Garnering increased attention for their potential to provide absolute returns, commodity trading advisors (CTAs) have enjoyed a recent spike in asset growth over the years. Today, managed futures programs are too prominent an asset class to remain the domain of institutional investors. Below is a primer designed to help investors navigate the complex landscape of managed futures as well as evaluate the merits of adopting them for portfolio diversification purposes.
What Are Managed Futures?
Simply put, managed futures are a set of strategies that trade futures contracts and options in financial instruments and physical commodities. Managers of these strategies are called Commodity Trading Advisors (CTAs), and money managers required to register with the Commodity Futures Trading Commission (CFTC) and National Futures Association (NFA) to manage or exercise discretion over customer accounts. The vast majority of CTAs – approximately two thirds – are systematic traders or trend followers, making extensive use of computer programs to forecast price direction and execute trades on various commodities, equity indices, or foreign exchange. Some CTAs rely on backward-looking and forward-looking signals to determine whether to buy or sell in certain markets, whereas others rely on relative price changes rather than directional trends. The number of trading strategies employed by managers have expanded greatly with the introduction of new trading technologies and methods of data analysis.
Managed Futures vs. Hedge Funds
Despite sharing numerous similarities with macro hedge funds, managed futures programs feature idiosyncrasies that are well worth understanding. To be fair, much of the confusion surrounding proper classification isn’t unwarranted, since both feature similar fee structures (2/20), tout non-correlation with traditional investments, follow trends, and often exploit fluctuating currency valuations. Consider famous examples such as Soros’ shorting of the British pound back in ’92, and in more recent news, a Carlyle hedge fund’s successful bet on the Chinese yuan’s devaluation. Neither were CTAs, but many of the tactics and instruments they employed overlap with those used by managed futures programs. Add to this the media’s frequent identification of managed futures as a subset of hedge fund strategies, and you have many reasons for conflating the two.
While some CTAs are indeed incorporated as hedge funds and exhibit characteristics associated with pooled investment vehicles, this is not always the case. One major structural difference between the two is that investors are able to invest in managed futures through individually managed accounts. In these instances, CTAs purchase securities on behalf of the individual investors, not on behalf of a fund. Thus, investors can specify whether to emphasize or exclude certain markets, view the trading activity of the account on a daily basis, and have much more control over the activities of the account. By extension, investors are able to liquidate their investments in as little as 24 hours, which may or may not be a significant benefit depending on the investor’s need for liquidity.
Additionally, as previously mentioned, CTAs offering managed futures programs are required to be registered with the CFTC and NFA, a requirement not imposed on hedge fund managers. As such, CTAs are subject to a unique set of rigorous reporting standards that ensure a degree of transparency to investors. That is not to say hedge funds lack reporting requirements altogether. Rules outlined in the Dodd-Frank Act impose reporting requirements to larger hedge funds that are registered.
The Managed Futures Industry Is Growing
The CTA industry has grown substantially in recent years, with assets under management jumping from $206 Bn in 2008 to just over $328 Bn in 2015 (YTD). Assets have grown nearly every year since 1980, when the managed futures industry stood at only $300MM.
The sudden growth from 2008 onwards can largely be attributed to the impressive performance of managed futures in 2008’s market crisis. Managed futures were up 14% according to the Barclay CTA Index when the S&P 500 suffered heavy losses. This did not go unnoticed by institutional investors, such as numerous pension and endowment funds, who began allocating to CTAs in 2009.
Benefits of Including Managed Futures in Investment Portfolios
Managed futures programs have demonstrated many appealing features, delivering good returns in bear markets and remaining resilient in periods of market turmoil. Certain key traits can explain why this may be the case. Unlike stock and bond trading, which seek to profit from upward trends, managed futures programs have the ability to go short and profit when asset prices are trending down. This ultimately contributes to potential for low correlations to other asset classes. Moreover, systematic CTAs are able to limit exposure to behavioral risk or fear-based selling since very little manual intervention affects the programs that are already put in place. Given the aforementioned characteristics and a historically low correlation with traditional assets, managed futures can be a potent portfolio diversifier for investors seeking well-balanced portfolios.
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