Managed Futures are a popular variety of alternative investments in the U.S for corporate and businesses. 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 U.S government’s Commodity Futures Trading Commission (CFTC).
Managed Futures are futures contract positions which are 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 taken in energy, agriculture, currency markets most commonly.
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Why is it “Managed” Futures?
Futures a 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 prior to 2008 crisis, stringent measures have been taken around permissions and disclosures on this type of trading. Since the company has given a “free hand” to the trader to invest and trade on their behalf, the term “managed” is to create 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 future contracts have specific date and quality, 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 managed properly and buying and selling calls are not taken on time.
Need for Managed Futures
One question that will arise in your minds 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 which are entered for this purpose. It does that by creating a hedge of positive and negative assets which set-off each other and the overall portfolio losses are minimized.
Most of the futures trade is inversely related to stocks and bonds and during high inflations and lower equity profits, commodities like gold, energy give the required set-off with their increasing prices.
Types of Investments
The investments in futures can be done 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 as “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 and these documents also provide a important information on the trading fees, trading plans for potential investors.
Importance of Risk-Adjusted Returns
While return 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 the performance of each trader.
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 various ratios such as Sortino Ratio, Sharpe Ratio and MAR ratio which is more commonly used as a measure of 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 at an average. It requires commodity traders with strong capabilities to give the ideal risk-adjusted returns.1,2