Demand for managed futures is soaring as investors, stung
by losses from equities during the bear market and attracted
by historically high returns from the strategy, stream into
alternative investments to pep up their portfolios and diversify
Total assets in managed futures have more than doubled since
the end of 2002, rising from US$ 50.1 billion to US$ 104.6
billion on 31 March 2004, according to data from Barclay Trading
Group. In the first quarter of this year alone, assets in
managed futures rose by US$ 18.1 billion, or 20.9%, with a
lot of that new capital coming from traditionally conservative
The idea of using managed futures, or even alternative investments,
to improve the risk and return characteristics of an investment
portfolio would have found little support a decade ago. Today,
however, investors have come to recognise that a disciplined
approach to portfolio construction can enable statistically
predictable risk-adjusted returns to be generated from investment
Also known as Commodity Trading Advisors (CTAs), managed
futures are a pool of futures or forwards contracts managed
by professional money managers. They are similar to a mutual
fund, in that individual or institutional investors have a
share, only the investments in this case are mainly futures
contracts. Unlike basic securities such as stocks and bonds
which are held within mutual funds, a future is a derivative
instrument, one whose value depends on the value of an underlying
Managed futures provide direct exposure to international
financial and non-financial asset sectors. Trading advisors
have the ability to trade in over 100 different markets worldwide.
These markets include interest rates, stock indexes, currencies,
precious metals, energies and agricultural products. Managed
futures tend to have a low correlation with traditional investments.
In contrast to traditional hedge funds, the futures markets
offer greater regulation, transparency and liquidity.
They also have traditionally offered high returns, with a
commensurate degree of risk, as the tables below demonstrate.
| Managed Futures Snapshot (Jan 1987 - Dec 2003)
|Compound Annual Return
|Correlation vs S&P 500
|Correlation vs US Bonds
|Correlation vs World Bonds
|Source: Barclay Capital Group
|The performance of managed futures: 1980 to 2004
YTD performance for 2004 calculated with reported data as
06:23 US CST
Source: Barclays Capital Group
Futures investments benefit from the ability to diversify,
very broadly, by sector and by geography. A key step in constructing
a futures fund is the careful selection of the markets to
be included in the fund portfolio. The greater the number
of markets traded, the greater the portfolio diversification
and thus the potential for enhanced risk-adjusted returns.
The growth in the number and liquidity of futures markets
has made it possible to avoid over-concentration in any market
sector. It is worth adding that certain markets, such as stock
indices, can only be accessed via futures and related derivatives
Exposure across the full range of market sectors reduces
risk because it helps to smooth out peaks and troughs in performance.
This is due to the tendency of markets in different sectors
to exhibit broadly different behavioural characteristics.
Growth in Rising and Falling Markets
A second advantage offered by futures funds is the potential
to generate profits in many market environments. This relates
to the fact that in futures markets it is possible to sell
short contracts as well as buy them, thus being able to profit
in falling markets. In physical markets it is often difficult,
or even impossible, to sell assets you do not own, necessitating
a more traditional 'buy and hold' approach that is dependent
on bull markets to return profits. In addition, by applying
specialised strategies to the trading of futures markets,
investment managers are able to generate profits when markets
are rangebound or moving sideways or, indeed, choppy and volatile.
Low Correlation with Traditional Investments
A further advantage of managed futures investments is their
potential to show low correlation with traditional investments,
thus enable combined portfolio of managed futures and traditional
investments achieve improved risk return characteristics.
Futures markets are linked to their underlying assets - be
they stocks, bonds, currencies or commodities - and there
is no escaping the correlation between price movements in
the futures contracts and those in the underlying assets.
But what is important is the approach to investing in the
Because managed futures provide an opportunity to profit
from both upward and downward directional moves in the underlying
assets, it is possible to achieve a low level of correlation
with traditional forms of investment. In other words, the
performance of managed funds need not be tied directly to
the price movements of the underlying assets being traded.
Correlation is also an important issue in combining constituent
markets (and strategies) in a judicious way to form an investment
portfolio. Careful calculation of the correlation of each
market traded can ensure that no highly correlated sectors
are given too great a weighting in the overall portfolio.
Excess risk is also kept to a minimum by constantly measuring
the volatility of each market in the portfolio and adjusting
positions accordingly. The intention is to keep within target
levels of risk capital for each market traded as well as for
the portfolio as a whole. Typically, as a market becomes more
volatile, exposure to that market is reduced. Thus the unit
of risk for each market is kept fairly constant and the risk
attached to the portfolio as a whole stays within predefined
An important feature of futures markets is the fact that
they are traded using margin deposits. This enables the creation
of an important class of investment vehicles that guarantee
the return of at least the initial investment capital at maturity.
Many investors have found these structures very attractive
as the guarantees can be constructed in such a way as to have
no impact on performance potential.
In futures markets, traders only need to deposit a comparatively
small proportion of capital (margin) in order to take positions.
Margin acts as a security deposit called in by the exchange
clearing house to protect all parties from the effect of default.
The amount of margin required relates to the worst probable
loss on a position in one day and will vary subject to market
volatility. Trading on margin makes it possible to leverage
futures: for a low outlay it is possible to gain a large exposure
to the asset being traded.
Since the capital exposure to the markets required is relatively
low, a properly constructed futures fund can be positioned
to achieve its target performance whilst still carrying a
reasonably high proportion of cash. In open-ended funds (no
specified maturity date), this is placed in short-term deposits
whose yield enhances performance. In so-called 'guaranteed
funds' typically, some of the cash is invested in secure longer-term
highly-rated securities (such as zero coupon Treasury bonds)
whose maturity dates match those of the fund and thereby underpin
Futures investments offer diversification by sector, geography
and trading approach. They are able to profit in most market
conditions and show little correlation to traditional investments.
Because of these valuable features, futures investments are
today playing an increasingly important role in improving
the performance characteristics of a wide range of investment