Diversifying with managed futures could improve risk-adjusted returns, says Forward
Historical analysis suggests that diversifying portfolios with managed futures may enable investors to earn better risk-adjusted returns, according to a white paper from Forward.
Titled Managed Futures: Stepping Up the Quest for Portfolio Diversification, Forward's white paper notes that managed futures strategies historically have maintained very low correlations to stock and bond indexes while producing equity-like returns.
Over the 32-year period ending 31 December, 2011, the Barclay CTA Index achieved a compound annualised return of 11.16 per cent versus annualised gains of 11.06 per cent for the S&P 500 Index and 8.69 per cent for the Barclays Capital US Aggregate Bond Index. During the same period the CTA Index also experienced somewhat less overall volatility and substantially lower drawdowns than the S&P 500.
Significantly, the CTA Index showed positive returns during the dot-com crash of 2000-2002 and the financial crisis of 2008, years when the S&P 500 sustained major losses.
The paper cautions, however, that the performance and correlations of any specific managed futures strategy may vary substantially from that of the CTA Index, which tracks performance of a peer group of managed futures strategies.
"While there may be no perfect all-weather strategy, managed futures strategies have a record of zigging when equity markets zag. As a group they have also maintained their low correlations to many other asset classes during a time when correlations have generally been rising," says Forward chief executive Alan Reid (pictured). "In light of this, it's not surprising that managed futures has been among the fastest-growing non-traditional investment categories."
Assets under management by commodity trade advisors (CTAs), which historically have dominated managed futures investing, grew from USD38bn at the end of 2000 to USD314bn by the end of 2011. CTAs are limited partnerships that are restricted to wealthy investors and charge hedge-fund-style performance fees.
Over the last five years, the availability of managed futures mutual funds has made the strategy more broadly accessible while lowering fees, relative to limited partnership vehicles, and providing daily liquidity, states the Forward white paper. Since the introduction of the first such mutual fund in 2007, the number of managed futures mutual funds has grown to 31 funds with total assets of nearly USD9bn, according to Strategic Insight as of 31 May 2012.
Forward's white paper includes discussion of the various kinds of managed futures strategies, most of which use some type of systematic, trend-following approach. It also traces the use of futures contracts back to 17th century Japan and describes how managed futures strategies evolved from a commodity-focused approach to a dynamic, multi-asset-class strategy in the 1970s and '80s.
"Because many investors are unfamiliar with how futures markets operate, managed futures are often assumed to be exotic, complex and risky. But given the track record and diversification potential of these strategies, we strongly believe it is worth the time it takes to explore them," says Norman Mains, a managing director of Forward and principal author of the white paper.
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