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September 3, 2010 by  
Filed under Silver Investment Basics

 


Managed Futures describes and industry that is made up of professional money mangers who trade in investments such as commodities, futures, and foreign currency in lieu of  traditional investment s  such as stocks and bonds. These money managers are called  Commodity Trading Advisors(CTAs)
 
 
Unlike commodity or stockbrokers who makes recommendations on individual commodities or stocks, Commodity Trading Advisors have a proven track record and trading style,and are under strict regulation with the NFA National Futures Association.
 
Whether the economy is in a recession, an economic boom or is stagnant…whether interest rates rise or fall…whether there is an economic crisis or stability…in virtually any economic environment, professionally managed futures, unlike stocks, can potentially prosper.
 
 
Defining Managed Futures
 
The term “managed futures” refers to a 30-year-old industry made up of professional money managers who are known as “commodity trading advisors” (CTAs). CTAs are required to register with the U.S. government’s Commodity Futures Trading Commission (CFTC) before they can offer themselves to the public as money managers. CTAs are also required to go through an FBI deep background check, and provide rigorous disclosure documents (and independent audits of financial statements every year), which are reviewed by the National Futures Association (NFA), a self-regulatory watchdog organization.
 
CTAs generally manage their clients’ assets using a proprietary trading system, or a discretionary method, that may involve going long or short in futures contracts in areas such as metals (gold, silver), grains (soybeans, corn, wheat), equity indexes (S&P futures, Dow futures, NASDAQ 100 futures), soft commodities (cotton, cocoa, coffee, sugar) as well as foreign currency and U.S government bond futures. In the past several years, money invested in managed futures has more than doubled and is estimated to continue to grow in the coming years if hedge fund returns flatten and stocks underperform.
 
Benefits of Managed Futures
1. Reduced Portfolio Volatility Risk – The primary benefit of adding a managed futures component to a diversified investment portfolio is that it may decrease portfolio volatility risk. This risk-reduction contribution to the portfolio is possible because of the low to slightly negative correlation of managed futures with equities and bonds. One of the key tenets of Modern Portfolio Theory, as developed by the Nobel Prize economist Dr. Harry M. Markowitz, is that more efficient investment portfolios can be created by diversifying among asset categories with low to negative correlations.
 
2. Potential for Enhanced Portfolio Returns – While managed futures can decrease portfolio volatility risk, they can also simultaneously enhance overall portfolio performance. Adding managed futures to a traditional portfolio can help to improve overall investment quality. This is substantiated by an extensive bank of academic research, beginning with the landmark study of Dr. John Lintner of Harvard University, in which he wrote that “The combined portfolios of stocks (or stocks and bonds) after including judicious investments…in leveraged managed futures accounts show substantially less risk at every possible level of expected return than portfolios of stocks (or stocks and bonds) alone.” (Lintner, John, “The Potential Role of Managed Commodity Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds,” Annual Conference of Financial Analysts Federation, May 1983)
 
3. Ability to Take Advantage of Any Economic Environment – Managed futures trading advisors can take advantage of price trends. They can buy futures positions in anticipation of a rising market or sell futures positions if they anticipate a falling market. For example, during periods of hyperinflation, hard commodities such as gold, silver, oil, grains, and livestock tend to do well, as do the major world currencies. During deflationary times, futures provide an opportunity to profit by selling into a declining market with the expectation of buying, or closing out the position, at a lower price. Trading advisors can even use strategies employing options on futures contracts that allow for profit potential in flat or neutral markets. However, profits are not guaranteed, and there is risk of substantial loss.
 
4. Ease of Global Diversification – The establishment of global futures exchanges and the accompanying increase in actively traded contract offerings has allowed trading advisors to diversify their portfolios by geography as well as by product. For example, managed futures accounts can participate in at least 150 different markets worldwide, including stock indexes, financial instruments, agricultural products, precious and nonferrous metals, currencies, and energy products. Trading advisors thus have ample opportunity for profit potential and risk reduction among a broad array of non-correlated markets.
 
Managing Risk
One of the major arguments for diversifying into managed futures is their potential to lower portfolio risk. Such an argument is supported by many academic studies of the effects of combining traditional asset classes with alternative investments such as managed futures. Dr John Lintner of Harvard University is perhaps the most cited for his research in this area.
 
Taken as an alternative investment class on its own, the managed-futures class has produced comparable returns in the decade before 2005. For example, between 1993 and 2002, managed futures had a compound average annual return of 6.9%, while for U.S. stocks (based on the S&P 500 total return index) the return was 9.3% and 9.5% for U.S. Treasury bonds (based on the Lehman Brothers long-term Treasury bond index). In terms of risk-adjusted returns, managed futures had the smaller drawdown (a term CTAs use to refer to the maximum peak-to-valley drop in an equities’ performance history) among the three groups between Jan 1980 and May 2003. During this period managed futures had a -15.7% maximum drawdown while the Nasdaq Composite Index had one of -75% and the S&P 500 stock index had one of -44.7%.
 
An additional benefit of managed futures includes risk reduction through portfolio diversification by means of negative correlation between asset groups. As an asset class, managed futures programs are largely inversely correlated with stocks and bonds. For example, during periods of inflationary pressure, investing in managed futures programs that track the metals markets (like gold and silver) or foreign currency futures can provide a substantial hedge to the damage such an environment can have on equities and bonds. In other words, if stocks and bonds underperform due to rising inflation concerns, certain managed futures programs might outperform in these same market conditions. Hence, combining managed futures with these other asset groups may optimize your allocation of investment capital.
 
Evaluating CTAs
Before investing in any asset class or with an individual money manager you should make some important assessments, and much of the information you need to do so can be found in the CTA’s disclosure document. Disclosure documents must be provided to you upon request even if you are still considering an investment with the CTA. The disclosure document will contain important information about the CTA’s trading plan and fees (which can vary substantially between CTAs, but generally are 2% for management and 20% for performance incentive). In addition, most CTA’s require large minimum investments, however investors can get around this buy going through a commodities brokerage firm that has an agreement with various CTA’s and  acts as a liaison between the investor and the CTA.  Another benefit of working with a broker, is their ability to create a CTA diversified porfolio to match your goals and risk tollerence.
 
In Conclusion
Managed Futures can help:
 
1. Help improve portfolio performance
 
2. Reduce portfolio volatility risk
 
3. Non-correlated investment (to stocks & bonds)
 
4. Historically serve as a natural hedge against inflation.
 
5. Portfolios incorporating Managed Futures show
 
substantially less risk at every possible level of
 
expected return than portfolios of stocks (or stocks &
 
bonds) alone.*
 
* Chicago Board of Trade, “Managed Futures”, Publication (2003 edition).
 
Futures trading involves risk of loss and is not appropriate for all investors. Past performance is not indicative of future results
 
 
 

 

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