PART II: A Primer on Managed Futures strategies

In the previous article we talked about what managed futures are, their use in modern asset allocation models and given their limited correlation to traditional equities and fixed income, why they are an indispensable ingredient for optimal portfolio construction.

In the final part of this series, we shall touch upon liquidity, risk management and leverage within managed futures strategies.

1. How does a Managed Futures strategy adhere to risk management restrictions?

The risk management style of Managed Futures reflects positive convexity return, similar to deploying options. However, unlike options which have a limited outflow in terms of option premium (paid upfront), losses in futures as an asset class can be unlimited. At Boolean Algorithmic Trading, risk management is a subset of tail behaviour of returns – the nature of the symmetry and peaked ness of returns and embodies an anti-Martingale system i.e. an in-built risk management to embody volatility-adjusted position sizing and loss limits per position. Furthermore, historically, drawdowns in majority of Managed Futures strategies have been significantly lower than in most other hedge fund strategies.

2. Are the futures traded by Managed Futures strategy liquid?

Managed Futures strategies utilize the most liquid exchange-traded futures with the highest level of open interest.

3. What is the relationship of leverage in Managed Futures strategies?

Managed Futures do not employ leverage in the traditional sense of borrowing money to increase exposure. Futures contracts have implicit leverage, which is managed and controlled by the conservative margin-to-equity ratios employed by each firm.

4. Do Managed Futures firms impose gates and lockups on investors?

Managed Futures strategies generally have liberal redemption policies, usually monthly. Unlike what took place in some other hedge fund strategies, Managed Futures firms generally did not impose either gates or lockups during the financial crisis of 2008 – 2009. With managed accounts, investors can terminate a trading manager’s power of attorney and liquidate positions themselves. Firms cannot restrict customers from making withdrawals from their managed accounts post lockup phase.

5. What academic literature and/or research supports the inclusion of Managed Futures in portfolios to explain the benefits of diversification?

There is a substantial research:

• Dr. Lintner, John.'s pioneering research “The Potential Role of Managed Commodity-Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds.” The Handbook of Managed Futures: Performance, Evaluation & Analysis. Ed. Peters, Carl C. and Ben Warwick. McGraw-Hill Professional, 1996. 99-137
• Center for International Securities and Derivatives Markets (CISDM). “The Benefits of Managed Futures: 2006 Update.” Isenberg School of Management, University of Massachusetts, 2006.
• Lintner, John. “The Potential Role of Managed Commodity-Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds.” The Handbook of Managed Futures: Performance, Evaluation & Analysis. Ed. Peters, Carl C. and Ben Warwick. McGraw-Hill Professional, 1996. 99-137.
• Ramsey, Neil and Aleks Kins. “Managed Futures: Capturing Liquid, Transparent, Uncorrelated Alpha.” The Capital Guide to Alternative Investment. ISI Publications, 2004. 129-135.

As concluding remarks, Managed futures strategies offer unique risk and return properties that have offered attractive returns and delivered diversification benefits during times of prolonged downward trends in equities, fixed income and commodities markets.

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