Managed futures have been one of the fastest-growing alternative asset classes. As of December 2010, $266.8 billion was invested in the space, a more than tenfold jump since 1994. But many investors-and their advisors-are on a learning curve when it comes to deploying them in portfolios.
At a panel discussion on managed futures at Financial Advisor and Private Wealth magazines' 2nd Annual Innovative Alternatives Strategies conference in Chicago, a trio of executives talked about the best ways to deploy this strategy in client portfolios.
Managed futures are programs run by commodity trading advisors (CTAs) who are registered with the Commodity Futures Trading Commission. They manage client assets in proprietary programs that trade an array of futures contracts in hard and soft commodities, equity indexes, currencies and other assets.
Managed futures shined during the 2008 meltdown, as the industry's various indexes gained around 18% to 20% while the S&P 500 slumped 37%. The beauty of this asset class, proponents say, is that it invests in areas that have low correlation to traditional assets, such as stocks and bonds, to provide diversification to help mitigate investment risk.
"The amount of diversification within the managed futures space is huge," said Brian Bell, research director at alternative asset manager Equinox Fund Management LLC. "We recently looked at the correlation of all of the managers in our products and found that 80% of them have daily correlations to each other of less than 0.4%."
Bell said that since 1980 there have been 33 months when the S&P was down 5% or more, and during 79% of those months managed futures had positive performance.
"Managed futures should be a permanent part of a portfolio because we don't know when those months will occur," he continued. "They tend to perform better in times of economic calamity."
Bell addressed near-term events that could turn bad and negatively impact investment portfolios such as problems in Greece, out-of-control U.S. federal debt, dead lock in Washington, and the like. "I encourage you to think of these things and look at how managed futures have done during other bad economic times," he said.
Bell said volatility within the managed futures space has decreased during the past 30 years as more institutional money has entered the space. He added that volatility has come down as CTAs have become more sophisticated with their risk control.
Brad Weltler, regional director at Steben & Co., says managed futures' 30-year track record shows they have a positive impact on reducing portfolio volatility.
"There's a misperception about managed futures regarding the underlying risk," said Weltler, whose company specialized in managed futures funds. "That's not to say there hasn't been volatility, but over time it's proven to be a successful component of a portfolio."
Weltler noted that the managed futures universe consists of two types of managers: systematic or discretionary. "Discretionary managers use their emotions of where they expect gold to be or what [Federal Reserve Chairman Ben] Bernanke will do with interest rates, and then will build portfolios around that," he said.
Systematic managers want to back test models looking for identifiable trends in the marketplace. They're purely reactive, and Weltler said 90% of all managers fall into the systematic category.
He said his company looks at systematic managers that'll trade all sectors of futures contracts-from currencies and interest rates to financial futures and physical and agricultural commodities. And the portfolios that Steben constructs for advisors have between 60% to 70% in financials and 30% to 40% in physicals.
But while managed futures were stellar in 2008, they trailed equities by a mile when the markets recovered in 2009. As a result, Weltler says advisors need to understand how managed futures work over time and how they can play a long-term role in client portfolios.
"One of the struggles of managed futures is keeping people in the strategy when we're not performing at the peak when other assets might be," he said. "2008 was obviously a great sales year for all of us in the space, but we lost money in 2009 when other assets went up. But that's the reason why you have strategies that react differently over different times. Advisors try to get clients from Point A to Point B with the least amount of risk, and you do that by allocating to different strategies. Managed futures can be a piece of that overall puzzle."
Adam Berger, head of portfolio solutions at AQR Capital Management, noted that the nature of managed futures is that it's fundamentally about trend following, and that managed futures can outperform in markets in which CTAs can positions themselves to take advantage of turmoil that might affect traditional asset classes such as equities and bonds. Managed futures have struggled during periods of choppy markets, he added.
"We feel managed futures have a role in a diversified portfolio, but investors should not look at them as being an insurance policy," Berger said. "They've worked well in other crisis periods beyond 2008, but I'm concerned that some people might use this strategy blindly. Managed futures shouldn't be 100% of the alternatives in someone's portfolio."
Regarding the allocation of managed futures, Welter suggested they should comprise 15% of the equity portion of a portfolio. So in a 60-40 allocation, 15% of the 60% portion allocated to stocks-or 9% of the total portfolio-would provide the optimal risk reduction of the portfolio's equity component, he said.
Bell said portfolios should have at least 10% allocated to managed futures.
Berger offered that even though managed futures can help diversity portfolios and dampen volatility, investors shouldn't invest in them if they don't have the ability to stick with them over time and realize the long-term benefits of this asset class.