What are managed futures?

Managed futures are an alternative investment where professional managers oversee a portfolio of futures contracts. They’re often used by large funds and institutional investors to achieve portfolio and market diversification.

Managed futures provide exposure to asset classes that often have low or inverse correlation with traditional investments like stocks and bonds. This gives them the potential to lower overall portfolio risk and enhance potential returns when used in addition to stocks and bonds.

One of the key features of managed futures is that they can take both long and short positions, allowing them to capitalize on market trends in either direction. This flexibility, combined with their transparency, diversification, and liquidity, makes managed futures an ideal tool for managing overall portfolio risk.

Managed futures can provide an alternative to traditional hedge funds.

How do managed futures work?

Managed futures involve professional managers actively trading a diversified portfolio of futures contracts across various markets, including commodities, energy, agriculture, or currencies.

Most managers have a stated trading program that guides their market approach. Two common approaches are the market-neutral strategy and trend-following strategy:

Market-neutral strategy

The market-neutral strategy seeks to minimize market risk and volatility by taking matching long and short positions within the same industry or market. For example, a manager might go long on undervalued stocks while shorting overvalued ones. These strategies aim to generate returns by exploiting price differences (arbitrage) due to perceived mispricing.

The success of a market-neutral approach relies on the portfolio manager’s ability to identify mispriced assets and maintain zero beta exposure to the overall market. The ultimate goal is to profit from both increasing and decreasing prices.

Trend-following strategy

The trend-following strategy seeks to capitalize on market momentum. Portfolio managers analyze various indicators or technical market signals to identify upward or downward price trends. Execution of trades is then based on these signals.

For example, when an asset shows an upward trend, managers might take a long position. If an asset’s price is trending downward, they might enter a short position on that asset.

The role of Commodity Trading Advisors (CTA) and Commodity Pool Operators (CPOs) in managed futures

As we have learned, managed futures refer to a professionally managed portfolio of diversified futures contracts. These professional managers are called Commodity Trading Advisors (CTAs).

Commodity trading advisors (CTAs)

CTAs are professional asset managers who are responsible for actually trading managed futures. While traditional money managers focus on stocks or bonds, CTAs specialize in trading futures contracts. They are members of the National Futures Association (NFA) and required to register with the Commodity Futures Trading Commission (CFTC) to promote transparency and regulatory compliance.

Commodity pool operators (CPOs)

CPOs are responsible for managing commodity pools – collective investment vehicles that pool funds from multiple investors to trade in futures and other derivatives. They employ CTAs to execute trading strategies for their pools, often combining the expertise of multiple CTAs to diversify management styles and market exposure.

What’s the difference between managed futures and hedge funds?

Managed futures are similar to hedge funds, however they differ in terms of focus and strategy. Managed futures generally only trade in exchange cleared futures, options on futures, and forwards markets. They are highly liquid, transparent, and regulated.

Hedge funds, on the other hand, trade in various markets, including fixed income derivatives, over-the-counter (OTC), and individual equity.

What are the benefits of managed futures investments?

Managed futures offer a range of potential benefits for investors, including reduced overall portfolio risk, low correlation with equities, diversification, and transparency amongst others.

Reduced risk

When combined with traditional investments like stocks and bonds, managed futures have the potential to reduce overall portfolio risk. This is achieved by investing across a range of global markets with low correlation to traditional asset classes. Managed futures have historically performed well during adverse market conditions and can offer downside protection when considered in the context of a traditional portfolio.

Non-directionality

While stocks rely on increasing prices to generate profits, managed futures can generate returns whether markets are going up or down. This ability to achieve profits from both rising or falling prices is known as non-directionality.

Futures contracts allow managers to take long (expecting prices to rise) or short (expecting prices to fall) positions relatively easily, often without restrictions or additional borrowing costs. For example, unlike traditional securities, managed futures are free from up-tick rules and don’t require managers to borrow the underlying stock when shorting. The margin is also the same for both long and short positions.

These features provide an opportunity to benefit equally whether an asset’s price increases or decreases.

Low correlation with traditional assets

Managed futures often exhibit low correlation to traditional investments, like stocks and bonds, and other alternative asset classes, such as hedge fund strategies. This is because CTAs can enter long or short positions across a wide range of markets, such as equity index, commodities, foreign exchange, and fixed income, without taking on any systemic exposure to beta.

This lack of correlation can provide a cushion during periods when traditional assets underperform, reducing the likelihood of all investments losing value at the same time.

Diversification opportunities

Managed futures can provide diversification on a number of levels. Firstly, they can be traded in more than 150 global financial and commodity markets, including agriculture, metals, energy, currencies, and financial instruments like stock indices, offering the opportunity to potentially profit from various non-correlated markets.

Secondly, investors can further diversify by investing in managed futures that employ various differentiated systematic and discretionary strategies. For example, some may follow mean-reversion while others pursue macro-fundamental approaches. Many managed futures firms will combine multiple strategies to spread risk and reduce dependency on a single market or approach.

High liquidity

Managed futures are traded in some of the most liquid markets in the world, which means there’s almost always someone ready to buy or sell. This allows managers to enter or exit positions quickly and frees investors from the typical lock-up provisions of other alternative investments, like many hedge fund strategies.

Most managed futures funds offer daily or monthly liquidity, providing investors with more control and easier access to their funds when needed.

Transparency

Futures contracts are traded on public exchanges with prices updated in real-time, which allows for contract values to continuously be tracked. The managed futures industry is also subject to regulations, which enhance accountability and transparency.

With traditional funds, such as mutual funds or hedge funds, the level of transparency is typically determined by the fund manager and is often limited. This can leave investors with less insight into the fund's specific holdings or strategies.

Managed futures accounts, on the other hand, offer complete transparency so investors can stay fully informed about the status and value of their accounts. This transparency provides greater control and peace of mind, as investors know exactly what is happening with their investments.

Cash efficiency

Futures contracts trade on margins which typically range from 5% to 15% of the contract’s value. For example, an investor might only need $5,000 in cash to secure a $100,000 futures position (total contract value). This concept provides the investor greater cash efficiency, by allowing managers to maximize exposure while preserving liquidity and avoiding borrowing costs.

In contrast, many investment strategies, such as hedge funds, use leverage to potentially enhance returns. These strategies often involve less liquid assets, incur borrowing costs, and lack transparency. Managed futures, on the other hand, provide investors with the benefits of cash efficiency while avoiding the costs and risks associated with borrowing capital. This enables investors to increase exposure without the borrowing costs typical of other alternative investments.

Who is eligible to participate?

Managed futures aren’t your typical investment vehicle; they’re designed with more experienced investors in mind. In most cases, you’ll need to meet certain eligibility requirements to participate, especially when investing directly with a CTA or through a managed account.

In the US, this usually means being an accredited investor or a qualified eligible person (QEP). These terms generally apply to individuals with a high net worth, significant income, or a strong background in investing. These rules are in place because managed futures can be complex and involve a higher level of risk compared to traditional investments like stocks or mutual funds.

There’s also the question of how much you need to get started. Many CTAs have a minimum investment requirement of $100,000, though this can go much higher for larger or more exclusive programs. Some institutional-level managers may ask for several hundred thousand dollars or more to join.

That said, there are more accessible options out there. If you’re interested in the potential benefits of managed futures but don’t meet the requirements for direct investment, you can explore publicly available mutual funds or ETFs that follow similar strategies. These are often designed for retail investors and usually have much lower minimums, sometimes just a few thousand dollars or even less.

In short, managed futures are best suited for those who understand the risks and are prepared to meet the entry requirements. But thanks to newer investment products, it’s easier than ever to find a way in that fits your financial situation and comfort level.

This material is for informational purposes only and should not be considered as an investment recommendation or a personal recommendation.