Winton has been constructing diversified portfolios from futures markets for more than two decades, offering an alternative to equities and bonds that mostly avoids such liquidity risks.

Sea of Liquidity

Winton has been investing in futures instruments since the firm’s inception in 1997, but the markets behind them have been around a lot longer, with today’s oldest exchanges dating back to the 19th century. The Chicago Board of Trade, now part of CME Group, was founded in 1848, while the London Metals Exchange was established in 1877.

Futures are contracts to buy or sell an asset at a future date at an agreed price. The contracts are standardised and traded on regulated exchanges, connecting buyers and sellers that range from agricultural producers looking to hedge their financial risk to investment managers seeking market exposure.

This diverse collection of market participants makes for a large and liquid investment universe, quantified in the chart below. The blue bars indicate the average US dollar value of daily trading volume during 2018 for the 50 largest futures markets traded by the Winton Absolute Return Futures Fund.

Daily trading volume in S&P 500 futures alone was about 50% higher than that for stocks across the entire of both the New York Stock Exchange and Nasdaq during 2018. Similarly, trading in US 10-year Treasury note futures was almost three times that of the underlying bonds. Futures also provide liquid exposure to non-financial assets, such as crude oil and gold.

Despite the vast scale of futures markets, strategies predominantly applied to these instruments are largely missing from the portfolios of most UK retail investors.

Drop in the Ocean

Winton’s futures strategies are applied to sizeable assets, with the firm advising on approximately $20 billion in total. Still, comparing Winton’s overall average position in larger markets during 2018 to their average daily trading volume shows how the firm’s potential liquidity demands can be minimal relative to typical market activity.

Average Position Versus Average Daily Trading Volume During 2018

Source: Winton, Bloomberg, as at 31 December 2019.

Another way of looking at liquidity is considering how long it would take to convert a portfolio to cash. Assuming a strategy uses 2% of daily trading volume per day in the markets in which it invests, one can estimate how long it would take to liquidate a portfolio. Under these conditions, 99.97% of a £500 million portfolio trading a strategy similar to that of the Winton Absolute Return Futures Fund could be liquidated within one day.

Keeping it Watertight

One cannot be complacent, however, as liquidity tends to disappear when it is needed most. Winton takes the following steps to guard against this occurrence:

• Winton is conscious of the dangers of leverage and its strategies are designed to avoid rapid rebalancing.
• Winton continually seeks to differentiate its strategies from those of other managers to avoid the risk of crowding.
• Winton complies both with speculator and exchange limits set by regulators, and internal trading volume and open interest caps, all of which are embedded in the firm’s daily investment process.
• The liquidity profile of each of Winton’s products informs its investment universe – a daily-dealing UCITS fund such as the Winton Absolute Return Futures Fund, for example, excludes less-liquid markets.
  

A Liquid Alternative

Recent issues with certain UCITS funds have highlighted the risks involved with seeking returns in unconventional places. But investment alternatives to equities and bonds can still be liquid. Strategies in highly liquid futures markets have long provided returns and a source of long-term diversification for institutional investors. Since the Winton Absolute Return Futures Fund launched in July 2017, UK investors have been able to gain exposure to futures through a systematic multi-asset strategy, managed by a firm with two decades of experience in these markets.