“Managed Futures” is an extremely broad term that requires a more specific definition. Managed Futures
traders are commonly referred to as “Commodity Trading Advisors” or “CTAs,” a designation which
refers to a manager’s registration status with the Commodity Futures Trading Commission and National
Futures Association. CTAs may trade financial and foreign exchange futures, so the name Commodity
Trading Advisor is somewhat misleading since CTAs are not restricted to trading only commodity futures.
[Note: many investors generically say “Managed Futures” or “CTAs” when they more precisely mean “systematic CTAs who employ trend following strategies (or ‘Systematic Trend Followers’),” likely due to the fact that many of the largest and most successful trading managers employ some variation of a trend following strategy.]
That being said, Managed Futures may be thought of as a collection of liquid, transparent hedge fund
strategies which focus on exchange-traded futures, forwards, options, and foreign exchange markets.
Trading programs can take both long and short positions in as many as 400 globally diverse markets,
spanning physical commodities, fixed income, equity indexes, and currencies. Daily participants in these markets include hedgers, traders, and investors, many of whom make frequent adjustments to their positions, contributing to substantial trading volume and plentiful liquidity. These conditions allow most Managed Futures programs to accommodate large capacity and provide the opportunity to diversify across many different markets, sectors, and time horizons.
Diversification across market sectors, active management, and the ability to take long and short positions are key features that differentiate Managed Futures strategies not only from passive, long-only commodity indexes, but from traditional investing as well. Although most Managed Futures programs trade equity index, fixed income, and foreign exchange futures, their returns have historically been uncorrelated to the returns of these asset classes. The reason for this is that most managers are not simply taking on systematic beta exposure to an asset class, but are attempting to add alpha through active management and the freedom to enter short or spread positions, tactics which offer the potential for completely different return profiles than long-only, passive indexes.
Early stories of futures trading can be traced as far back as the late 1600s in Japan. Although the first
public futures fund started trading in 1948, the industry did not gain traction until the 1970s. According
to Barclays (2012), “…a decade or more ago, these managers and their products may have been considered different than hedge funds; they are now usually viewed as a distinct strategy or group of strategies within the broader hedge fund universe. In fact, Managed Futures represent an important part of the alternative investment landscape, commanding approximately 14% of all hedge fund assets [which equated to] $284.4 billion at the end of 3Q11.” More recent estimates, according to alternative investment database BarclayHedge located in Fairfield, Iowa, show that Managed Futures now account for approximately 13% of all hedge fund assets under management ($316.8 billion of the total $2,478.6 billion invested in hedge funds).
Managed Futures should also be thought of as a subset of global macro strategies that focuses on global futures and foreign exchange markets and is likely to utilize a systematic approach to trading and risk management. The instruments that are traded tend to be exchange-listed futures or extremely deep, liquid, cash-forward markets. Futures facilitate pricing and valuation and minimize credit risk through daily settlement, enabling hedge fund investors to mitigate or eliminate some of the more deleterious risks associated with investing in alternatives. Liquidity and ease of pricing also assist risk management by making risks easier to measure and model.
In fact in research conducted before the Global Financial Crisis, Bhaduri and Art (2008) found that the value of liquidity is often underestimated, and, as a result, hedge funds that trade illiquid instruments have under-performed hedge funds that have better liquidity terms. The quantitative nature of many Managed Futures strategies makes it easy for casual observers to mistakenly categorize them as “black box” trading systems. According to Ramsey and Kins (2004), “The irony is that most CTAs will provide uncommonly high levels of transparency relative to other alternative investment strategies.” They go on to suggest that CTAs are generally willing to describe their trading models and risk management in substantial detail during the course of due diligence, “short of revealing their actual algorithms.” CTAs are also typically willing to share substantial position transparency with fund investors. Ramsey and Kins conclude that, “It is difficult to call CTAs black box, considering they disclose their methodology and provide full position transparency so that investors can verify adherence to that methodology.”
Separately managed accounts, common among Managed Futures investors, greatly enhance risk management by providing the investor with full transparency, and in extreme cases, the ability to intervene by liquidating or neutralizing positions. In addition, institutional investors who access CTAs via separately managed accounts substantially reduce operational risks and the possibility of fraud by maintaining custody of assets. Unlike the products traded in other hedge fund strategies, those traded by CTAs allow investors to customize the allocation by targeting a specific level of risk through the use of notional funding. The cash efficiency made possible by the low margin requirements of futures and foreign exchange allows investors to work with the trading manager to lever or de-lever a managed account to target a specific level of annualized volatility or other risk metric. Some CTAs offer funds with share classes with different levels of risk. Unlike traditional forms of leverage, which require
the investor to pay interest to gain the additional exposure, assets used for margin in futures accounts
can earn interest for the investor. Another advantage of trading futures is that there are no barriers to short selling. Two parties simply enter into a contract; there is no uptick rule, there is no need to borrow shares, pay dividends, or incur other costs associated with entering into equity short sales. Thus, it is easier to implement a long-short strategy via futures than it is using equities.