Over the long term, managed futures are likely to do better than stocks, according Ernest Jaffarian, chief executive office of Efficient Capital Management. Also known as commodity trading advisers (CTAs), these funds use futures to bet on the likely direction of currency, bond, equity and commodity markets on the basis of buy or sell signals from computer models based on technical analysis.
“People are saying managed futures’ ability to make money has gone,” said Jaffarian. “But over the past 25 years, managed futures have made more money … It takes patience. You won’t get immediate gratification … CTAs have a better risk profile.”
Jaffarian says managed futures funds have little or no correlation to stock indexes, which means they help diversify risk and should be able to make money even when stock markets are falling. “[Managed futures] should receive a meaningful allocation in any well-run, broadly diversified portfolio,” Jaffarian said this week at a London conference on managed futures organised by IQPC. “Allocating 10% of your portfolio to managed futures would be conservative and easily justifiable.”
Managed futures funds have demonstrated in the past that they pay off based on their return-risk ratios, he added. Return-risk profiles – a measure how much additional return can be achieved in exchange for one more unit of risk — are calculated as the ratio of returns over the volatility of those returns. The higher the ratio, the better the profile.
The S&P 500 U.S. benchmark stock market index returned an annual average of 10.64% between January 1980 and January 2005, with a return-risk ratio of 0.7. That compares with 12.17% for managed futures and a return-risk ratio of 0.76, according to the Center for International Securities and Derivatives Markets (CISDM).
Recently, managed futures returned only 5.9 percent in 2004 and lost nearly 5% in the first quarter of 2005, according to data provider CSFB/Tremont. That is below the total return of 10.8 and minus 2.1% respectively on the S&P 500. Even so, CTAs have been drawing in more assets. Their assets amounted to around $120 billion at the end of last year, compared with zero in 1980 and around $50 billion in 2002, according to The Barclay Group, a research firm based in the United States.
Jaffarian reports that Efficient Capital allocates more than $600 million for private banks, insurance companies, funds of funds and wealthy individuals to strategies such as managed futures. Managed futures funds trade on margin, which means that they have to pay only part of the cost of a futures contract. If the price of a contract falls, then the fund has to increase the margin payment to cover it.
These funds should not be tossed into the same bucket as hedge funds, Jaffarian said. One major difference is that hedge funds normally borrow to make bigger investments and incur interest charges. Managed futures portfolios don’t need to borrow to boost returns. Most managed futures funds keep between 70 and 90% of their assets in cash or in securities that can easily be turned into cash. “Hedge funds need capital,” Jaffarian said. “Don’t throw them (managed futures) into the hedge fund space.”
Another feature is that futures are traded on exchanges around the world, which makes them liquid and transparent financial instruments. If necessary, managed futures portfolios can be liquidated quickly, according to Jaffarian. In contrast, some hedge funds offer monthly liquidity, and others won’t take investors’ money unless they commit to at least one year. Some recent launches have demanded lock-ins of up to four years.