Most financial advisors and the general public have little knowledge of
managed futures as an investable asset class. In effect, most advisors we
know shrug them off and say "high fees" (a true statement)
without understanding the merits of such an investment when the words
"managed futures" are mentioned.
Let’s begin with the basics. Managed futures are a sector of the
investment industry in which professional money managers actively manage
client assets using global futures and other derivative securities as
their primary investment instruments. Managed futures managers are also
commonly known as Commodity Trading Advisors (CTA’s). CTA’s are
required to register with the Commodity Futures Trading Commission (CFTC).
The National Futures Association (NFA) is the self-regulatory organization
that CTA’s are regulated by. Collectively, as an industry, managed
futures funds, which for many years were viewed skeptically at best by the
financial advisory industry did not take off as an industry until the
1980s. In reality they have only recently begun to earn respect in the
financial advisory community. Many advisors though would still say they
have not garnered such respect.
Growth in the managed futures industry has been tremendous. Assets
managed by the managed futures industry exceeded $120 billion in 2005. The
global futures markets have historically been dominated by agriculture and
commodity futures. In 1980, agricultural futures trading approximated 64%
of market activity and metals trading comprised a total of 16%. Currency
and interest rate futures accounted for the remaining 20%. Today, global
futures markets are dominated by financial futures for currency, interest
rates, and stock index futures. Twenty years ago, agriculture was the
predominant piece of managed futures trading. Currently, it represents
less than 10% of the total. In fact, for many of the largest managed
futures managers, agricultural futures represent even less of their
Managed futures managers can usually be segregated into two primary
categories: In general, they can either be categorized into various
markets (oil, currencies etc.) that they focus on, or the trading
strategies they utilize. The majority of futures managers will typically
diversify across numerous markets and oftentimes trade hundreds of
different types of futures contracts. Other futures managers specialize in
a specific market or a group of similar contracts. For example, a futures
manager might focus on the energy category (oil, gasoline, natural gas,
diesel fuel, etc.) as opposed to just oil. Futures managers are also
grouped together by trading strategies. The majority are trend-followers,
which attempt to find trends in price movements of futures and jump on the
bandwagon. These trends could last for a few hours, days, weeks or months.
Man Investments AHL Group, a trend-following manager, and currently the
largest managed futures manager, re-analyzes various futures markets with
their computers models over 2,000 times per day. This is spread over a 24
hour period since they operate in a global market. Fundamental analysis
(more commonly known as discretionary trading) which is less popular
relies on analysis of global supply and demand, macroeconomic indicators,
and geopolitical forces which is similar to a macro fund hedge fund
managers except that the investment instruments and markets that they
follow are far broader.
Trend-following approaches generally rely on quantitative models to
perform technical analysis resulting in buy and sell signals. They can be
further sub-classified as either trend-following or counter trend-following.
Trend-following managed futures’ trading systems are almost always
highly computerized and new models are continually created by the
management team. Futures management trading systems tend to be highly
diversified across numerous markets. Most trend-followers refrain from
trying to predict trends. Instead, they take futures positions that will
profit from a continuing trend. They constantly review a number of
widespread indicators such as momentum and moving averages. This helps the
futures managers to identify the direction of a particular market. Futures
managers often use different time horizons to identify the existence of a
trend. On the other hand, counter-trend systems look for trend
reversals. Futures managers that utilize a counter trend-following
strategy typically rely on several technical indicators and methodologies.
These include obscurely named indicators (to most financial advisors and
investors) such as rate of change indicators. These rate of change
indicators are called oscillators and momentum indicators. Counter-trend
futures management systems alternatively can use more familiar technical
indicators such as head and shoulders patterns.
Furthermore, fundamental (discretionary) managed futures managers also
frequently use systematic models, which are based on fundamentals and
underlying economic factors. However, the trading decision process is
determined by the manager’s thoughts regarding the models results.
Because experience and trader-specific skill are critical to the success
of fundamental strategies, fundamental futures managers will often
specialize in a particular sector or market. However, some fundamental
futures managers diversify across strategies by basing their trading on a
mix of trend-following and fundamental methods. These managers may or may
not diversify their portfolio across numerous markets.
There are three ways to invest in managed futures. The first, public
futures funds, in effect, in some cases offer investors the managed
futures equivalent of a mutual fund (although this statement is somewhat
exaggerated, it is not unusual for a managed futures fund to have a fairly
low minimum investor criteria. For example, a $35,000 income and a $35,000
net worth or a $100,000 net worth is not unusual). Some public funds may
require investors to be of accredited investor status (Individuals and/or
jointly with their spouse must have in excess of $1,000,000 or if an
individual, income in excess of $200,000 or $300,000 if held jointly with
a spouse for each of the last two years and expect to meet that criteria
in the current year). Public funds can often be liquidated on a monthly
basis. Expenses are often higher than other managed futures opportunities.
The second way to invest in managed futures is that high net-worth and
institutional investors (these are either accredited or super accredited
investors) can obtain exposure to managed futures through private
commodity funds or pools, (usually a $500,000 or higher minimum
investment). Usually the expenses are lower than a public fund. Private
funds offer diversification benefits similar to public funds. A negative
is that they often possess the characteristics of hedge funds and other
private investment vehicles, with regards limited transparency.
The third method is that extremely high net worth investors can hire a
futures manager directly. While there are advantages to hiring a managed
futures manager directly as part of a customized investment program, the
cost of doing so usually requires at least a $5,000,000 or $10,000,000
Many managed futures strategies in whatever form, when added to a mix
of traditional stock and bond investments will likely add significant risk
reduction and/or improved returns. Diversification across trading styles
and futures markets can significantly enhance a portfolio’s performance
with regard to risk reduction and enhanced returns.
Stock and bond portfolio managers, derive the bulk of their returns due
to risk and return characteristics from the stock and bond markets
themselves. Managed futures managers add value primarily through their
trading skills and are considered skill based. As a result, managed
futures are considered an absolute return investment strategy. Through
their ability to invest in derivatives and to take both long and short
positions, as well as invest in hundreds of different types of
instruments, managed futures managers offer investors an effective way to
gain exposure to investment markets and vehicles as well as investment
strategies that are not otherwise easily accessed.
Should One Use Managed Futures?
As a result of Legend’s
studies over the past 18 months on managed futures, we have found that
well-diversified managed futures funds offer risks and returns comparable
to diversified equity portfolios. In fact, like equity managers,
diversified managed future managers are similar in nature with regard to
risk and reward levels. On average, managed futures managers (at least the
ones we have studied) have offered higher returns with less risk, and
there also high reward/high risk managers as well. In addition, managed
futures historically have had low correlation with traditional stock and
bond investments. This is due to the fact that return from managed futures
are frequently due to factors different from those affecting traditional
stock and bond investments. These low correlations are exactly what we
find attractive from a diversification standpoint. In fact, in our
studies, (which we will detail in the coming months) we have generally
found that most managed futures funds will either enhance return, decrease
risk or both when added to a number of Lower Volatility Portfolios. As
mentioned previously, significant risk reduction and/or enhanced returns
are possible when combined with traditional mixes of stocks and bonds.
In the numerous studies that we have read to date almost all say that
managed futures have the potential to provide downside protection
(although losses are of course possible), along with producing positive
returns. These studies also indicate the financial instruments used by
managed futures managers are not available to stock and bond managers.
Another finding is that both managed futures managers and the stock market
indices have a positive correlation in a bull market and are negative in
bear markets. This is in all likelihood due to the fact that futures
managers will align their portfolios utilizing may of the broad array of
investments available to them to structure their portfolios in an
appropriate manner which will take advantage of a strong upward or
downward trend in the stock market.
History has shown that managed futures also perform well in rising
interest rate markets unlike bonds and stocks. This is particularly
important due to the fact that we are most likely in a long-term (secular)
bear market for rising interest rates which will eventually have a
negative impact on the markets for stocks and bonds.
Several studies have also shown managed futures to have a low or even
negative correlation with hedge funds and hedge funds of funds. As a
result, managed futures funds further reduce the risk in the portfolios
and generally have enhanced returns as well. Some studies have also
indicated that managed futures are better diversifiers than hedge funds.
A number of studies have indicated that the key foundation for managed
futures returns, is the risk transfer function of the futures market
itself. Some commercial market participants, i.e. businesses that consume
commodities and/or the suppliers themselves, by hedging, are willing to in
effect pay the equivalent of an insurance premium to investors, for the
assumption of risk. In total and over the long-term, futures markets tend
to move in the investors’ favor, and as a result in effect pay a net
positive insurance premium. Investors receive this premium in the form of
net trading profits because they provide liquidity.
Mutual funds as required by the Securities and Exchange Commission have
disclosure requirements. Management companies that manage a mutual fund
must report their investment performance and other activities to
regulatory authorities. Managed futures managers provide performance
information on their funds voluntarily to database vendors. This voluntary
reporting is somewhat a suspect. This makes accurate performance
measurement and consequently, evaluation difficult. The two most common
problems are survivorship bias and back-fill bias.
Survivorship bias, also a common problem with hedge funds, separate
equity and bond accounts, as well as mutual funds typically occurs because
a manager stops reporting investment performance due to poor results or
closure of their fund. As a result, the return for that group of similarly
managed funds rises due to the elimination of the poor results.
Back-fill bias for futures managers (similarly for hedge funds but not
mutual funds and not since the early 1990’s by separate account bond and
equity managers) occurs when managers decide to start reporting
performance. Typically, a manager begins reporting after having achieved
good performance for a certain number of months thereby eliminating poor
results. Also, some managers may add in performance with back-tested
In reality within the managed futures and hedge fund worlds, these
biases in reported performance are offset to some degree by termination
bias. This type of bias is an election by successful managers who
can no longer accept additional monies or investors and (due to having
reached the capacity of their investing style. This is similar to small
cap managers closing their funds because of too much money to manage)
simply stop reporting performance to the public databases.
Comments on Performance Expectations:
Managed futures funds will not automatically be profitable during
unfavorable periods for traditional stock and bond investments, and vice
versa. It must not be forgotten that a large part of the returns will be
determined by the skills of the manager and the presence of exploitable
trends in the futures markets. If trends are non-existent or close to
non-existent ala 2004, positive performance will be difficult to produce.
How non-correlated a given managed futures fund is will also vary,
particularly as a result of market conditions and the manager skill set.
In some cases not all managed futures will have significantly lower
correlation with stocks and bonds. A fund by fund analysis will need to be
made. Some funds are quite volatile, while others have less risk but
higher returns than U.S. Equities. Nevertheless, these more conservative
funds might pale in comparison to their more aggressive, sometimes highly
leveraged and more volatile counterparts that provide significantly higher
Managed futures funds offer distinct risk and return characteristics to
investors that are not easily replicated through investing in traditional
stock and bond investments. Including a modest allocation to managed
futures in portfolios of virtually all types can also improve the
risk-return tradeoff of long-term asset allocation portfolios even during
in a bull market for stocks. Furthermore, managed futures on average will
exhibit excellent performance during periods in which most traditional
asset classes underperform in addition to periods when interest rates are
In short, we have entered a new era for both stock and bond returns –
one of low nominal rates of returns (2% to 4%) for a period of probably
another ten to fifteen years. Managed futures funds should be considered
as a potential investment to enhance future returns.