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GUEST ARTICLE: Improving The Odds With Managed Futures In An "Up And Down" World
Diane Harrison
21 March 2014
With uncertainty dominating world news and subsequent market reactions, investors are searching for ways to help them mitigate portfolio investment risk, says Diane Harrison. She believes that 2014 is going to present opportunities in a range of markets, and that it's become an up-and-down world that investors should embrace. This piece looks at how managed futures fit the bill for both retail and institutional players. Opinions are the author's, but Family Wealth Report is grateful for the right to publish them and welcomes reader responses. Harrison is principal and owner of Panegyric Marketing, a marketing communications firm founded in 2002 and specializing in the alternative assets sector. The use of alternatives has long been accepted by sophisticated investors as a proven way to help reduce overall portfolio risk over market cycles. Managed futures have always been central to this option, particularly when sharp volatility spikes drag traditional market classes down together. Yet the asset class remains somewhat of a mystery to many investors. They question how managed futures can provide a port in the storm during choppy markets. They have been led to be skeptics based on a general tendency of the media to focus its coverage on trend followers’ downside performance during the fiscal intervention years of recent past, and to exhibit a lack of emphasis on the benefits managed futures offer to investors through diversification and non-correlation. To achieve the benefits of managed futures, investors need to minimize the risks and do everything they can to improve their chances for success during difficult market conditions. Managed futures have low correlation to stocks and bonds, mainly due to equal facility in up or down market cycles. Here are some of the basic benefits that this strategy provides: - Able to achieve absolute returns: Commodity trading advisors, the professionals who trade managed futures, are comfortable trading both long and short markets, increasing the potential to profit from market moves in either direction and creating potential for absolute returns. CTAs can deliver absolute returns by buying futures positions in anticipation of a rising market or selling futures positions if they anticipate a falling market. They can also employ options strategies with futures contracts that allow for profit potential in flat or neutral markets. - Able to profit from rising or falling markets: Commodities markets often respond more strongly to supply and demand factors as primary drivers rather than macro factors such as a strong economy, credit conditions, or corporate profits. CTAs are also trading in highly liquid, well-regulated, exchange-traded instruments and foreign exchange markets, which allows for the portfolio to be “marked-to-market” daily. And unlike long-only commodity indices and commodity ETFs, which rely on the price of commodities rising, managed futures programs actively trade both sides of commodity price movements, allowing them to potentially perform whether commodity markets go up or down. - Able to offer protective stance during prolonged or severe market declines: History shows that managed futures are often one of the best performing assets during bear markets and financial crises. Participation across market categories and in the world’s largest and most liquid markets - Market diversification: Most managers trade across dozens or even hundreds of individual futures contracts to increase diversification. Due in part to its deep market penetration, the growth of managed futures has risen dramatically over the past decade. - Dynamic asset allocation: Most CTAs allocate dynamically across multiple asset classes – equities, commodities, fixed income, and currencies – aiming to deploy capital where they perceive the strongest opportunity. - Rising interest rates: Managed futures are one of the few strategies that can produce positive returns in both rising and falling interest rate environments. Investing in managed futures that include commodities and foreign currency participation can offset a portfolio’s losses produced in equities and bonds when inflationary pressures impact stocks and bonds, resulting in underperformance. With 2014 likely to be a pivotal year for the direction of interest rates, managed futures should be a key focus for consideration in portfolio management. A variety of strategies in which to participate in the global markets In addition to the deep market penetration, highly liquid and well-regulated markets, and the ability to profit in rising and falling markets that CTAs can take advantage of in managed futures, there are additional ways for investors to diversify among the trading advisors who offer managed futures strategies. Several of the most popular include: - Trend following: Managers in this category use quantitative systems and models to identify trends in financial and commodity markets. Most trend-following managers trade in over 30 different futures markets in all asset classes: equities, commodities, currencies, and fixed income. Trend followers historically have done well when stocks are down. In good times for managed futures overall, trend followers are often one of the best performing strategy groups. However, trend followers may experience large or sustained draw downs, and they typically have a relatively high correlation to one another. - Short-term trading: In the short-term, markets often experience less trend behavior and more mean-reversion. Also, market segmentation across time zones, with markets opening and closing across the globe at different times, can lead to a rich set of opportunities in addition to trend. Short-term managers tend to trade in ten or more of the most liquid financial futures markets: equities, currencies, and fixed income. Most short-term CTAs employ counter-trend and mean reversion trading, with holding periods from inter-day to two weeks in duration. These CTAs historically have exhibited low draw downs and volatility with demonstrated low correlation to other managers and strategies in managed futures. - Sector specialists: These managers offer focused participation with fundamental input in key markets or sectors . They often show low correlation to other managers and strategies, potentially providing excellent diversification benefits. - Discretionary and global macro: Often considered the broadest category of CTAs outside of trend followers, these managers analyze global factors and themes that are affecting the markets to formulate their strategy approach. They are well diversified across asset classes, conceptual investing themes, and trading time-horizons. They may offer superior return potential and attractive risk-adjusted returns. Managers typically rely on fundamental inputs which can be combined with technical analysis in this strategy. Discretionary and global macro CTAs traditionally exhibit low correlation to other CTAs as well. Assistance in taming the volatility that increasingly impacts the world markets Using managed futures can help investors improve their overall portfolio performance - particularly in a thoughtful and balanced way with a portfolio focusing on the three managed futures strategy groups that have a low correlation to trend following and to each other. Including managed futures within a portfolio can offer investors consistent returns, help to manage volatility, potentially constrain draw downs, and complement allocations to other assets. It’s an asset class well worth devoting time to understanding today and for the long term.