During the 2008 financial crisis optimally diversified investment portfolios did not fare much better than those that were concentrated in a particular asset class. Commodities, equities, corporate bonds, real estate, hedge funds, developed and emerging markets, all took a hit together. However, there was one standout during 2008 - managed futures funds – returning 17 per cent that year.

Both hedge funds and managed futures are alternative investment vehicles, along with private equity and venture capital. Sometimes, considered to be a sub-set of the hedge fund industry, managed futures funds trade liquid instruments. The sector has proven to be one of the fastest growing strategies within the hedge fund universe. However, unlike hedge funds where investor funds are pooled into a single account, managed futures investment vehicles keep investor funds segregated in separate accounts.

The managed futures sector has the largest allocation within the hedge fund space. Strategies are designed to capture returns related to short term market trends through the use of futures, options and foreign exchange. Managers take an absolute return approach seeking positive performance under various market conditions – whether the market is rising or falling. Therefore, investors don’t need to rely on the market appreciating to profit. This makes managed futures a highly attractive investment vehicle to enhance overall portfolio performance - providing true diversification and offering protection during downturns.

Industry growth

Investor interest in alternative investment strategies – hedge funds and managed futures - has been growing in recent years after declining during the financial crisis. By the first quarter of 2011 assets under management (AUM) in managed futures funds had grown to over $290 billion, more than 14 per cent of total hedge fund industry assets, according to BarclayHedge. This reflects a greater than 600 per cent growth in AUM since 2000, and is 50 per cent above the growth rate of the larger global hedge fund industry.

In 2008 hedge fund assets decreased significantly due to performances losses and investor redemptions. According to Hedge Fund Research global hedge fund assets are now over $2 trillion, above the pre-crisis high of $1.9 trillion reached in the second quarter of 2008.

Benefit from financial crisis

Interest in managed futures has grown since the 2008 financial crisis due to the desire by investors to seek out uncorrelated returns and the need for better diversification of investment portfolios. Awareness of the positive performance exhibited by managed futures strategies during 2008 put the sector back on the top of the list for consideration by many institutional and high net worth individuals (HNWs).

Further, a number of problems associated with hedge funds became a cause for concern during that time, including liquidity and transparency issues, negative absolute performance, manager fraud, and style drift. Investors sought solutions to these issues, including that of control over assets.

During the crisis many hedge funds found themselves faced with the possibility of significant investor redemptions within a short period of time, while at the same time having to deal with the impact of negative performance on assets, as investors rushed to get out. Due to the potential for large capital withdrawals in a short period of time, the illiquid nature of many investments, and the impact that multi-investor redemptions would have on the management of the fund, restrictions on redemptions were implemented by many hedge funds.

Without such restrictions hedge fund managers would be forced to exit positions early in order to provide liquidity to their investors. Managers found themselves selling their liquid positions and were forced to hold on to their illiquid positions, thereby throwing a wrench into their management strategies and negatively impacting performance.

The drive for better returns and portfolio diversification since the crisis has seen institutions and high net worth individuals (HNWs) begin to seriously examine opportunities in the managed futures sector. A managed futures investment program provides a solution for some of the problems faced, at least for certain strategies.

One of the biggest benefits to managed futures funds is that they trade mostly liquid securities via regulated exchanges. Liquidity risk that exists in many other hedge fund strategies is therefore diminished.

Portfolio Benefits

Numerous studies over the years have shown the benefits of managed futures in providing risk-adjusted returns that enhance diversification of an investment portfolio. This means that by allocating a certain portion of a total portfolio to managed futures, returns of a portfolio are enhanced while risk in the overall portfolio is reduced. Studies suggest that positive portfolio enhancement can be found by allocating up to 20 per cent of a portfolio into managed futures strategies.

Due to the historically low correlation with equity markets a portfolio’s return can be enhanced while reducing risk. A 2009 study published by CME Group and AlphaMetrix found that the BarclaysHedge CTA Index recorded positive returns in 12 out of 15 of the worst months for equities since 1987.

Understanding Managed Futures

Portfolios are designed to maximize returns for a given level of risk and may trade any combination of the following sectors including a single market:

• Energy
• Agriculture
• Currencies
• Metals
• Bonds
• Stock indices

Important performance characteristics:

• Low or negative correlation to equity markets
• Potential to profit and rising and falling markets

Any number of investment/trading strategies may be utilized including:

• trend following
• countertrend
• volatility
• discretionary
• spread

Similar to hedge funds, the investment manager’s incentive is performance driven and therefore more aligned with that of the investor.

Alternative to hedge fund structure

Managed futures offer many similar strategies as hedge funds but there are a few important distinctions including:

Segregated Funds: Investments into hedge funds are pooled into a fund whereas managed futures accounts are segregated for the particular investor.

Position Level Transparency: Capital and investors generally do not have access to specific details of which investments are made, whereas in most managed futures products they do.

Liquidity: Securities traded are highly liquid instruments listed on regulated futures exchanges

Control of Assets: Most hedge funds require a period of time during which invested capital must stay invested in the fund and cannot be removed until after a “lock-up period.” Most managed futures funds do not have this requirement.

Benefits of Managed Futures

• Opportunities for reduced overall portfolio risk.
• Enhanced portfolio returns - May add substantial diversification to an investment portfolio
• Alpha generating strategies
• Historically low correlation to stocks and bonds
• Ability to profit independent of the economic environment with opportunities in both bull and bear markets
• Flexible trading strategies - opportunity to profit in rising and falling markets
• Leverage benefits - typically in futures, 5% cash of the contract size is required

For further information, please contact:
Bruce Powers
Head of Research & Analysis
Trust Securities
Dubai, UAE
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