In the past, managed futures investing has been associated with complex trading strategies, high fees, high minimums for investment and lockup agreements that resemble the unregulated hedge fund industry. Despite such obstacles, the managed futures industry has grown from virtually nothing in 1980 to more than $300 billion at the end of 2011.1 In recent years, the asset class and investment approach has started to become democratized in more retail-friendly vehicles. Today investors can access the benefits of managed futures by not only investing with the traditional commodity trading advisors (CTAs),2 but also by investing in mutual funds3 and exchange-traded funds.4
In this paper, we review some history of managed futures strategies, discuss the reason why investors have included them in their portfolios, and discuss the challenges and various solutions for crafting passive, rules-based benchmarks for measuring the returns of this investment approach.
Origins Of Futures Trading
Prior to the early 1970s, futures contracts exchanged hands principally as a means for producers and consumers of agricultural commodities to protect and lock in prices for their production or their supply. The history of futures contracts for hedging purposes is believed to date back thousands of years to the ancient city of Babylon where people exchanged contracts on livestock—goats, pigs, sheep and other items—to trade one good for another and lock in a set of prices for these goods.
The growth of futures trading expanded with the introduction of interest rate and currency trading that typified “financial futures” in the early 1980s. Now the markets are accessed by speculators, hedgers and investors alike in over 100 liquid markets ranging from equity futures, financial futures and commodity futures 24 hours per day. This rapid increase in trading instruments also gave birth to the CTA, or a third-party decision-maker who is charged with making buy or sell decisions on an investor’s behalf.
The term “CTA” tends to be vague, and the term “commodity” may not always accurately reflect the nature of the underlying securities in many of these strategies. Over time, the composition of CTAs has shifted; in the 1980s, agricultural futures represented about 64 percent of market activity, metals futures accounted for 16 percent, and currency and interest rate futures totaled approximately 20 percent.5 Today financial futures such as currencies, interest rates and stock indexes dominate trading in the global futures markets. CTA composition has also reflected this evolution, as many CTA portfolios are heavily invested in noncommodity-related futures contracts.
Benefits Of Incorporating Managed Futures In A Portfolio
As managed futures have grown in popularity, it is important to understand why many seek to diversify their traditional stock and bond portfolios to include this alternative asset class, including:
- Potential for returns in up and down markets: The flexibility and ease in taking long and short positions allows profit both from rising as well as falling markets.
- Noncorrelation to traditional investments: Returns of managed futures strategies have historically been noncorrelated to traditional stock and bond market returns over long-term periods.
- Enhanced diversification: The noncorrelation of managed futures, combined with their potential ability to provide returns during up and down markets, help provide enhanced overall portfolio diversification.
During the volatility experienced in the markets during the financial crisis of 2008, there were few asset classes that provided adequate desired diversification and negative correlation. Managed futures were one of the select areas that did provide that diversification potential. A growing number of retail-friendly vehicles like mutual funds and ETFs are making access to this once-institutional-only product set more easily attainable.