CBOT Managed Futures: Portfolio Diversification Opportunities

By Chicago Board of Trade     ISSUE 502 | FEB 2006

What are Managed Futures?

Investment management professionals have been using managed futures for more than 30 years. More recently, institutional investors such as corporate and public pension funds, endowments and trusts, and banks have made managed futures part of a well-diversified portfolio. In 2004, it was estimated that over $130 billion was under management by trading advisors.

The growing use of managed futures by these investors may be due to increased institutional use of the futures markets. Portfolio managers have become more familiar with futures contracts. Additionally, investors want greater diversity in their portfolios. They seek to increase portfolio exposure to international investments and nonfinancial sectors, an objective that is easily accomplished through the use of global futures markets.

The term managed futures describes an industry made up of professional money managers known as commodity trading advisors (CTAs). These trading advisors manage client assets on a discretionary basis using global futures markets as an investment medium. Trading advisors take positions based on expected profit potential.

Four Benefits of Managed Futures

Managed futures, by their very nature, are a diversified investment opportunity. Trading advisors have the ability to trade in over 150 different markets worldwide. Many funds further diversify by using several trading advisors with different trading approaches.

The benefits of managed futures within a well-balanced portfolio include:

• Opportunity for reduced portfolio volatility risk
• Potential for enhanced portfolio returns
• Ability to profit in any economic environment
• Opportunity to participate easily in global markets

1. Reduced Portfolio 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 or 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 risk, they can also simultaneously enhance overall portfolio performance. 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."
   
   In addition, the potential for higher returns using managed futures compares well with other asset classes in terms of risk.



3. Ability to Profit in 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.



4. Ease of Global Diversification
   The establishment of global futures exchanges and the accompanying increase in actively traded contract offerings have 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 noncorrelated markets.

We've provided an edited summary of this CBOT publication; you can download the complete brochure from the managed futures area of our Web Site. The full text of this article further explores managed futures as an investment opportunity, and their use as a portfolio diversification tool. This article was reprinted with permission of the CBOT. You can also visit the CBOT's Web site at www.cbot.com for more information.

Kristina Zurla Landgraf is editor of Lind eWire. She can be reached by email at editor@lind-waldock.com.

Futures trading involves substantial risk of loss and is not suitable for all investors.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

© 2006 Lind-Waldock, a division of Man Financial Inc. All Rights Reserved.