What are managed Futures
The term managed futures describes an industry made up of professional money
managers known as commodity trading advisors (CTAs). These trading advisors
manage client assets on a discretionary basis using global futures markets as
an investment medium. Trading advisors take positions based on expected profit
potential.
Investment management professionals have been using managed futures for more
than 30 years. More recently, institutional investors such as corporate and
public pension funds, endowments and trusts, and banks have made managed futures
part of a welldiversified portfolio. In 2004, it was estimated that over $130
billion was under management by trading advisors.
The growing use of managed futures by these investors may be due to increased
institutional use of the futures markets. Portfolio managers have become more
familiar with futures contracts. Additionally, investors want greater diversity
in their portfolios. They seek to increase portfolio exposure to international
investments and nonfinancial sectors, an objective that is easily accomplished
through the use of global futures markets.
Four Benefits of Managed Futures
Managed futures, by their very nature, are a diversified investment opportunity.
Trading advisors have the ability to trade in over 150 different markets worldwide.
Many funds further diversify by using several trading advisors with different
trading approaches.
The benefits of managed futures within a wellbalanced portfolio include:
• opportunity for reduced portfolio volatility risk
• potential for enhanced portfolio returns
• ability to profit in any economic environment
• opportunity to participate easily in global markets
1. Reduced Portfolio Volatility Risk
The primary benefit of adding a managed futures component to a diversified investment
portfolio is that it may decrease portfolio volatility risk. This riskreduction
contribution to the portfolio is possible because of the low to slightly negative
correlation of managed futures with equities and bonds. One of the key tenets
of Modern Portfolio Theory, as developed by the Nobel Prize economist Dr. Harry
M. Markowitz, is that more efficient investment portfolios can be created by
diversifying among asset categories with low to negative correlations.
Table 1 compares the correlations between managed futures, bonds, and domestic
stocks from January 1995 through December 2004. As you can see, managed futures
are essentially uncorrelated to the other asset classes.
2. Potential for Enhanced Portfolio Returns
While managed futures can decrease portfolio risk, they can also simultaneously
enhance overall portfolio performance. For example, chart 1 shows that adding
managed futures to a traditional portfolio improves overall investment quality.
This is substantiated by an extensive bank of academic research, beginning with
the landmark study of Dr. John Lintner of Harvard University, in which he wrote
that "the combined portfolios of stocks (or stocks and bonds) after including
judicious investments... in leveraged managed futures accounts show substantially
less risk at every possible level of expected return than portfolios of stocks
(or stocks and bonds) alone."1
Table 2 shows that when viewed as an independent investment, managed futures
have compared favorably with U.S. stocks and bonds, as well as international
stocks, in 2003 and 2004. In addition, the potential for higher returns using
managed futures compares well with other asset classes in terms of risk. One
way to compare risk is to measure the magnitude of the worst cumulative loss
in value of an investment from any peak in performance to the subsequent low.
This worst-case, peak to valley scenario is called a drawdown in the futures
industry. Chart 2 shows that managed futures outperformed U.S. and international
stocks during the worst peak to valley drawdowns of the S&P 500(r), the
NASDAQ(r), and the MSCI(r) Europe, Australasia, and Far East (EAFE(r)) Index.
3. Ability to Profit in Any Economic Environment
Managed futures trading advisors can take advantage of price trends. They can
buy futures positions in anticipation of a rising market or sell futures positions
if they anticipate a falling market. For example, during periods of hyperinflation,
hard commodities such as gold, silver, oil, grains, and livestock tend to do
well, as do the major world currencies. During deflationary times, futures provide
an opportunity to profity selling into a declining market with the expectation
of buying, or closing out the position, at a lower price. Trading advisors can
even use strategies employing options on futures contracts that allow for profit
potential in flat or neutral markets.
4. Ease of Global Diversification
The establishment of global futures exchanges and the accompanying increase
in actively traded contract offerings (see table 3) have allowed trading advisors
to diversify their portfolios by geography as well as by product. For example,
managed futures accounts can participate in at least 150 different markets worldwide,
including stock indexes, financial instruments, agricultural products, precious
and nonferrous metals, currencies, and energy products. Trading advisors thus
have ample opportunity for profit potential and risk reduction among a broad
array of noncorrelated markets.
Most actively traded futures Contacts
Types of Investment Opportunities
According to the Barclay Trading Group, Ltd. in 2004, it was estimated that
over $130 billion was under management by futures trading advisors worldwide.
Currently, there are three primary categories of managed futures.
Individual Accounts are usually opened by institutional investors or
high net worth individuals. These funds usually require a substantial capital
investment so that the advisor can diversify trading among a variety of market
positions. An individual account enables institutional investors to customize
accounts to their specifications. For example, certain markets may be emphasized
or excluded. Contract terms may include specific termination language and financial
management requirements.
Private Pools commingle money from several investors, usually into
a limited partnership. Most of these pools have minimum investments ranging
from approximately $25,000 to $250,000. These futures partnerships usually allow
for admissionredemption on a monthly or quarterly basis. The main advantage
of private pools is the economy of scale that can be achieved for middlesized
investors. A pool also may be structured with multiple trading advisors with
different trading approaches, providing the investor with maximum diversification.
Because of lower administrative and marketing costs, private pools have historically
performed better than public funds.
Public Funds or Pools provide a way for small investors to participate
in an investment vehicle usually reserved for large investors.
Evaluating Risk
Participants in the Managed Futures Industry
There are several types of industry participants qualified to assist interested
investors. Keep in mind that any of these participants may, and often do, act
in more than one capacity.
Commodity Trading Advisors (CTAs) are responsible for the actual trading
of managed accounts. There are approximately 800 CTAs registered with the National
Futures Association (NFA), which is the self regulatory organization for futures
and options markets. The two major types of advisors are technical traders and
fundamental traders. Technical traders may use computer software programs to
follow pricing trends and perform quantitative analysis. Fundamental traders
forecast prices by analysis of supply and demand factors and other market information.
Either trading style can be successful, and many advisors incorporate elements
of both approaches.
Futures Commission Merchants (FCMs) are the brokerage firms that execute,
clear, and carry CTAdirected trades on the various exchanges. Many of these
firms also act as CPOs and trading managers, providing administrative reports
on investment performance. Additionally, they may offer customers managed futures
funds to help diversify their portfolios.
Commodity Pool Operators (CPOs) assemble public funds or private pools.
In the United States, these are usually in the form of limited partnerships.
There are approximately 1,500 CPOs registered with the NFA. Most commodity pool
operators hire independent CTAs to make the daily trading decisions. The CPO
may distribute the product directly or act as a wholesaler to the brokerdealer
community.
Investment Consultants can be a valuable institutional investor resource
for learning about managed futures alternatives and in helping to implement
the managed fund program. They can assist in selecting the type of fund program
and management team that would be best suited for the specific needs of the
institution. Some consultants also monitor daytoday trading operations (e.g.,
margins and daily marktomarket positions) on behalf of their institutional clients.
Trading Managers are available to assist institutional investors in
selecting CTAs. These managers have developed sophisticated methods of analyzing
CTA performance records so that they can recommend and structure a portfolio
of trading advisors whose historic performance records have a low correlation
with each other. These trading managers may develop and market their own proprietary
products or they may administer funds raised by other entities, such as brokerage
firms.
How the Fee Structure for Managed Futures Works
Total management fees in the managed futures industry tend to be higher than
those in the equities market. These fees, however, may be partially offset by
the lower commission costs for comparable dollar transactions in the futures
industry. While management fees do vary by the type of managed futures account
and may be negotiable, there is a general fee structure. Investors should understand
that performance information for a managed futures account or fund is almost
always expressed net of all such fees.
Typically, the trading advisor or trading manager is compensated by receiving
a flat management fee based on assets under management in addition to a performance
"incentive" fee based on profits in the account. The performance fee
is almost always calculated net of all costs to the account, such as management
fees and commissions. The performance fee is thus based on net trading profits,
which are usually paid only if the account or fund exceeds previously established
net asset values.
A few trading managers assume the "netting risk," whereby the performance
results of all trading advisors in the account are netted before the investor
is charged a performance fee. The trading manager assumes the netting risk by
paying each CTA according to his or her individual performance.
In addition to management and performance fees, an account or fund pays transaction
costs or brokerage commissions. These expenses reflect the cost of executing
and clearing futures and generally are calculated on a perroundturn basis.
Investor Safety Is Paramount in the Futures Market
Protecting the interests of all participants in the futures market is the responsibility
of exchange and industry members as well as federal regulators. Working together,
they ensure the financial and market integrity required by investors.
The Market Integrity of the CBOT...
A brief overview of the Chicago Board of Trade (CBOT(r)) and it's clearing service
provider will illustrate why the credit risk of exchange traded products is
minimal for futures investors.
CBOT rules and regulations are designed to support competitive, efficient, and
liquid markets. These rules and regulations are reviewed continuously by the
CBOT and are periodically amended to reflect the needs of market users.
Making sure that these trading practices and regulations are followed is the
responsibility of the CBOT's Office of Investigations and Audits (OIA). The
OIA staff works to prevent trading irregularities and investigate possible violations
of exchange and industry regulations. The activities of the department include
daily onsite surveillance of trading activity, continuous monitoring of member
firms' trading practices with stateoftheart technology, and prompt, thorough
investigations of any customer complaints.
...Combined with the Financial Integrity of Clearing
Clearing operations are another mechanism used by exchanges to uphold the integrity
of the futures markets. The clearing service provider (CSP) for the CBOT acts
as a guarantor to clearing member firms for trades it maintains, reconciles
all clearing member firm accounts each day to ensure that all gains have been
credited and all losses have been collected, and sets and adjusts clearing member
firm margins for changing market conditions.
The CSP settles the account of each member firm at the end of the trading day,
balancing quantities of contracts bought with those sold. In clearing trades,
the CSP substitutes itself as the opposite party in each transaction, essentially
eliminating counterparty credit risk. It interposes itself as the buyer to every
clearing member seller and the seller to every clearing member buyer and becomes,
in effect, a party to every clearing member transaction. Because of this substitution,
it is no longer necessary for the buyer (or seller) to find the original seller
(or buyer) when one wishes to offset a position. The market participant merely
executes an equal and opposite transaction, usually with an entirely different
party, and ends up with a net zero position.
One of the most important financial safeguards in ensuring performance on futures
contracts is the clearing margin, which clearing member firms must maintain
against their position in each commodity. These margins are set by the CSP margin
committee and governors. They are separate from the margins that individual
holders of commodities accounts are required to deposit with brokers by exchange
regulation.
The CSP settles its accounts daily. As closing or settlement prices change the
value of outstanding futures positions, the CSP collects from those who have
lost money as a result of price changes and credits the funds immediately to
the accounts of those who have gained. Thus, before each trading day begins,
all of the previous day's losses have been collected and all gains have been
paid or credited. In this way, the CSP maintains very tight control over margins
as prices fluctuate and ensures that sufficient margin money is on deposit at
all times.
For More Information about the Futures Market
The Chicago Board of Trade is dedicated to helping investors learn more about
the benefits of using the futures market. It thus offers a wide variety of educational
publications and research materials which can be reviewed and ordered online
at www.cbot.com.
For More Information about Managed Futures
Contact the sources listed here for information account, and other topics related
to managed futures.
Regulatory Agencies
Commodity Futures Trading Commission (CFTC)
Three Lafayette Centre 1155 21st Street, NW Washington, DC 20581 2024185000
/ Fax: 2024185521 www.cftc.gov
National Futures Association (NFA)
200 West Madison Street, Suite 1600 Chicago, IL 606063447 3127811300 / Fax:
3127811467 http://www.nfa.futures.org
Industry Associations
Managed Funds Association (MFA)
2025 M Street NW, Suite 800 Washington, DC 200363309 2023671140 / Fax: 2023672140
www.mfainfo.org
Reporting Services
Futures Industry Association (FIA)
2001 Pennsylvania Avenue NW, Suite 600 Washington, DC 200061807 2024665460 /
Fax: 2022963184 www.futuresindustry.org
Barclay Trading Group, Ltd.
2094 185th Street, Suite 1B Fairfield, IA 52556 6414723456 / Fax: 6414729514
www.barclaygrp.com
International Traders Research, Inc.
1020 Prospect Street, Suite 405 LaJolla, CA 92037 8584590818 / Fax: 8584590819
www.managedfutures.com
Mount Lucas Management Corporation
47 Hulfish Street, Suite 510 Princeton, NJ 08542 18005450071 www.mtlucas.com
Managed Account Reports (MAR)
1250 Broadway, 26th Floor New York, NY 10001 2122136202 / Fax: 2122131870 www.marhedge.com
Business Development
141 W. Jackson Boulevard Chicago, IL 606042994 3123417955 • fax: 3123413027
New York Office
One Exchange Plaza 55 Broadway, Suite 2602 New York NY 10006 2129430102 •
fax: 2129430109
Europe Office
St. Michael's House 1 George Yard London EC3V 9DH United Kingdom 442079290021
• fax: 442079290558
Latin America Contact
525556051136 • fax: 525556054381
www.cbot.com
(c)2005 Chicago Board of Trade. All rights reserved.
The information herein is taken from sources believed to be reliable. However,
it is intended for purposes of information and education only and is not guaranteed
by the
Chicago Board of Trade as to accuracy, completeness, nor any trading result,
and does not constitute trading advise or constitute a solicitation of the purchase
or sale of
any futures or options. The Rules and Regulations of the Chicago Board of Trade
should be consulted as the authoritative source on all current contract specifications
and
regulations.
"Dow Jones," "The Dow," "Dow Jones Industrial
Average," and "DJIA" are service marks of Dow Jones & Company,
Inc. and have been licensed for use for certain pur
poses by the Board of Trade of the City of Chicago, Inc. (CBOT). The CBOT futures
and futures options contracts based on Dow Jones' Indexes are not
sponsored, endorsed, sold, or promoted by Dow Jones, and Dow Jones makes no
representation regarding the advisability of trading in such products.
"Dow Jones," "AIG," "Dow JonesAIG Commodity Index,"
and "DJAIGCI" are service marks of Dow JonesSM & Company, Inc.
and American International Group, Inc. (AIG),
as the case may be, and have been licensed for use for certain purposes by the
CBOT(r). Futures based on the DowSM JonesAIG Commodity Index are not sponsored,
endorsed, or promoted by Dow Jones, AIG, AIG International Inc. (AIGI), or any
of their respective subsidiaries or affiliates, and none of Dow Jones, AIG,
AIGI, or any of
their respective subsidiaries or affiliates, makes any representation regarding
the advisability of investing in such product(s).
EM 352R2 11.01.10000 05110120
(c)2005 Chicago Board of Trade. All rights reserved.
Source: All material was copied from: Chicago Board of Trade. (2005) .CBOT Managed
Futures "Portfolio Diversification Opportunities" Chicago Board of
Trade. Located here: http://www.cbot.com/cbot/pub/page1/1,3248,1060,00.html
Other Referances:
1 Lintner, John, "The Potential Role of Managed Commodity Financial Futures
Accounts (and/or Funds) in Portfolios of Stocks and Bonds," Annual Conference
of Financial Analysts Federation, May 1983.
