|When a bull market prevails investors rarely complain. On the other hand, in a world of lower equity returns financial advisors and institutional planners turn to alternative assets. Why? Basically, because adding alternatives to a portfolio of traditional assets may potentially lower risk and increase returns. At the end of 2019, over $1.6 trillion was allocated among these alternative strategies:
|Source: Barclay Hedge, 2019, calculated by Arrow.
|Managed futures strategies account for 20% of the overall alternative market. They have grown in popularity for the past few decades. Yet they remain a mystery to many investors. The term “managed futures” comes from commodity trading advisors (CTAs) who manage accounts on behalf of high net worth clients and institutional investors. CTA managed futures accounts have grown in popularity from $10 billion in assets under management (AUM) in 1990 to more than $295 billion through the end of 2019.In 2007, managed futures became available in liquid instrument like mutual funds, which represent over 6% of the market share within that asset class.
Growth of Managed Futures
Source: Barclay Hedge and Morningstar, 2019, calculated by Arrow.
|Although today’s managed futures traders use very complicated algorithms and trading systems, the central story behind managed futures is grounded in the basic principles of supply and demand. Futures contracts were originally created in the mid-1800s to help farmers control seasonal price changes for their crops while helping the buyers of crops manage swings in production costs. The price of a crop was often lower right after the harvest because there was so much available from all the various farmers. But as the season ended, the supply of crops diminished and the prices would increase.|
This method of variable supply and demand pricing was quite erratic. To help stabilize these fluctuations, buyers and sellers created contracts in which they agreed upon a predetermined price for delivery of the crop at a designated time in the future. These contracts allowed farmers to lock in a price for the entire season and helped reduce the risks of changing demand. For manufacturers who relied on the crops, the contracts stabilized their costs and guaranteed continuous delivery for production.
This new method of future crop pricing became so popular that soon there was enough demand to open an organized futures market in a centralized location. So, in the late 1840s the Chicago Board of Trade (CBOT) was created. Chicago was a popular location for farmers from the mid-west to meet with manufacturers who were largely concentrated in the more industrialized east coast region. This CBOT attracted speculators who began to trade the contracts with one another for profit. The presence of speculators was generally welcomed by farmers and manufacturers as it led to increased trading volume and created far greater liquidity, which helped to narrow the spreads of sometimes wildly fluctuating seasonal price swings.
The 1970s and 1980s brought about the creation of financial futures instruments. Just like farmers and manufacturers, the financial markets needed a way to hedge against inflation, market volatility and foreign currency fluctuations. Similar to commodity futures, financial futures contracts help establish a price today for the future delivery of stocks, bonds and currencies. The combination of commodities and financials, along with electronic trading, has helped the futures market grow into a truly worldwide place of commerce.
The reason for the growth in popularity of managed futures is quite clear. Managed futures are a compelling choice for investors seeking portfolio diversification, exposure to nontraditional assets, and access to directional trading strategies. One of the key benefits of managed futures is their low correlation to traditional assets, which makes them an attractive and efficient portfolio diversification tool.
Many of the more popular managed futures investments use long/short trend-following systems to identify opportunities during both rising (long) and falling (short) markets. The long/short nature of managed futures has allowed for periods of historically strong performance even during periods of stress in the equity markets. It is precisely this lack of correlation that makes managed futures so attractive to investors seeking improved portfolio diversification. The table below illustrates the types of investment objectives within the managed futures market.
Source: Barclay Hedge, 2019, calculated by Arrow.
The equity markets in the decade of the 2000s
were marked by two distinct bear market periods: a bear market and the
financial crisis. The first three years of the decade saw a bear market
resulting from the Internet bubble burst. Then the financial crisis of 2008, this
was the aftermath of the subprime lending crisis which led to a litany of other
problems around the globe. During both of these periods the equity
markets experienced extreme volatility. Although past performance should never
be used as an indication of forward-looking returns, the decade covering the
years from 2010 to 2019 does provide an opportunity to review how asset classes
performed during a decade long equity bull market. Also included was the recent
market panic from the Covid19 pandemic, during this crisis the broad equity
markets bottomed in late March. The table measures the market’s
performance over the last 12-month heading into March 31, 2020. The table
below illustrates the performance and volatility risk of various asset classes
during the bear, financial crisis and the pandemic of 2020 and bull markets
over the last decade. Over the last decade the table also shows the correlation
of each asset class relative to the S&P 500.
Past performance is not indicative of future returns. Risk data is illustrated using standard deviation, a statistical measurement of
volatility based on historical returns, where a lower number indicates less historical volatility. Correlation measures how closely two securities’
movements are associated, ranging from 1.0 (highly correlated) to -1.0 (inversely correlated).
Conclusion: For many years, only accredited high net worth clients and institutional investors could gain access to managed futures. Many private managed futures investments require exclusive pre-qualification guidelines or large initial deposits to open a direct managed account. But now, thanks to a new breed of alternative mutual funds, individual investors can easily access the potential benefits of managed futures. These open-end mutual funds allow for greater transparency, liquidity and lower minimums with the same regulatory oversight as other more traditional mutual funds. The world of managed futures is no longer exclusive as individual investors are now able to gain exposure to investments once reserved for the ultra-wealthy.
Past performance is not indicative of future returns. Historical data may be used for illustrative purposes only and should not be used as a predictive measure for the future return expectations of any investment. This information is based on hypothetical strategies and should not be construed as a recommendation of any specific security or investment product. The information was prepared without regard for specific circumstances and objectives of any individual investor. Managed futures investing involves risks, including the potential for loss of principal.
Data source: Morningstar/Ibbotson and Bloomberg. Asset class proxies: U.S. Stocks (S&P 500 Index); International Stocks (MSCI EAFE); Bonds (Barclays Aggregate Bond Index); Commodities (S&P GSCI); Managed Futures High Vol (DUNN World Monetary & Agriculture); Managed Futures Low Vol (Barclay TOP 50 Index). Index returns assume reinvestment of all dividends and do not reflect any management fees, transaction costs or expenses. The indexes are unmanaged and are not available for direct investment.
Before investing, please read the prospectus and shareholder reports to learn about the investment strategy and potential risks. Investing involves risks, including the potential for loss of principal. An investor should consider the fund’s investment objective, charges, expenses and risks carefully before investing. This and other information about the fund is contained in the fund’s prospectus, which can be obtained by calling 1-877-277-6933. Content reviewed by an affiliate, Archer Distributors, LLC.