Whilst stock markets have failed to generate any real return in the last 10 years there is an asset class, Managed Futures, which has outperformed most other assets with greater levels of consistency and, in many cases, lower levels of volatility.  Managed Futures funds have not only generated above stock market return for the very wealthy, but also for retail clients who were lucky enough to have been introduced to this little known asset class.

Managed Futures refers to a 30-year-old industry made up of professional fund managers who are known as Commodity Trading Advisers.  Commodity Trading Advisers, or CTA's, manage their client's money using systems which they have developed themselves to make profits, from the market, on both upward and downward movements in various asset classes.

These systems are often know as proprietary and may be made up of many different further sub-systems. One very popular CTA has a multimillion dollar research facility at Oxford University that is dedicated to developing the very best Managed Futures trading systems.  There are also examples of funds that are made up of many different CTA's grouped together, of all whom trade Managed Futures.

So what is traded in such funds? The different asset classes include metals (gold, silver), grains (soybeans, corn, wheat), equity indexes (S&P futures, Dow futures, FTSE 100 futures), soft commodities (cotton, cocoa, coffee, sugar) as well as foreign currency and government bond futures. So nothing new in terms of the things they buy and sell. The important differentiating factor against say an index tracker fund is that the Commodity Trading Advisers, and the Managed Futures Funds which they manage, have the ability to make money whether the assets are going up or down in value.

Managed Futures have performed exceptionally well in comparison to other asset classes. If we look at the years from 1980 to 2010 managed futures, as measured by the CASAM CISDM CTA Equal Weighted Index, had a compound average annual return of 14.52 percent, while for U.S. stocks (based on the S&P 500 total return index) the return was 7.04 percent. In 2008, when the stock market lost 40 percent +, Managed Futures funds recorded strong growth for the same year with some generating returns of 50 percent or more.

Managed futures have historically displayed very low correlations to traditional investments, such as stocks and bonds. If we apply modern portfolio theory, this lack of correlation builds the robustness of the portfolio, reducing portfolio volatility and risk, without significant negative impacts on return.

So, how have Managed Futures performed, historically, during extreme market declines? Many of these funds performed well during the crash in 2008. However, their ability to make a profit in 'all weather' conditions can also be seen during previous market crashes. Furthermore, the drawdown period tends to be much shorter. If you take the MSCI World Stock Market Index, the index has been in drawdown (period of loss) for as long as five years. Now compare this with the majority of the best Managed Futures funds that have maximum drawdown periods of less than three years. Therefore, these funds not only have the potential to perform better but also recover quicker when they experience periods of drawdown.

Managed Futures can be a worthwhile part of an overall asset allocation plan; their purpose is to add portfolio diversification whilst potentially reducing volatility and increasing return compared to traditional investment portfolios alone that do not feature Managed Futures funds. A study by the Chicago Mercantile Exchange (CME) concluded that a portfolio with 20 percent Managed Futures has less risk than a portfolio of Stocks and Bonds alone. The point is that Managed Futures funds are able to profit in any economic situation.

How do CTA's charge their fees? Most will levy a management fee and a performance fee. The performance fee often has a ‘watermark' feature which means that the manager must continually exceed the previously reached performance level before he starts making a profit. This feature, common to most Managed Futures funds, is attractive to many investors. Unlike most other fund managers that make money whether they perform or not, the people who manage these funds only make a decent wad of cash for themselves when they make the investor money.

There has been a recent move, with some CTA's, to offer ‘structured' versions of their funds where there are capital guarantees in place which mean that you are guaranteed to get your capital back at the end of a defined period, even if the underlying fund manager should generate a negative return. Of course, you are still exposed to the risk of default from the issuer of said guarantee. Plus, if you only were to get your money back in say five years time, you have actually lost money in real terms due to inflation. However, such guarantees do offer clients the option to make an investment into an asset class that has the potential to generate, substantial, uncorrelated, return whilst defining an element of capital risk at the outset.

Like any other asset class, whether or not you should invest into Managed Futures is very much dependent on your individual circumstances. There is never a ‘one size fits all' approach to wealth management which is why you should always seek professional advice when deciding whether or not to make any type of investment. 

So, investing into Managed Futures is only for the very wealthy, right? Not at all! In fact, many investors will have Managed Futures funds within retirement investment portfolios where they may be investing as little as EUR 500 a month. In short, Managed Futures are for all.

 

Russell Hammond is an Investment Specialist and senior financial adviser for AES International advising clients worldwide.