Why is there a buzz about managed futures? They offer the dual possibility of improving returns while reducing overall portfolio risk. When the stock market sputters, managed futures can offer a terrific hedge, as they did in 2008. While stocks slumped 37% that year, managed futures funds gained an average of 18.3% according to the Credit Suisse/Tremont Index.
Finding the positive in the negative. In a bad year for stocks, who wants a portfolio anchored in mutual funds or hedge funds? In contrast, a managed futures fund could perform relatively well in such a year, aided by negative correlation, the tendency for alternative asset classes to outperform a down market.
To take advantage of negative correlation, a managed futures fund may direct assets to assorted futures contracts, options on those contracts, currencies, and Treasury bonds and notes as alternatives to stocks. If certain commodities make a bull run, the fund may let you take advantage.
In any economy, investing in asset classes with low or no correlation to the stock market is a savvy move. When seasoned investors think of managed futures, they think “balance”, “diversification”, and “opportunity.” They see an absolute return strategy they would like to enact or know more about.
The mission: exploit market trends. Managed futures programs use computer models to try to determine near-term market movements (the “near term” may be anywhere from the next few market days to the next few months). The more price movement, the more opportunity for the fund.
It’s not just about exploiting the upside: a managed futures fund also seeks to capitalize on the downside. To do all this, the fund manager (the CTA, or commodity trading advisor) truly has to “run the show” and take discretionary control over the invested assets.
The Barclay CTA Index (which tracks representative performance of commodity trading advisors) has posted a 12.2% average annual gain since 1980. It has had only three losing years in that period. From January 1980 to May 2003, the gap between the peak return and the worst return for managed futures was just -15.7%, compared to a -44.7% variance for the S&P 500 and a -75.0% variance for the NASDAQ.
Strong regulation. Managed futures funds are closely monitored by the Commodity Futures Trading Commission (CFTC), that’s a federal entity. Another layer of supervision exists: the private-sector National Futures Association patrols their behavior. Additionally, each CTA has to pass an FBI background check.
A welcome level of transparency. Investors in managed futures programs often have online access to their accounts and can see each individual trade made by a CTA. They can usually also make redemptions whenever they wish. These funds only trade in liquid instruments, no REITs, no private equity funds or leveraged buyouts. All capital invested in managed futures funds is held in customer-segregated accounts, CFTC rules prohibit commingling of assets.
As for fees and minimums – The minimums on these accounts vary widely. Annual fees can be high, as high as 6-8%. (Returns are reported after fees are deducted, sales charges excepted.)
For serious investors only. Trading futures can involve considerable risks as well as considerable rewards, and you must recognize this if you direct part of your investable assets into a managed futures program. Futures markets tend to run in cycles, which is why many investors tend to hold their accounts for several quarters or longer. They understand this is not a short-term trading opportunity.
If you are seriously looking for a way to diversify your portfolio and improve its performance, then take a look at managed futures with your financial advisor. You may soon join the ranks of the savvy investors who are assigning slices of their portfolios to this alternative asset clas