Managed Futures Funds Fly High
Managed futures funds outperformed hedge funds in 2008 and do well in times of unpredictable price swings because customized trading algorithms can react to market reversals that human traders may be slower to accept.
In 2008, one of the few bright spots in investments was the performance of managed futures funds. With more than $225 billion under management, the managed futures industry racked up gains of 13.9 percent in 2008, according to the Barclay CTA Index.
“Managed futures have delivered because they represent true diversification,” says Tom O’Donnell, first vice president of the alternative investments group at Newedge, the world’s largest futures commission merchant and a leading multi-asset broker. “Managed futures managers invest in a globally diversified portfolio of liquid, exchange-traded assets comprised of stocks, bonds, currencies and commodities. They’re not organized around the principles of buy-and-hold, or beta with leverage. These managers recognize that markets move in two directions, and they have the ability to invest long and short in order to profit from market trends.”
MANAGED FUTURES DEFINED
Managed futures funds – also known as commodity funds, commodity pools and commodity trader advisors (CTAs) – aggregate the monies of multiple investors for the purpose of taking a view on markets using futures and options. Their recent growth has been substantial. In 2002, more than $45 billion was estimated to be under management by managed futures trading advisors. Today, that number has grown to more than $225 billion. Most CTAs are less than $1 billion in size, though some are much larger. Among the sector’s leaders are Man Group, PLC, with $24.9 billion in assets under management; Winton Capital Management, with $13.3 billion; and Campbell & Co., with $4.7 billion as of fourth-quarter 2008.
Managed futures tend to be allocated broadly across asset classes. For example, at the end of 2008, the Winton Futures Fund projected risk was approximately 33 percent in commodities (crops, livestock, base and precious metals, energy sources), 16 percent in equity indexes, 22 percent in currencies, 17 percent in bonds and 12 percent in interest rates.
Managed futures traders generally fall into two primary categories: systematic and discretionary traders. Many systematic traders use proprietary trading systems to determine when to go long or short in anticipation of large directional moves or market reversals. Some systematic traders incorporate fundamental market data into their models while others favor a combination of the two methods. Discretionary traders tend to seek profit from spreading between different markets or different futures contracts in the same market. The majority of funds use fully automated technical trading systems based on a set of rules predefined by fund management.
MANAGED FUTURES' ROLE IN PORTFOLIO MANAGEMENT
Despite their overall success, managed futures are still dwarfed by hedge fund investments, which managed in excess of $1.5 trillion worldwide as of fourth-quarter 2008.
“In the hedge fund world, CTAs have often been viewed like an unwelcome guest at a party,” observes Robin Eggar, public relations manager at Winton Capital. “We are not glamorous or sexy or given to making headline-grabbing predictions. Partly, this is due to our intrinsic nature and partly to the requirements that come from being regulated.”
Ranjan Bhaduri, head of research for AlphaMetrix, a research and investment platform, believes there is a general misunderstanding of managed futures.
“Many institutional investors view CTAs as simply trend followers, which can have a big drawdown of 40 percent to 50 percent – sort of like wild cowboy trading,” says Bhaduri. “But they couldn’t be more wrong. CTAs have excellent risk controls, and investors in managed futures have the ability to select programs with volatility targets.”
The stabilizing capability of managed futures was perhaps best illustrated in a 1983 paper by the late Harvard Business School professor John V. Lintner. Lintner provided detailed evidence that, “...the combined portfolios of stocks (or stocks and bonds) after including judicious investments…in leveraged managed futures accounts show substantially less risk at every possible level of expected return than portfolios of stocks (or stocks and bonds) alone.”
A number of elements contribute to the stability of managed futures, including their non-correlation with other asset classes, as well as their liquidity and transparency.
“There are many different strategies in the hedge fund universe, ranging from very liquid to quite illiquid,” notes Elizabeth Flores, associate director, interest rate products at CME Group. “The most liquid would have to be futures funds because exchanges are open and ready to trade all day, every day.”
In terms of transparency, futures are marked to market by a clearinghouse, a neutral party, rendering all valuations public.
Another plus – there is virtually no counterparty risk. “The counterparty is the clearinghouse, which in the case of CME Group has operated for more than 100 years without a failure in the system,” notes Flores.
Many observers believe that CTAs are a must for large portfolios.
“I think every institutional investor has a fiduciary responsibility to consider managed futures,” says Bhaduri. “There are no valuation issues and their liquidity is strong. With the vast and growing marketplace of futures, CTAs are potentially an excellent way to achieve a superior risk-adjusted return.”
Back to Winter 2009 Issue Home 