Why managed futures

Initial methods of extracting alpha by managed futures firms involved purchasing or selling a specific market instrument once a particular market high or low was reached.

The initial approaches were based on the observation that markets often move with momentum that can continue in a particular direction. Over time, original break-out strategies developed into more sophisticated approaches.

Trend-following strategies based on break-out and momentum concepts continued to evolve with the introduction of volatility filtering, risk budgeting, and more dynamic time-frame selection. In addition, some managers began to develop non-long-term trend concepts and employed more than just technical data in their systems.

Often opportunities for managed futures traders have historically come in periods that have proved difficult for conventional asset classes and other alternative investments.

Managed futures characteristics Managed futures investments offer a number of beneficial characteristics for investors. These benefits stem from both the investment strategies employed and the attributes of the underlying futures and foreign exchange instruments held.

Non-directionality The ability to generate investment gains in rising or falling market environments is referred to as non-directionality. Futures markets were created to allow market participants to enter long or short positions based on their hedging or speculative needs with equal ease.

As a result, managers can profit with equal opportunity from the increase or the decrease in the price of an asset. Unlike the securities world, a managed futures programme is free from the dual burden of up-tick rules and the need to borrow the underlying when shorting.

Also unlike equities, the margin required for a short position is the same as the margin required for a long position. The ability to profit equally from long or short positions, without the restrictions or additional costs, is one of the key attributes of managed futures.

Non-correlation Managed futures historically have exhibited low correlation to traditional investments and other alternative asset classes.

Further, they can go long or short without any funding or exposure constraints. Relative to equities, managed futures have exhibited a measurable negative correlation in equity bear markets, and a positive correlation or non-correlation in equity bull markets.

Overall, there has been non-correlation to equities as the net average correlation is near zero. The often timely negative correlation of managed futures to equities is summarized in Fig. Some of the most difficult periods for equity markets have corresponded with positive performance realized by managed futures.

Over extended periods of rising or falling equity markets, managed futures managers will often profit from the prevailing trend. Profiting from a trend in a falling equity market drives the timely negative correlation. A type of quant strategy, managed futures employs trend-following across asset classes. In contrast, momentum investors seek positions in securities that have moved in one direction for a period of time — either up or down.

They join the trend, taking long positions in assets that are going up in price, and short positions in assets whose prices are declining. Momentum investors use quantitative signals to define when securities are trending.

Often, these signals compare the current spot price of an asset to the trailing historical moving average of the price. If the spot price is above the moving averages, then the security is in an uptrend, and vice versa. While most managed futures strategies focus on time series momentum, there are different types of momentum strategies:.

A well-studied anomaly in academic literature, beginning with Jegadeesh and Titman, , 1 momentum is a recognized phenomenon across global asset classes. And in practice, it has worked remarkably well over long periods of time, generating positive returns with low correlations to stocks and bonds, and especially strong positive returns during equity bear markets.

But if everyone knows about it, why does it work? There are some interesting behavioral reasons that are thought to cause momentum to persist over time and across asset classes:. While all managed futures strategies focus on quantitative trend-following, not all trend-following strategies are designed the same. S government bond futures.

In the past several years, money invested in managed futures has more than doubled and is estimated to continue to grow in the coming years if hedge fund returns flatten and stocks underperform. One of the major arguments for diversifying into managed futures is their potential to lower portfolio risk. Such an argument is supported by many academic studies of the effects of combining traditional asset classes with alternative investments such as managed futures.

John Lintner of Harvard University is perhaps the most cited for his research in this area. Taken as an alternative investment class on its own, the managed-futures class has produced comparable returns in the decade before For example, between and , managed futures had a compound average annual return of 6.

Treasury bonds based on the Lehman Brothers long-term Treasury bond index. In terms of risk-adjusted returns , managed futures had the smaller drawdown a term CTAs use to refer to the maximum peak-to-valley drop in an equities' performance history among the three groups between January and May During this period managed futures had a An additional benefit of managed futures includes risk reduction through portfolio diversification by means of negative correlation between asset groups.

As an asset class , managed futures programs are largely inversely correlated with stocks and bonds. For example, during periods of inflationary pressure, investing in managed futures programs that track the metals markets like gold and silver or foreign currency futures can provide a substantial hedge to the damage such an environment can have on equities and bonds.

In other words, if stocks and bonds underperform due to rising inflation concerns, certain managed futures programs might outperform in these same market conditions. Hence, combining managed futures with these other asset groups may optimize your allocation of investment capital. Before investing in any asset class or with an individual money manager you should make some important assessments, and much of the information you need to do so can be found in the CTA's disclosure document.

Disclosure documents must be provided to you upon request even if you are still considering an investment with the CTA. There are largely two types of trading programs among the CTA community. One group can be described as trend followers, while the other group is made up of market-neutral traders, which include options writers. Trend followers use proprietary technical or fundamental trading systems or a combination of both , which provide signals of when to go long or short in certain futures markets.

Market-neutral traders tend to look to profit from spreading different commodity markets or different futures contracts in the same market. Also in the market-neutral category, in a special niche market, there are the options-premium sellers who use delta-neutral programs.

The spreaders and premium sellers aim to profit from non-directional trading strategies. Drawdowns: Whatever type of CTA, perhaps the most important piece of information to look for in a CTA's disclosure document is the maximum peak-to-valley drawdown. This represents the money manager's largest cumulative decline in equity or of a trading account. Discretionary trading relies on the judgement of the manager and their expertise within a particular market to make investment decisions.

The more prevalent systematic approach relies on the application of technical analysis to evaluate the movements of markets, such as changes in price and volume. The trading is based on the systematic application of quantitative models that use moving averages, break-outs of price ranges, or other technical rules to generate buy and sell signals for a set of markets.

This tends to be automated, particularly with the emergence of electronic trading systems. In general, most managed futures managers tend to view price trends as a function of supply and demand for a particular commodity or financial instrument.

As the interaction of these elements form continuous market movements they try to capture profits. In short, managed futures managers attempt to identify the beginning of a trend, take a position and exit it as it ends. Protective stops can be adjusted daily and more positions might be built up if the trends are stable, or quickly reduced during adverse or highly volatile periods.

Also the amount of risk on groups of related markets and on the total portfolio can be controlled. Further risk reduction is achieved by means of market diversification. Managed futures investments can benefit from the application of a range of trading systems or investment strategies, such as systematic, arbitrage, and spread trading strategies. Investment approaches can also be differentiated by trading frequency and duration.

The developments over the last twenty years have made managed futures a specialised but increasingly significant asset class within the investment industry. Importantly, high quality managed futures funds are capable of achieving attractive returns with risks comparable to those of a traditional stock investment.

Furthermore, managed futures can enhance the diversification of a portfolio and therefore play an important role in improving the risk and reward characteristics of that portfolio. Potential impact of adding managed futures to a traditional portfolio 1 January to 28 February There is no guarantee of trading performance and past performance is not necessarily a guide to future results.