Managed Futures are a popular variety of alternative investments for corporate and businesses in the U.S. With a low-interest rate regime and low returns on U.S equity markets or, in fact, many other developed markets, companies look for alternatives to park their funds and earn money. The investment money is given in the hands of a well-respected and experienced trader – usually, a commodities trader who has to be registered with the U.S government’s Commodity Futures Trading Commission (CFTC).
Managed Futures are futures contract positions taken by actively managing money managers, who are mostly commodity traders and help companies and businesses hedge their positions against losses. Most positions in futures contracts are commonly taken in energy, agriculture, and currency markets.
Why is it “Managed” Futures?
Futures are complicated security, especially when a number of them need to be managed. A company will outsource it to an experienced trader who will take the money and buy and sell futures within his own account, also called “proprietary trading.” Though it was very common before the 2008 crisis, stringent measures have been taken around permissions and disclosures on this type of trading. Since the company has given the trader a “free hand” to invest and trade on their behalf, the term “managed” is to create a distinction to the futures the company’s own departments might be doing for hedging purposes.
A futures contract creates an obligation to buy or sell a physical commodity at a pre-determined price at a future date. The standardized futures contracts have a specific date, quality, and quantity as an underlying to facilitate trading on a futures trading platform. While the downside risk can be managed, there is also a potential for huge losses if not appropriately managed, and buying and selling calls are not taken on time. (Read about various types of futures contracts).
Need for Managed Futures
One question that will arise in your mind is the need for managed futures is when companies have options like hedge funds, international exposure buy stocks and bonds and funds. The answer is that each company has a portfolio of investments it wants to hedge and minimize the potential loss. Thus it needs to enter into specific trades to set off risk and invest in currencies abroad. While these are possible with other instruments, the risk mitigation is done best with futures entered for this purpose. It does that by creating a hedge of positive and negative assets that set off each other, minimizing the overall portfolio losses.
Most of the futures trade is inversely related to stocks and bonds, and during high inflations and lower equity profits, commodities like gold and energy give the required set-off with their increasing prices.
Types of Investments
The investments in futures can be made in various heads such as agriculture (seeds, corn, wheat, and soybeans), energy (gas, oil), soft commodities (coffee, tea, cocoa, cotton), foreign currencies, equity indices (NASDAQ100, DowFutures, other foreign indices) and various other new places where there is profit potential.
The traders are called “Commodity Trade Advisors,” who are specialized in taking calls in futures in various areas.
They are made to go through deep background checks by the FBI in the U.S along with strict document disclosures on an annual basis with independent audits of financial statements each year and reviewed by the National Futures Association (NFA), which is a self-regulatory organization.
These documents are essential as the trader will be in charge of the company’s money. These documents also provide a important information on the trading fees and trading plans for potential investors.
Importance of Risk-Adjusted Returns
While returns might be high under the managed futures strategies, the returns make sense only when they are seen with the adjustment of risk, i.e., how much losses did actually occur in a time frame. There are various comparison techniques the NFA provides to be used as a standard measure to understand each trader’s performance.
The ratio of return –to-drawdown ratio (Calmer Ratio) gives a comparison of the average annual compounded rate of return and the maximum drawdown risk of commodities traders and hedge funds. The time period used to judge the performance is three years.
There are other ratios, such as Sortino Ratio, Sharpe Ratio, and MAR ratio, which are more commonly used to measure risk.
Managed Futures is a highly technical and risky form of asset trading and can be used best when the portfolios run into millions. The reason is also that the trader fee and commissions can range from $25,000 to $250,000 on average. It requires commodity traders with strong capabilities to give the ideal risk-adjusted returns.