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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. 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.
The benefits of managed futures within a well-balanced portfolio include:
1. Opportunity to balance portfolio volatility risk.
The main benefit of adding managed futures to a balanced portfolio is the potential to decrease portfolio volatility. Risk reduction is possible because managed futures can trade across a wide range of global markets that have virtually no long-term correlation to most traditional asset classes. (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. Opportunity to enhance overall portfolio returns
Adding managed futures to a traditional portfolio improves overall investment quality while also potentially reducing risk. This is substantiated by an extensive bank of academic research, beginning with the landmark study of the late 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."
3. Opportunity to profit in a variety of economic environments
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 investments 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. Opportunity to easily participate in global market investments.
Managed futures accounts can participate in at least 50 different markets worldwide, including stock indexes, agricultural and tropical 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.
The study below by Barclay’s Hedge is an updated study published by CME Group in their brochure Portfolio Diversification Opportunities, showing the effect managed futures had when combined in a stock and bond portfolio. The statistics were not based on theory but actual performance statistics from the sources listed. Earlier academic research concluded that managed futures can potentially increase performance and reduce risk in an overall investment portfolio. As one can see, this “theory” is backed by actual performance statistics covering the periods indicated.