Demystifying Managed Futures

Simplify And VettaFi Executives Explain Managed Futures Strategies And Underlying Assets, Placement In Portfolios And Interactions With Inflationary Environments

As advisors search for the best solutions to navigate their clients through uncertain markets, managed futures are frequently suggested. While employing managed futures may be wise advice, it raises more questions than it answers due to the complexity and variety of managed futures funds available.

Often called “CTAs” for the CFTC-registered commodity trading advisors who manage them, managed futures funds have become increasingly available to retail clients in recent years.

According to David Berns, Chief Investment Officer & Cofounder of ETF manager Simplify, managed futures “have been available to hedge fund investors for five decades, and it’s only now that the ETF wrapper is amenable to these types of strategies given recent regulatory changes, expansion of ETF market making capabilities, and improved access to data and trading of futures.”

Managed futures are frequently cited for their diversification benefits. According to Investopedia, managed futures often have an inverse correlation to stocks and bonds, and certain classes of underlying assets can provide protection against inflation.

Todd Rosenbluth, Head of Research at data, indexing and distribution firm VettaFi, points out, “These alternative investments have historically been less correlated to long stocks or bonds, performing better in down markets.”  

While managed futures can provide diversification benefits, an advisor must carefully consider the broad array of assets held and strategies employed by managed futures funds to determine the best fit for each client.

Under The Hood

Rosenbluth explains that managed futures typically hold derivatives of underlying assets that “can include commodities, currencies and interest rates both from a bullish long perspective and bearish short perspective, as well as the shorting of equities and fixed income.”

According to Berns, managers apply a suite of algorithmic strategies across the assets, and the most common strategy is trend following.

PIMCO explains trend following as “seek[ing] positions in securities that have moved in one direction for a period of time – either up or down. They join the trend, taking long positions in assets that are going up in price, and short positions in assets whose prices are declining.”

Berns adds that aside from trend following, strategies may “include mean reversion, carry and breakout strategies to name a few. Additionally, these strategies can be designed to work over days, weeks or even months. Because of this wide range of strategies, horizons and asset classes, it is paramount for investors to get under the hood and really know what they are investing in.”

Client Portfolios

Berns points out that certain types of managed futures provide diversification for traditional equity and bond portfolios. For example, a managed futures algorithm trading equities with a trend strategy should be short during an equity drawdown, which diversifies a long-equities core position. Similarly, a bond trading trend algorithm should short bonds when interest rates rise, offsetting losses in long bond positions.

Regarding the size of the managed futures position relative to the portfolio, Berns says, “I’ve seen managed futures occupy up to 30% of a portfolio that is otherwise composed of the classic equity/bond mix.”

Rosenbluth advocates for a smaller portion of the portfolio dedicated to managed futures: “Advisors who are looking to provide enhanced diversification to a client’s portfolio should consider up to a 5% slice into managed futures.”

He cautions that although managed futures counterbalance other asset classes, a managed futures position may “lag in bullish environments.” 

Managed Futures And Inflation

According to Berns, managed futures predominantly employing trend-following algorithms are “a natural candidate for inflation protection without sacrificing long-term returns. And if inflation is accompanied by rising rates, trend following on bonds will also contribute nicely to the return profile during inflationary periods.”

While acknowledging that long positions in commodities provide the best hedge against inflation, Berns says that “these assets struggle during non-inflationary regimes, diminishing their value to portfolios over extended periods. On the other hand, trend-following strategies on commodities can capture a lot of the desired upside during inflationary periods while also avoiding a lot of the drag during low inflation periods.” 

Julius Buchanan, Managing Editor at Wealth Solutions Report, can be reached at jbuchanan@wealthsolutionsreport.com