A Complete Guide to Managed Futures Strategy

4 years ago

Simply put the term Managed futures describes a strategy whereby a professional manager assembles a diversified portfolio of futures contracts. … CTAs will often invest in a portfolio of futures contracts consisting of: Fixed income futures, such as U.S. treasury notes or treasury bonds.

What is Managed Futures Strategy?

Managed Futures Strategy is essentially  a strategy of investing in a portfolio of futures contracts with the short term intent of profiting from price fluctuations as a result of changes in prevailing interest rates, supply and demand and many other factors. 

Simply put, the term managed futures describes a strategy whereby a professional manager assembles a diversified portfolio of futures contracts which may include currencies, grains, energies. etc. The manager then invests and continuously adapts the portfolio to changes in the underlying market forces and manages the risk of the portfolio.

What are the benefits of Managed Futures Strategy?

Managed futures provides a high level of risk adjusted return and historically has proven to be relatively more successful in up markets. One of the major risks of managed futures is the tracking error. Tracking error is the difference between the portfolio returns and the benchmark. For instance, if the benchmark is the S&P500, and the portfolio returns 8% with a tracking error of 20%, then the manager will be trading away 6% of the benchmark return. In other words, the manager is trying to do better than the market and consequently has to pay for the privilege. The key point is that the tracking error must stay within an acceptable range.

What are Managed Futures Strategies?

Managed Futures strategies trade on the short term basis in different financial futures’ markets. It is a form of futures trading. Managed futures are known for their relative low correlation to traditional assets. So, investors are aware of the potential tracking error. Unlike traditional managers, managed futures are on their toes and always in tune with the market forces ready to take action. 

Essentially there are two main types. The first is that of discretionary managed futures. A discretionary Managed Futures Strategies is usually designed by its manager and the manager has complete discretion and freedom to select the assets and trade the assets through a direct trading account. 

The second is that of managed accounts. Managed Accounts are designed through a methodology. The methodology is usually determined by the investor and the manager is the one in charge of implementing the plan. A Managed Account is like a ready-to-trade managed futures portfolio that requires little hands-on management.

What are the benefits of Managed Accounts?

The principal benefit of managed accounts is that the investor can arrive at the conclusion of the investment based upon their expectations, and not those of the CTA. This is accomplished by setting up predefined risk and return expectations. The manager is then able to tailor the investments to the particular set of rules.

In Managed Accounts, the investor trades through a broker and pays a commission. Please note that not all futures brokers offer Managed Accounts and not all Managed Accounts are available through a futures broker. When opening an account, the investor should find out if their broker can accommodate Managed Accounts. If they can’t, the investor may have to file a ‘Form AD’ for the futures account. 

How large should the Managed Account be?

Please note that there are no set size requirements for Managed Accounts. However, it is important that the investor and the manager be in agreement as they are entering into a long term relationship. For instance, the investor needs to determine if there is a minimum or maximum initial capital that they can swing. Is it $10,000 or $5 billion? Some professional managed futures managers have minimums of $50,000, while others require $10 million. An investor should be aware that a higher minimum will usually ensure that the manager is going to be investing in a higher quality account.

Does the investor have to be a hedge fund or a pension fund?

No, there is no restriction on the type of investor. Professional Managed Futures Strategies are available to individuals, corporations, pension funds, endowments and fund of funds.

Who manages the Managed Accounts?

Managed Accounts offer several advantages: Attractive Returns: In managed futures investing, the investor should get used to making 12% to 16% returns. High Alpha: Managed Accounts can generate high alpha, which means they have an edge for outperforming the market. End of Month Payout: Managed Accounts pay out on a monthly basis. Paying out on a monthly basis rather than quarterly or annually means that investors will benefit from small monthly gains. Invest only when market conditions are favourable:  Investors have the opportunity to invest only when market conditions are favourable. Investors can also take timely cash withdrawals. 

Managed Accounts can be maintained by a variety of fund managers, including, but not limited to, commodity trading advisors, management companies and individual traders. Investors are able to choose their Managed Accounts based upon their own requirements. Managed Accounts can be used as stand-alone accounts or investors can choose to use them as part of a larger portfolio. 

For long term investors, Managed Accounts offer peace of mind, guidance and direction. Investors do not have to go through the trouble of researching the market to find hot traded commodities. Managed Accounts tell them what is hot. 

Investors can choose the attributes of their account, and the types of market conditions they want to capitalize on. Investors will know whether they can easily risk their assets for a 1% gain or whether it would be prudent to risk their assets only in times of significant market movements. Choosing to use Managed Accounts will benefit an investor in many ways. As long as the investor does their homework and understands the risks associated with the investment, they will be greatly rewarded with a high level of returns, diversification and convenience.

What are the benefits of Managed Futures?

The benefits of Managed Futures have been summed up as follows: Drawdowns of Individual Accounts on Average nothing of consequence: Drawdowns are generally manageable in nature, perhaps 10% on average. Hedging Futures Contracts is Easy: The futures markets are readily available to be hedged, and hedge strategies are relatively simple. Price Discovery to the Industry: Managed Futures are a price discovery mechanism for most commodities. Benchmark to the Industry: Managed Futures are a benchmark to measure performance in many aspects of the industry. Professional Management: Managed Futures provide professional quality investment management.

How does one choose a Managed Futures Strategies?

Choosing a CFTA can be a daunting task. Perhaps the most important thing to do is understand your goals. Are you looking for a high level of return? Low Volatility? Or is it a combination of both? Through careful research your will come to a conclusion of how much risk you are willing to take and the level of return you are looking for and then look for the manager. Here are a few suggestions to help you narrow down your choices. 

Demand References: Make sure to contact previous investors that used the CTA in order to speak to them directly. You will be able to get a feel for the investment and to do your own due diligence. Read Past Performance Charts: Past performance charts will show you the range of returns for any CTA. Understand the Drawdowns and Total Commissions: These two numbers will show you the average returns and the average drawdowns. 

Before choosing a CFTA, it is a good idea to check out the CTA’s website and to request a copy of their performance chart. Interested investors should be willing to speak with a representative of the CTA. For more information on Managed Accounts in Futures, please go to http://www.managedaccountstrategies.com/

People with different risk-return expectations and objectives may prefer different orientations. Investors with a high risk exposure may prefer an orientation that maximises returns, called an equity approach. Long-only equity investors will find an equity oriented CTA that accepts long positions to be a suitable candidate, given the nature of their risk objectives. On the other hand, investors with a low risk exposure may prefer an orientation that minimises losses, known as a hedged approach. Hedged-oriented CTAs may be a suitable option for such investors. Extremely conservative investors may prefer a stable Return of Capital over a period of time, commonly referred to as a capital preservation approach. Investors who are the least risk-averse and given to bear market fluctuations might wish to go for non-directional strategies that have a limited use of protfolios, such as trend following. 

A separate consideration is whether one is buying a CTA from a brokerage firm or from a fund manager. 

Buy-and-hold CTAs such as those belonging to non-directional strategies may be suitable for investors looking for a traditional buy-and-hold approach. The upside and downside are limited to a certain win/loss ratio, and their performance is geared toward achieving the highest returns over a time period. 

Short-term CTAs are mostly geared towards the equity approach. Their performance is geared toward maximising absolute returns over a shorter period. This is with the caveat, however, that although the upside may be higher, the drawdowns and risk of capital loss are also increased. 

Who is liable in case of failure of a CTA?

If you buy a single-manager Managed Account, the manager usually has accounts with several broker-dealers and may also have funds on which investors have the potential to place stop losses. If the broker-dealer where the investor has a futures account has net capital of less than $1 million, it probably cannot take full care of the investors’ futures positions. In case the futures broker-dealer goes bankrupt, the investors with futures positions could be liable for the loss in their futures accounts. This risk is similar to any futures account at a futures commission merchant (FCM). In the case of a fund futures account, however, where the investors’ money is actually deposited with the FCM, the investors are not at risk of loss of their capital. However, if the futures broker-dealer they hold their transaction accounts with becomes insolvent, they could lose everything they have in that account, possibly including cash, securities, and futures positions where they do not have transactional accounts. Thus, it is advisable to do a thorough due diligence on broker-dealers handling CTAs and their financial solidity.
There are also CTAs that also manage ETFs, Mutual Funds and other money market instruments. They are not traded on the futures or options exchanges and are not regulated by the CFTC. When these investments are denominated in US Dollars, it is possible that the investors may not have any protection from what is called “monetary devaluation” which is legally defined as “any act or omission by a central bank that results in theft or expropriation through inflation or is the equivalent of monetary theft or expropriation.”

Investing in futures contracts entails substantial risks, and investors should understand the contracts before they invest. Investors may lose all or a substantial portion of their investment in futures contracts. Certain of the risks of futures investing, in particular, the possibility of losses due to trading or market-making by an FCM or its customers, the possibility of losses in excess of the amount that may be lost through traditional securities investments, and the risk of currency devaluation by the government are unique to futures contracts. Futures contracts are not suitable investments for all investors and may lose money based on market conditions.

Investing in CTAs involves risks specific to them. Investors in CTAs, in the aggregate, may experience greater losses than would be possible with an investment only in traditional securities, including greater losses than might be expected given the performance of the relevant market as a whole. Investments in CTAs are speculative and involve a significant degree of risk. Prospective investors must carefully consider their tolerance for risk and ability to bear losses prior to investing in a CTA. An investment in a CTA is not suitable for all investors. As with all investments, there are associated risks and the investor could potentially lose some or all of their investment.

Because of the investment and trading strategies used by CTAs, investors may experience a loss of some or all of their investment. Investments in CTAs are subject to the volatility of the markets to which the CTA’s investment and trading strategies are applied. CTAs frequently use highly leveraged and volatile instruments such as futures contracts. These instruments may experience significant price movements regardless of the broad underlying movements of the markets to which they relate. Such price changes may result in the loss of a portion or all of an investor’s investment.

In the event of bankruptcy of the CTAs and the parties responsible for the assets of the CTA, losses to investors are possible. There is no legal requirement that the assets of the CTA be kept separate from other accounts of the CTA or from third parties. The assets in a CTA could theoretically be used to satisfy obligations owed to a CTA’s creditors. In extreme cases, the failure of a CTA may be accompanied by a bankruptcy of the CTAs.

The leverage of a CTA’s investments may lead to losses in excess of an investor’s original investment in a CTA. CTAs may use instruments that provide leverage. The risk of leveraged instruments may be substantial. This means that the return on these investments can increase dramatically when the price of the underlying instrument rises even slightly. This also means that leveraged instruments can lose substantial value when the price of the underlying instrument falls, even slightly. Leverage can lead to losses in excess of an investor’s original investment in a CTA.

CTAs may not precisely mirror the performance of their underlying benchmarks. Their strategies may involve the use of swaps and other futures, options and similar contracts. This may result in the CTA deviating from actual performance of the benchmark. There are furthermore a number of ways a CTA can deviate from its benchmark: 1) The CTA might actively change the weighting in its model portfolio to adjust its performance relative to the benchmark. 2) CTAs may change strategies all the time. Their performance may differ strongly from that of their benchmarks over time. CTAs may use leverage for portions of their portfolios. Leverage can increase volatility in the underlying market and can lead to losses in excess of the amount invested. CTAs may invest in futures and options contracts. These can result in the CTA deviating from the performance of the benchmark.

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