Correlation NonCorrelation
Long-term: Figure 2 shows the correlation of the same benchmarks since the pro-forma introduction of the BTOP50 on January 1, 1987, based on monthly data. (Most managed futures advisors report monthly; the CS-Tremont Managed Futures Index pro-forma start date is January 1, 1994.)



Ten years: Figure 3 shows the correlations over 10 years to June 30, 2007.



Recent history: Figure 4 shows the correlations since January 1, 2004, when live calculation of the DTI began.



The picture is clear. While the indexes of actively managed futures performance are historically uncorrelated with conventional investment benchmarks, they have become significantly correlated in recent years, surging to 0.60 over the last three years. Over the same period, the DTI’s correlation has moved from solidly negative, but is still barely positive; as well, its correlation with the active managed futures benchmarks is consistently in the 0.4-0.5 percent range.

Volatility And Performance

Figure 5 shows the standard deviation of annual returns over various time periods; historically, the DTI has exhibited barely half the volatility of the active managed futures indexes, although it has blipped up over the shortest period analyzed. It’s also worth noting that, despite managed futures’ reputation for volatility, both active benchmarks are less volatile than the S&P 500 over all time frames.
The data clearly confirms Rydex’s contention that the pro-forma risk-return profile of the DTI is more conservative than active managed futures investments.



Figure 6 shows annualized compound returns of the same periods as the volatility table. Much of the long-term advantage of the managed futures strategies is the result of a handful of highly successful years, most of them more than a decade ago in a much different market environment. As well, those strategies, demonstrating their capital protection attributes, have never experienced drawdowns of the size endured by the stock market in the 2000-02 time frame.



Implementing The Strategy
The Rydex Managed Futures Fund is structured as a plain vanilla mutual fund, with a $2,500 minimum investment, daily liquidity, subject to a 1 percent redemption fee on shares owned for less than 90 days, and a 1.65 percent expense ratio.

[Editor's Note: The RYMFX data page shows the minimum as $25,000; however, that is misleading, as it actually represents the minimum to open an account at Rydex].

According to the fund documents, the funds use “quantitative methods to construct a portfolio that correlates highly with the fund’s underlying benchmark,” and statistical techniques to determine the optimal asset mix. It “places particular emphasis on controlling risk relative to the underlying benchmark in order to maintain consistency and predictability.”

The fund implements much of its investment strategy not by trading the contracts underlying the benchmark index; instead, the bulk of its assets are invested in hybrid derivatives, such as commodity- and commodity-index-linked structured notes. The instruments are subject to both normal market risks, such as price fluctuations and liquidity, but add counterparty credit risk; while Rydex does not disclose the names of its counterparties, it only deals with those it believes to be creditworthy, according to the prospectus.

The use of structured notes allows Rydex to overcome the obstacles traditionally associated with offering managed futures exposure in a 1940 Act mutual fund format. Ed Egilinsky, who heads Rydex's alternative investment initiative, said that structured notes enable the fund to adhere to IRS requirements, which do not treat income derived from commodities-based futures contracts as “good income,” as well as other concerns, including the tax treatment of returns on futures contracts.

“The notes are fixed income instruments tied to the price return of the DTI. Our counterparties create the notes which mature in a year and a day, making the income eligible for long-term tax treatment.”

About one-third of the portfolio is invested in the structured products, with the balance in short-term Treasury instruments. “That's pretty analogous to a typical active managed futures portfolio that will have one-third of its assets in futures margin, and the rest in Treasuries. We get the managed futures return stream in a form that, for the purposes of a registered investment company, meets IRS requirements.”

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