An Introduction to Managed Futures
Although futures can help to decrease the risks of unpredictable investments and even allow wise investors to make money from speculating on opportunities that would otherwise be too volatile, the complex and lightning-quick nature of these markets can test the mettle of all but the most advanced investors. Managed futures have therefore emerged as a way to capture the best of these opportunities and to maximize profits when investing in futures markets.
Humble Beginnings
Managed futures have been around for more than 60 years. Retail investors in the early 1950s would hire Commodity Trading Advisors and Commodity Pool Operators to supervise trading of their separately managed accounts and administer the commodity pools in which they invested. More recently, the industry has expanded due to the investments of institutional entities such as corporate pension funds, banks, and endowments. Commodity Trading Advisors often use technical trading systems that are founded on price patterns established over centuries of history.
How it Works
Managed futures funds, also known as commodity pools or commodity funds, speculate on options and futures markets using a pool of funds invested by numerous investors. These funds are most commonly managed by an official Commodity Pool Operator, or CPO. Routine daily trading is done by Commodity Trading Advisors, or CTAs, hired by the head CPO, which frees him to focus on the big picture of evaluation, accounting, and monitoring the performance of the managed futures fund. Much like mutual fund or stock managers, these CTAs and CPOs are assigned by investors to manage their investments. Trading is primarily done in global futures markets.
Managed Futures Returns
Ever since the 1980s, managed futures investments have accelerated wildly alongside the rapid growth of the futures industry itself. The industry has been consistent in producing compelling returns almost every year since its inception. As an asset class, managed futures are both excellent portfolio assets and great individual investments.
This asset class has been calculated to produce an average monthly profit of about 1.02%. This is significantly higher than the average .71% profit given by bonds and even marginally higher than the average 1.00% profit linked with stocks. This is, of course, merely an average figure. Actual returns on managed futures fluctuate depending on the current market climate.
Reduction of Portfolio Volatility
Investment portfolios that include managed futures have been shown to feature significantly lower levels of volatility combined with greater returns. These portfolios are even less risky than those containing only stocks and bonds.
Although volatility levels of these accounts are greater than those of bond investments, the amount of deviation in the monthly return levels used to calculate this volatility is actually less than that of stock investments. Additionally, managed futures tend to feature less of a maximum monthly drawdown than stock investments.
To reduce the volatility of the portfolio even further, it’s best to combine your managed account with a basket of stocks, bonds, and other traditional assets. Because the correlation of managed futures with investments into stock and bonds is usually extremely low and even sometimes negative, this combination has been shown to be highly productive.
This investment strategy is so well-recognized that it has even been practiced by such distinguished investment entities as institutional pension plans. The investments of the S&P 500, for instance, are made up of 30 percent bonds and 60 percent stocks. The rest is comprised of other minutiae that include real estate and commodities.
A Snapshot of the “Flash Crash” of May 2010
Kathryn M. Kaminski, Ph.D., Senior Investment Analyst, RPM Risk & Portfolio Management has published a study on the performance of Managed Futures Accounts during economic crises, such as the “Flash Crash” of May 2010.
In her report, Dr. Kaminski has reviewed the performance of managed futures accounts of the major financial upheavals back through 1998. What many futures investors know is that their portfolios tend to do well when equity markets become subject to unanticipated and profound “adjustments.”
Equity market crisis events (sometimes referred to as “tail risk events”) can be evaluated and analyzed after-the-fact. Observations by analysts reveal persistent trends which appear across markets, and which can extend well beyond the “end” of the crisis.
Smart money managers do not have to “react” to crises. They will have already opened positions in currencies, metals, soft commodities, equities, and other asset classes well before market dislocations, the net effect of which will produce a strong return for the investor.
What does this mean for the retail investor? Simply that diversifying into alternative investments may be a most prudent decision and well-timed decision.
An Alternative to Managed Forex
On occasion we will review a managed account which includes financial futures as well as forex. There is indeed an asset class known as Forex Futures.
A Managed Futures account would primarily invest in exchange-traded contracts. These are contracts to either buy or sell a particular currency, with a specific price. The contract however is set for some date in the future. There is always a specific date in the contract at which the contract must be fulfilled. This could be 30, 60, 120 days or more into the future. When the termination of the contract occurs, delivery of the currency must occur unless an offsetting trade is made to flatten the initial position.
There are two principal purposes for the use of Forex futures as financial instruments. The first purpose involves risk management by companies which engage in international trade, or depend on cross-border shipments of goods. By agreeing to purchase a certain amount of currency at price “x” in 30 days, the company has fixed its risk regardless of the actual currency value 30 days out.
The second purpose is to allow speculators to work off of future values in an attempt to profit from price fluctuations.
Because these are flexible financial instruments, and traded around world in different markets and exchanges, their acceptance and ability to offer diversification in many dimensions. Rises in gold and silver prices, oil, corn, rice, and other commodity markets tend to have very low correlation, if any, to the S&P or other equity indices.
International futures exchanges continue to expand. Every year new types of futures contracts are announced as we are able to correlate various global influences on the fundamental requirements of living. These contracts inevitably will be incorporated into Managed Futures accounts.
