Benchmarking Alternative Beta

The year 2015 will mark Mount Lucas’ 30th as an alternative investment manager. We formed as a CTA in the halls of Commodities Corporation in Princeton, New Jersey. Our particular mandate was to attract managed futures assets from the institutional marketplace. In doing so we became the first managed futures manager to register with the SEC as a Registered Investment Advisor. Just two years later our we created the MLM Index – the first price based index for Managed Futures – and possibly the first attempt at measuring alternative beta.

But what is a price based index for Managed Futures – what does that mean, what does it measure? I’m glad you asked. A key quality of any “good” benchmark is that it measures premium available to the investor. That is – the premium the investor should expect to earn by taking risk with his/her money. In the equity world, the investor invests his/her money into a company so that the company can grow and expand. The use of investor capital does not come for free; it must be paid for – a premium. In the equity example this premium comes in the form of capital appreciation and dividends. A simple benchmark measure of this premium can be created by buying a broad basket of stocks – the S&P 500.

The same premium can be earned in Managed Futures, but here we are not measuring Managed Futures, but “price risk premium”. Prices can be volatile, and as an input into the cost function of businesses, need to be controlled. This is why the futures market was created, as a mechanism for transferring price risk to the investor. Now, as we learned in the previous paragraph, investor capital does not come for free, a premium must be paid. The MLM Index is the benchmark that measures this “price risk premium”. When prices are more volatile, one can expect the premium businesses are willing to pay is larger, and when prices are stable, one can expect the premiums to be lower.