Managed Futures Revolution

For many investors, the attractive potential returns possible in managed futures are reason enough to participate in them. However, there is another very important reason for participating in managed futures, and its foundation lies in the Modern Portfolio Theory. The premise of Modern Portfolio Theory is that the risk of an investment can be reduced, and performance increased, by holding a number of uncorrelated investments in different asset classes, which do not move in lockstep with each other. Futures fit this description. Futures are an asset class distinct and different from securities. Studies have shown the correlation between commodities and stocks and bonds to be low, making futures an asset class with which clients can possibly diversify an investment portfolio.

The appeal of futures' potential high returns and portfolio diversification lead to a phenomenon of amateur commodities traders. Studies show that the majority of these individuals lose. This is only natural: if a non-professional attempted to practice medicine or law, he or she probably would perform quite poorly, similar to many nonprofessional futures traders. Studies have also shown that professional Commodity Trading Advisors do experience an appreciably higher success rate than amateur traders. Numerous Commodity Trading Advisors use prudent money management to achieve potential returns.

For some reason these amateurs are willing to risk their money, although they would never agree to risk their health on an amateur doctor. From monitoring non professional traders who trade futures on their own, we have observed most trade on rumors, tips from friends, gut feelings, part-time research, and for the fun of it. But in futures trading there is a vast difference in performance between non-professionals and professionals. Futures trading requires full-time preparation, participation, study, focus, and natural aptitude. It should be no surprise, then, that in the highly complex and challenging field of commodity futures trading the majority of non-professional traders are not successful.

Characteristics of managed funds

* Returns are usually independent of U.S. stock and bond market trends
* Opportunity to participate in virtually all sectors of the world economy
* Flexible enough to potentially profit as easily in rising markets as declining markets (the potential for loss is, of course, also equal)
* Potential to perform well in both inflationary and deflationary periods
* Viability of managed futures is enhanced, given the trend towards globalization of world economies.
* Provide direct access to markets unavailable in traditional investment portfolios. These include:
* Currencies and Indices (Stocks & others)
* Credit Instruments and Petroleum Products
* Grains, Seeds, Livestock & Meats
* Food, Fiber and Metals

Reasons for growth of managed futures

A number of factors have been responsible for the growth in managed futures trading:
* Diversification: sophisticated investors have long sought more effective methods of diversification. With a low correlation with stocks, professionally managed futures can be an ideal asset class that may help diversify a securities portfolio.
* Scope: the expansion of futures to encompass stock indexes, debt instruments, currencies, and options as well as conventional commodities has created new categories of investment opportunities. The global nature of today's futures markets also has expanded the scope of investment possibilities.
* Profitability: managed futures accounts have proven to be considerably more profitable on the average than accounts that individuals trade on their own. Please note that there is substantial risk of loss in trading futures, regardless of who is managing your money.
* Stability: the addition of managed futures can potentially increase performance and reduce volatility when added to a portfolio of stocks and bonds. In my experience, futures can be a good addition to manage the risk in an overall portfolio.

Futures' ability to enhance an overall stock and bond portfolio was documented by the prestigious investment banking firm of Goldman Sachs. In their study, conducted over a twenty-five-year period, they concluded that by allocating only 10% of a securities portfolio to commodities, investors can improve their portfolio’s performance. Based on this research, Goldman Sachs recommends that futures be included in their clients' investment portfolios.

Additional evidence of the value of futures in a stock portfolio can be seen when comparing four of the major advances and declines in the S&P 500 with the corresponding futures performances over the past twenty-five years. During each advance in the S&P, futures were positive. However, during all of the S&P's largest declines, futures were also positive. In fact, in all but one decline in the S&P, the advance in futures completely offset the loss in the S&P 500.

Profit opportunities in falling markets

In the month of October 1987 the world equity markets suffered devastating losses while managed futures had a strong positive return. Despite this fact, many people are still unaware of the opportunity offered by the futures markets to earn potential returns by selling futures contracts in falling markets.
This is made possible by the counter-intuitive action of selling now and buying later, which increases the number of trading opportunities with managed futures.
During periods of declining market prices, funds that only contain asset classes such as stocks and property can, at best, preserve their capital by converting to cash. However, this is often made difficult due to low liquidity, falling prices, high transaction costs and regulatory restrictions. During these same periods in the markets the usual low correlations between traditional asset classes disappeared. This is yet another benefit of investing in managed futures.
The value of including futures in an overall investment portfolio can best be summed up by the Chief Executive Officer of Harvard Management Company, Jack Meyer, who manages Harvard University's huge pension fund. He was quoted in a November 1996 Wall Street Journal article as saying, "holding commodities offers protection against the ups and downs of stocks and bonds". Referring to commodities, he added, "they're the most diversifying asset in the portfolio."

A December 2, 1996 article in Baron's had the following to say about Harvard Management Company's Chief Executive Officer:
"In the months after arriving from the Rockefeller Foundation back in 1990, one of his biggest decisions was to settle on diversification as a key theme. Relying on techniques of modern portfolio theory to get the best returns with lowest level of risk, Harvard needed to cut its exposure to publicly traded U.S stocks and bonds, and increase its investments in foreign stocks, commodities and private companies. The result: right now the Harvard endowment has about only half its portfolio in U.S. stocks and bonds, versus about 75% for the typical university endowment". Harvard Management Company's Chief Executive was quoted in the article as saying, "the benefits of diversification are indisputable. Diversification rules. It's powerful and our portfolio is a good deal less risky than the S&P 500".

*Studies have shown that professional CTAs do experience returns greater than the individual investor. Nevertheless, the risk of loss exists in futures trading and past results are not necessarily indicative of future results regardless of who is managing your money. Before investing in any managed futures program, you should carefully review the CTA's disclosure document.