· What is Managed Futures
· Benefits of Managed Futures
· Vision's CTA Website
Managed Futures study by:
Thomas Schneeweis - Professor of Finance, CISDM/SOM, University of Massachusetts
Georgi Georgiev - Ph.D. Candidate, CISDM/SOM, University of Massachusetts
The views expressed in this section are entirely those of Thomas Schneeweis and Georgi Georgiev. Three Lakes Trading Company has no affiliation with the authors.
Commissioned by Alternative Investment Management Association (AIMA)
‘The Benefits of Managed Futures’ (AIMA, 2002)
This research paper we conducted provides evidence that managed futures:
The term managed futures represents an industry comprised of professional money managers known as commodity trading advisors (CTAs) who manage client assets on a discretionary basis, using global futures and options markets as an investment medium. However, for managed futures to grow as an investment alternative, individuals need to increase their knowledge and comfort level as to the use of managed futures in their investment portfolios. Exactly, what are the benefits of managed futures as part of an investor’s overall asset portfolio? Basically, managed futures provide direct exposure to international financial and non-financial asset sectors while offering (through their ability to easily take both long and short investment positions) a means to gain exposure to risk and return patterns not easily accessible with investment in traditional stock and bond portfolios. Investors must come to appreciate that the investment benefits in managed futures are well-founded in financial theory and empirical evidence.
Futures
Futures and options have been used for centuries both as a risk management tool and return enhancement vehicle, yet managed futures, as an investment alternative, have been available only since the late 1960s. More recently, institutional investors such as corporate and public pension funds, endowments and trusts, and bank trust departments have been including managed futures as one segment of a well-diversified portfolio. As shown in Exhibit 1, the dollars under management for Commodity Trading Advisors in the Managed Futures sector has grown from less than $15 billion under management in 1990 to approximately $28 billion in 2001. Moreover, this number does not include the billions of dollars under management or in proprietary trading programs of major financial institutions which trade similar strategies but which do not report to traditional data sources.
1.This growth in investor demand for managed futures products indicates investor appreciation of the potential benefits of managed futures (e.g., reduced portfolio risk, potential for enhanced portfolio returns, ability to profit in different economic environments, and the ease of global diversification) as well as the special benefits that futures/options traders have in trading traditional asset classes (e.g., lower transaction costs, lower market impact costs, use of leverage, and trading in liquid markets). In addition, the market integrity and safety of trading on organized exchanges for futures/options contracts provide further assurances of investor safety.
Managed Futures: Risk and Return Performance
While CTAs have often been regarded as high risk investments, over the period 1990-2001 the average annualized standard deviations of individual CTAs and the Dow Jones 30 industrials were similar; that is, approximately 25%.2 More importantly, investment theory has shown that assets should be compared on a risk-adjusted basis (e.g., mean return/standard deviation). Also, the potential benefit of adding an asset to an existing portfolio may be measured by an asset’s excess breakeven return; that is, the difference between its actual return and the return required to improve an asset's or portfolio's Sharpe ratio.
More importantly, managed futures offer the investor an increased return to risk ratio when considered as an addition to widely diversified asset portfolios. When comparing portfolios, the Sharpe ratios of various portfolios we ran, which include at least a 10% investment in managed futures, dominate those that invest solely in traditional stock and bond investments or in stock/bond, and hedge funds.
Assets
The real benefit of managed futures is if they provide sources of returns that are uniquely different from traditional stocks or bonds or even hedge funds. For instance, hedge funds have been marketed as offering unique risk and return properties that are not easily available through traditional investment securities or investment products. These return opportunities stem from the expanded universe of securities available to trade and to the broader range of trading strategies. One reason for the supposedly low correlation and potential diversification benefit is that hedge funds often describe themselves as employing skill-based investment strategies that do not explicitly attempt to track a particular index.
Since their goal is to maximize long-term returns independently of a proscribed traditional stock and bond index, they emphasize absolute returns and not returns relative to a predetermined index. It is important to realize, however, that while hedge funds do not emphasize benchmark tracking this does not mean that their entire return is based solely on manager skill or is independent of the movement of underlying stock, bond, or currency markets. Hedge fund managers often track a particular investment strategy or investment opportunity. When appropriately grouped, these hedge fund strategies have been shown to be driven by the same common market factors such as changes in stock and bond returns or stock market volatility that drive traditional stock and bond markets.
In contrast, managed futures universe returns are not correlated with the stock and bond markets or changes in equity market volatility but track indices that reflect trend-following return patterns. Certain managed futures strategies, which are systematic and trend-following in nature, are highly correlated with simple passive trend-following indices. In contrast, managed futures programs that are not trend-following in structure are not correlated with these trend-following indices, such that diversification across trend-following and non-trend-following strategies may offer benefits.
The results of this study provide important information to the investment community about the benefits of managed futures. First, managed futures trade in markets which offer investors the same market integrity and safety as stock and bond markets. Managed futures investment, as for stocks and bonds, provide investors with the assurance that their investment managers work with a high degree of government oversight and self regulation and trade primarily in closely regulated markets. Second, managed futures are not riskier than traditional equity investment. Investment in a single commodity trading advisor is shown to have risks and returns which are similar to investment in a single equity. Moreover, a portfolio of commodity trading advisors is also shown to have risks and returns which are similar to traditional equity portfolio investments. Third, most traditional money managers (and many hedge fund managers) are restricted by regulation or convention to holding primarily long investment positions and from using actively traded futures and option contracts (which offer lower transaction costs and lower market impact costs than direct stock or bond investment). Thus, in contrast to most stock and bond investment vehicles, managed futures traders offer unique return opportunities, which exist through trading a wide variety of global stock and bond futures and options markets and through holding either long or short investment positions in different economic environments (e.g., arbitrage opportunities, rising and falling stock and bond markets, changing market volatility). As a result of these differing investment styles and investment opportunities, managed futures traders have the potential for a positive return even though futures and options markets in total provide a zero net gain among all market participants. Thus managed futures are shown on average to have a low return correlation with traditional stock and bond markets as well as many hedge fund strategies and to offer investors the potential for reduced portfolio risk and enhanced investment return. As important, for properly constructed portfolios, managed futures are also shown to offer unique downside risk control along with upside return potential.
Simply put, the logical extension of using investment managers with specialized knowledge of traditional markets to obtain maximum return/risk tradeoffs is to add specialized managers who can obtain the unique returns in market conditions and types of securities not generally available to traditional asset managers; that is, managed futures.
The views expressed in this section are entirely those of Thomas Schneeweis and Georgi Georgiev. Three Lakes Trading Company has no affiliation with the authors.
One must be aware that trading futures and options involves substantial risk of loss and is not suitable for all investors. Past performance is not indicative of future results and there are no guarantees of profit no matter who is managing your money. There is unlimited risk of loss in selling options. An investor must read and understand the current disclosure documents before investing.