Managed futures: Meaning, Criticisms & Real-World Uses

Managed Futures

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What Is Managed Futures?

Managed futures refer to an alternative investment strategy where professional money managers, known as Commodity Trading Advisors (CTAs), actively trade a diversified portfolio of futures contracts and other derivative products on behalf of clients. This investment approach falls under the broader category of alternative investments, aiming to generate absolute returns regardless of the direction of traditional markets like stocks and bonds. Managed futures strategies encompass a variety of active investment approaches expressed through liquid and transparent exchange-traded futures and foreign exchange markets, often utilizing options on these contracts.⁵⁷ CTAs primarily speculate on price fluctuations across various global markets and sectors, including equity indices, fixed income, commodities, and foreign exchange.⁵⁶,⁵⁵

History and Origin

The roots of futures trading can be traced back to the mid-1800s in Chicago, primarily serving agricultural communities to manage price risk between planting and harvest.⁵⁴ However, the managed futures industry as we know it today began to take shape with the establishment of the Commodity Futures Trading Commission (CFTC) in 1974, under the Commodity Futures Trading Commission Act, which led to the formal recognition and regulation of Commodity Trading Advisors (CTAs).,

A pivotal moment in the history of managed futures was the "Turtle Traders" experiment in the 1980s. Richard Dennis, a prominent commodities trader, made a bet that he could teach a diverse group of individuals to be successful traders. This experiment popularized systematic, rule-based trading approaches in the futures markets, demonstrating that successful trading did not solely rely on discretionary judgment.⁵³ Since then, the industry has seen significant growth in assets under management.⁵²

Key Takeaways

Managed futures are actively managed investment strategies that primarily trade in global futures and foreign exchange markets.⁵¹,⁵⁰
They are managed by professional Commodity Trading Advisors (CTAs) who speculate on price trends.⁴⁹,⁴⁸
Managed futures aim to provide diversification benefits to traditional portfolios due to their historically low correlation with stocks and bonds.⁴⁷,
Strategies often involve taking both long and short positions, allowing for potential profits in both rising and falling markets.⁴⁶,
The industry is regulated by entities such as the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA) in the United States.,⁴⁵

Formula and Calculation

Managed futures do not have a single, universal formula, as their performance is derived from the net gains or losses of the underlying futures and derivative contracts traded by the CTA. The success of managed futures strategies often relies on the CTA's ability to identify and capitalize on market trends. These strategies typically involve complex algorithms and quantitative models.

A simplified way to consider the profit or loss from a futures contract, which forms the basis of managed futures trading, is:

\text{Profit/Loss} = (\text{Selling Price} - \text{Purchase Price}) \times \text{Contract Multiplier} \times \text{Number of Contracts}

Where:

Selling Price is the price at which the futures contract is closed (either sold after being bought, or bought back after being sold short).
Purchase Price is the price at which the futures contract was initially opened (either bought, or sold short).
Contract Multiplier is a fixed value that determines the total value of one futures contract (e.g., for crude oil futures, it might be 1,000 barrels per contract).
Number of Contracts is the total number of futures contracts traded.

These calculations are performed for a wide array of futures contracts across different asset classes, and the aggregate performance determines the overall return of a managed futures account. The leverage inherent in futures trading can significantly magnify both gains and losses.⁴⁴

Interpreting Managed Futures

Managed futures are interpreted primarily by their ability to provide portfolio diversification and generate returns that are uncorrelated with traditional asset classes like stocks and bonds.⁴³ Investors often evaluate managed futures based on their "crisis alpha," which refers to their historical tendency to perform well during periods when traditional markets experience significant downturns. This non-correlation is a key characteristic, as managed futures managers can dynamically take long or short positions across various markets, avoiding systematic exposure to a single asset class.⁴²,⁴¹

When assessing managed futures, it's important to look beyond just absolute returns and consider their role within a broader investment portfolio. Their value often lies in reducing overall portfolio volatility and enhancing risk-adjusted returns, especially during adverse market conditions.⁴⁰,³⁹ Investors should also consider the specific trading strategies employed by the CTA, such as trend following or systematic macro strategies, and how these align with their overall investment objectives.,³⁸

Hypothetical Example

Imagine an investor, Sarah, has a traditional portfolio heavily weighted in stocks and bonds. She is concerned about potential market downturns and seeks to add a component that could perform well during such times, thereby reducing her overall portfolio risk. Sarah decides to allocate a portion of her portfolio to a managed futures fund.

The managed futures fund, overseen by a CTA, employs a systematic trend-following strategy. In a hypothetical scenario, the stock market enters a prolonged bear market, with equity indices steadily declining. While Sarah's stock holdings are losing value, the managed futures fund identifies this downward trend in various equity index futures. The CTA initiates short positions in these futures contracts. As the market continues its decline, the short positions in the managed futures fund generate profits, offsetting some of the losses in Sarah's traditional stock portfolio. Simultaneously, if commodity prices begin to rise due to inflationary pressures, the CTA might take long positions in commodity futures, further contributing to the fund's positive performance. This hypothetical example illustrates how managed futures, with their ability to go both long and short across different markets, can provide a counterbalance to traditional assets during challenging market environments.

Practical Applications

Managed futures have several practical applications in investment management:

Portfolio Diversification: A primary use of managed futures is to enhance portfolio diversification. Their low historical correlation with traditional asset classes like equities and fixed income means they can potentially reduce overall portfolio risk and volatility.,³⁷
Risk Management: By offering returns that are not dependent on rising markets, managed futures can act as a hedge against systematic market risk, particularly during periods of economic downturns or crises.³⁶
Access to Global Markets: Managed futures provide investors with exposure to a wide array of global markets, including currencies, interest rates, and commodities, which might be difficult for individual investors to access directly.³⁵,³⁴ This broad market access is a key feature of the strategy.
Inflation Hedge: During periods of rising inflation, managed futures can potentially provide a counterbalance to losses in equity and bond markets by investing in specific commodities or foreign currencies.³³
Institutional and Retail Investment: While historically popular among large institutions for their diversification benefits, managed futures are increasingly accessible to retail investors through various structures, including mutual funds. The Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA) regulate CTAs and the managed futures industry in the U.S.³². You can find more information about these regulatory bodies on the NFA's official website, which outlines the registration requirements for CTAs.

Limitations and Criticisms

While managed futures offer notable benefits, they also come with certain limitations and criticisms:

Dependence on Market Trends: Many managed futures strategies, particularly trend-following approaches, rely on the existence of clear and sustained market trends. If markets are range-bound or experience abrupt reversals, these strategies may perform poorly.,³¹
Fees and Costs: Managed futures accounts often involve higher fees compared to more traditional investment vehicles. These can include management fees (typically up to 3% of assets) and performance fees, which can significantly impact net returns., Some critics argue that these fees can erode much of the client returns.
Volatility and Drawdowns: While aiming for low correlation, managed futures can still be volatile and may experience significant drawdowns.³⁰ They are considered speculative investments.²⁹
Tax Implications: Investing in managed futures can have unique and potentially complex tax implications due to how futures are traded. In the U.S., profits from futures trading are often subject to the "60/40 rule," meaning 60% is taxed as long-term capital gains and 40% as short-term gains, regardless of the holding period. Investors should consult with a tax professional regarding their specific situation.
Manager Performance and Due Diligence: The effectiveness of managed futures can vary significantly based on the specific CTA and their strategy. There are hundreds of managed futures funds with different performances, requiring investors to conduct thorough due diligence to select a suitable manager.²⁸ Some studies suggest that much of the alpha in managed futures may be attributable to their trend-following strategies rather than unique managerial skill.

Managed Futures vs. Hedge Funds

Managed futures and hedge funds are both considered alternative investments, but they differ significantly in their structure, regulation, and investment focus.

Feature	Managed Futures	Hedge Funds
Primary Focus	Primarily trade exchange-traded futures contracts, options on futures, and foreign exchange markets.	Trade a much broader variety of financial instruments and markets, including individual equities, fixed income securities, and over-the-counter derivatives.²⁷
Regulation (US)	Regulated by the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA).	Generally regulated by the Securities and Exchange Commission (SEC), though some exemptions apply.
Liquidity	Typically offer higher liquidity, with accounts settled daily and greater transparency.²⁶,²⁵	Often have lock-up periods where funds cannot be withdrawn, and may invest in illiquid assets.
Transparency	Clients usually have daily access to account statements and details of all positions.²⁴	Less transparent than managed futures, with reporting often less frequent.
Investment Style	Dominated by systematic, quantitative strategies, often employing trend-following.²³,²²	Employ a wider array of strategies, including long/short equity, global macro, event-driven, and arbitrage, with both systematic and discretionary approaches.
Correlation	Historically exhibit low correlation to traditional stock and bond markets.²¹,²⁰	Correlations with traditional markets vary widely depending on the specific hedge fund strategy, though many also aim for low correlation.¹⁹,¹⁸ The global macro strategy is statistically similar to managed futures in some aspects.¹⁷
Accessibility	Minimum account sizes can be lower, making them more accessible to some investors.¹⁶	Often reserved for institutional investors and high-net-worth individuals due to high minimum capital commitments.¹⁵

Managed futures are often seen as "diversifiers" to traditional equity and fixed income portfolios, while many hedge fund strategies are considered "substitutes" or "enhancers."¹⁴

FAQs

What is a Commodity Trading Advisor (CTA)?

A Commodity Trading Advisor (CTA) is a professional money manager or organization that advises clients on trading futures contracts, options on futures, and other derivative instruments.¹³, CTAs are responsible for the active trading within managed futures accounts and are regulated in the U.S. by the CFTC and NFA.,¹²

How do managed futures generate returns?

Managed futures generate returns by actively trading futures and foreign exchange contracts across various global markets, aiming to profit from price movements. They can take both long positions (betting on rising prices) and short positions (betting on falling prices), allowing them to potentially generate profits in both bull and bear markets.¹¹,¹⁰ Many strategies are systematic, often using quantitative models to identify and follow market trends.⁹,

Are managed futures a good investment for everyone?

No, managed futures are not suitable for all investors. They are considered speculative investments due to the inherent leverage in futures trading and the potential for significant gains or losses.,⁸ They are often recommended for sophisticated investors with aggressive or speculative investment objectives seeking further diversification and who are comfortable with the associated risks and fees.⁷

What are the main benefits of including managed futures in a portfolio?

The main benefits of including managed futures in a portfolio are enhanced diversification, reduced overall portfolio risk, and the potential to generate returns in various economic environments, particularly during downturns in traditional markets.⁶,⁵ Their historically low correlation with stocks and bonds can help improve a portfolio's risk-adjusted returns.⁴,³

How are managed futures regulated?

In the United States, managed futures accounts and the Commodity Trading Advisors (CTAs) who manage them are regulated by the Commodity Futures Trading Commission (CFTC), an independent federal agency., Additionally, CTAs are typically required to be members of and adhere to the rules of the National Futures Association (NFA), a self-regulatory organization that operates under CFTC oversight.,² These regulations aim to ensure transparency and protect investors.¹