historically, only 30-40% of trades have been profitable, but the spokesman attributes favorable overall results to large profits on a few trades. These are in positions that, typically, exist for several months, while most losing positions are liquidated within weeks. The company has recently invested in both staff and technology and, as part of a review of its dealing controls, automated all its trading desks.
JWH offers 10 different investment programs. The Global Financial Portfolio - which invests in financial futures, foreign exchange and crude oil - returned a huge 86.2% in 1995, while the Original Investment Program returned 53.2%. The firms largest fund, the Financial and Metals Portfolio, which contains almost $900 million, earned 38.5%. Over the same period, the S&P 500 returned 37.6% and Lehman Brothers Long-Term Government Bond index rose 30.9%.
Picture Source: Managed Derivatives, May 1996