What are Managed Futures?
What are Managed Futures? Investors Worldwide Seek Stable Returns
Investors around the world aim to achieve satisfactory returns while realizing relatively secure profits regardless of market conditions. The search for this golden mean between the riskier stocks and the safer bonds led to the creation of “managed futures.” For years, this specific type of investment instrument was reserved only for professional traders at large banks or private clients with substantial portfolios. In recent years, the situation has changed thanks to a growing number of open-ended funds and ETFs. Now, the average Joe can use them to try to increase their portfolio gains. In this comprehensive guide, we show what managed futures are, how they work, how they perform historically compared to major financial instruments, and how a small investor can gain access to them.
What are Managed Futures?
Managed futures are not a separate asset class, but rather a collection of alternative strategies and investments that involve trading contracts across a wide range of global markets, including commodities, currencies, stocks, and bonds. These strategies are typically implemented by professional money managers known in the United States as Commodity Trading Advisors (CTAs). The first managed futures fund was established in 1949 and launched by Richard Donchian, a proponent of trend-following trading theory. Over the years, they have repeatedly shown that they do not correlate with the stock market, allowing investors to profit during financial crises, including the 2008 crash.
| Period | S&P 500 | Managed Futures |
|---|---|---|
| July 1990 to October 1990 | -19.2% | 9.7% |
| November 1980 to August 1982 | -27.1% | 38.8% |
| August 1987 to December 1987 | -33.5% | 9.7% |
| March 2000 to October 2002 | -47.4% | 22.5% |
| October 2007 to March 2009 | -55.2% | 18.3% |
When the stock market declines, managed futures perform best. Source: ICFS.com
What distinguishes managed futures? Primarily, the belief that “the trend is your friend,” market diversification, and flexibility in chosen directions. Since they are based on futures contracts, both long and short positions are in play.
4 key aspects of managed futures:
- Trend following: Most managed futures strategies use trend-following techniques, buying assets whose prices are rising and selling those that are falling.
- Diversification: Managed futures typically trade across a broad spectrum of global markets, providing inherent diversification.
- Flexibility: These strategies can take long or short positions in any market, potentially allowing them to profit from both price increases and decreases.
- Cash management: A large portion of assets in managed futures funds is often held in cash-like instruments, and these funds are used as margin for futures positions.
There are over 1,000 managed futures funds in the market, which have been managing over $300 billion in assets annually for 10 years. In 2023, it was nearly $340 billion, with the majority held by several dozen of the largest managed futures programs. The asset allocation in average portfolios will of course vary, but typically consists of currencies (about 25%), commodities and stocks (25% each), and the largest portion (up to 35%) in bonds.
The table below summarizes the main strengths and weaknesses of managed futures:
| Advantages | Disadvantages |
|---|---|
| Low correlation with traditional asset classes | Significant short-term volatility |
| Potential to generate positive returns regardless of market direction | Strategies can be difficult to fully understand and very complex |
| Downside protection | Potentially higher fees than traditional investments |
| Efficient trading and potentially lower transaction costs | Significant performance difference between various strategies and funds |
CTAs and Their Strategies for Managed Futures
As mentioned at the beginning, the managed futures market is reserved for professionals, namely individuals or firms licensed by the Commodity Futures Trading Commission (CFTC) and members of the National Futures Association (NFA) specializing in managing client assets through trading strategies in the futures market.
The most important characteristics of CTAs are:
- Regulatory oversight: CTAs are subject to strict regulatory requirements, ensuring a high level of investor protection.
- Fee structure: CTAs typically charge both management fees and performance fees. Management fees usually range from 0 to 2% annually, while performance fees often amount to as much as 20-30% of profits.
- Diverse strategies: While CTAs focus on trend following, other strategies are also employed depending on time horizons. What strategies are we talking about? Usually, the classification distinguishes between “systematic” and “discretionary” models. In addition, there are relative value strategies, mean reversion, and carry trading.
- Systematic trend following: This strategy uses quantitative models to identify and track price trends across various markets.
- Discretionary trading: Some CTAs rely on their judgment and expertise in making trading decisions, although this approach is less common.
- Mean Reversion: This strategy assumes that prices will return to their average levels after significant deviation.
- Relative Value: These strategies seek to profit from price discrepancies between related assets.
- Carry Trading: This approach aims to capitalize on interest rate differences between countries. In carry trading, currencies are borrowed in markets where interest rates are low (low debt cost) and invested in currencies in markets where interest rates are high (greater interest income).
Direct use of CTA services, however, is beyond the reach of most retail investors. The entry threshold is a minimum of $100,000, although it’s usually $1 million or even $10 million, and sometimes $100 million. A list of examples, with realized growth rates over this year and over the past five years, can be found, among others, on the IASG website:
List of example managed futures. Source: IASG
Fortunately, there are ETFs that allow indirect investment using managed futures, but more on that later.
ETFs on Managed Futures for Retail Investors
Until 2011, retail investors had virtually no chance to take advantage of managed futures offerings. Over a decade ago, however, the first ETF from WisdomTree appeared, allegedly tracking the positions of selected funds. However, it took until 2019 for full-fledged ETFs to arrive. Their current list is not long, but investors can choose from five different positions:
- WisdomTree Managed Futures Strategy Fund (WTMF) – assets under management worth $220 million
- iMGP DBi Managed Futures Strategy ETF (DBMF) – assets under management worth $990 million
- First Trust Managed Futures Strategy Fund (FMF) – assets under management worth $239 million
- KFA Mount Lucas Index Strategy ETF (KMLM) – assets under management worth $372 million
- Simplify Managed Futures Strategy ETF (CTA) – assets under management worth $281 million
These ETFs offer the advantage of greater liquidity and significantly lower entry thresholds compared to traditional managed futures. However, as you can see, their value is modest compared to closed managed futures funds valued at over $300 billion. The largest of them, DBMF, tracks the SG CTA index from Société Générale, which brings together the 20 largest CTAs. More information about it, along with return rates (192%) since 2000, can be found on the bank’s official website. The CTA fund itself includes many futures, but the indicated ETF focuses on a few of them, implementing a strategy based on 10 main contracts:
- Foreign exchange market: EUR/USD and USD/JPY
- Commodities: Gold and crude oil
- Stocks: S&P 500, emerging markets, and the EAFE index measuring developed markets outside the US and Canada
- Bonds: from short-term to long-term
And although managed futures themselves outperform the broad market in the long term, in the case of ETFs tracking them only for the last few years, the results seem to be worse than the main Wall Street indices. As can be seen in the chart below, only WTMF has generated over 12% return on investment since the beginning of 2023, while the S&P 500 has grown by almost 50% in the same period. The other managed futures ETFs, meanwhile, are moving close to zero or slightly negative.
In recent years, managed futures in ETF form have performed poorly compared to stock market indices. Source: Tradingview.com
Does this mean they’re not worth bothering with? Not necessarily! When we prepare the same comparison for 2022, when the S&P 500 fell by over 20%, the results will be quite different. This confirms the assumption that managed futures are inversely correlated with the stock market and perform best when traditional stock markets are losing. Throughout 2022, most managed futures ETFs were rising, with the record-holder KMLM strengthening by 15%:
Managed futures are an excellent idea during periods when stock markets are falling. Source: Tradingview.com
Managed futures will be a unique addition to a diversified investment portfolio. They offer exposure to a wide range of global markets and can provide opportunities for interesting results that are not correlated with traditional asset classes. By buying one ETF related to managed futures, you open your portfolio to commodities, bonds, currencies, and stocks. And although when stock markets are rising, it will be difficult to expect a return on investment, in times of market panic, they will be an excellent capital protection.
