Managed Futures

What are they? Why do people invest in them?

 

Ask an investor about managed futures, and you might draw a quizzical look or a blank stare. However, more investors are starting to look into them. Why? The average managed futures program returned 14% in 2008, as stocks lost 37%.¹

The basics. In simple terms, a managed futures account is like a mutual fund, except its positions are in government bonds and notes, futures contracts, and options on futures contracts. A special kind of professional money manager – a commodity trading advisor, or CTA - oversees the account.²

CTAs have to pass FBI background checks and register with the Commodity Futures Trading Commission (CFTC), a federal entity. A private industry watchdog group called the National Futures Association also patrols their behavior. All this oversight is reasonable, as CTAs take discretionary control of invested assets.³

When the market turns mediocre, managed futures intrigue. Have you heard of negative correlation? When stocks tank, some other asset classes tend to perform better. Managed futures follow this tendency.

While stocks and bonds may underperform when inflation accelerates, managed futures programs with positions in precious metals futures and foreign currency futures may perform comparatively well.

Just how well has this asset class performed? Historically, the answer is … well enough. Between 1993 and 2002, managed futures returned 6.9% annually (this is a compound average annual return) versus 9.3% for stocks and 9.5% for Treasuries.³ In 2008, they left equities in the dust.

More importantly, during a 23-year window, the risk-adjusted returns didn’t vary as much. Between January 1980 and 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.³

The picture looks very rosy out the 30-year window. 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 stretch.¹

While returns have been higher recently, fees could be lower. Annual fees on managed futures accounts can be as high as 6-8%.¹ (Returns are reported after fees are deducted, sales charges excepted.) A mutual fund would never put investors through fees like these – not yet, anyway.

 

When things roll, profits roll in. When they don’t, a managed futures fund might not perform so nicely. The CTAs in charge of these accounts look for a positive roll return – the chance to sell last month’s futures contract for more than the cost of next month’s contract. When the roll return turns negative, the performance of the fund may be hurt.¹

 

These caveats aside, when stocks are underwhelming, managed futures gain considerable appeal. Are they for you? Should they be part of your diversification strategy? Talk to a financial advisor who understands them to find out more.

 

Citations.

¹ online.wsj.com/article/SB124242429895325075.html     [5/16/09]