Diversification is a tool that investors use when building a portfolio in order to reduce risk while still maintaining a good rate of return. Largely, that diversification is done primarily by using a mixture of stocks and bonds. Other asset classes like real estate or gold have historically been added to the mix. All of this works well … until it doesn’t. The last few years of higher interest rates, high volatility and losses across all asset classes at the same time have thrown diversification principals for a loop.
But it doesn’t have to be that way.
The answer to this issue may be in looking outside the box. In this case, we’re talking about managed futures. The strategy — once reserved for hedge funds and high-net-worth families — can now be tapped with bread & butter ETFs. Investors of all sizes may want to follow the strategy.
A Focus on Derivatives
When building portfolios, investors focus on the actual ownership of assets: buying shares of stock, owning a bond, or even purchasing a building. But there is another way to own assets, and that’s synthetically. This gives way to the modern derivatives market place. Originally a way for investors to hedge their ownership or to secure raw materials at a later date for their production, the modern derivatives marketplace has ballooned into a behemoth of epic propositions. Just how big? Some estimates peg the world’s market for derivatives at over $1 quadrillion dollars. This dwarfs both the world’s stock and bond markets combined.
It’s here that managed futures take hold.
Managed-futures strategies generate returns by trading derivative’s contracts, including exchange-cleared and regulated futures, options, and currency forward markets. Strategies among commodity trading advisors (CTA) and commodity pool operators (CPO) vary and can focus on trend trading, one segment of the market such as natural resources or index futures, or a blend of different strategies. They can also be long or short, or a combination of the two.
Why Bother?
While managed futures may be a relatively new idea for retail investors, hedge funds, institutional investors and high-net-worth investors have been dabbling with them for years. The reason is simple — they generate so-called steady and absolute returns.
Absolute returns basically mean that an asset class makes money no matter what the market or economy is doing. The idea isn’t necessarily to outperform in a given year or to knock it out of the park, but to steadily return 3 to 5% year in, year out.
By and large, they have delivered on that promise. The Société Générale CTA Index, which is an index of popular managed futures strategies, has managed to gain 4.8% annually from January 2000 through May 2024. This has trailed the equity-focused Morningstar Global Markets Index, but has managed to beat the bond benchmark, the Morningstar Global Core Bond Index.
The secret to those steady returns happens to be that managed futures have delivered those returns with lower volatility than stocks or bonds. Big price swings and volatility can actually hinder the overall long-term total return of an asset class. This phenomenon is called volatility decay and underscores how average annual returns aren’t necessarily the same as what investors have truly received in an asset class.
You can see this play out in the below chart from Morgan Stanley. Looking at the Barclay CTA Index — which differs from the previous Société Générale CTA Index by expanding its holdings to 412 from 20 — and the drawdowns from the S&P 500, you can see how the NAV of the futures index has continued to move higher despite the broader index realizing drawdowns.
Source: Morgan Stanley
Additionally, managed futures may offer something that is becoming scarce in the current marketplace: true diversification.
When comparing managed futures to other asset classes, futures have very low and negative correlations to a variety of asset classes. This is key, and also what makes diversification work. For example, futures are only 0.02 correlated to the broader stock market and offer a negative 0.02 correlated to the broader U.S. bond market. Even when looking at hedge funds, managed futures offer just a 0.21 correlation to the asset class. 1
The ‘why bother with managed futures’ answer is simple. With the strategy, investors are able to get steady returns while providing actual diversification for their portfolios. That’s a huge win for portfolio construction and underscores why using the asset class is a powerful tool. For example, adding managed futures to a classic 60/40 stock/bond portfolio increases returns by roughly 2% annually according to research conducted by investment manager AQR. 2
Adding Managed Futures to a Portfolio
With managed futures, investors can have a steady asset class that can deliver no matter what. That’s a huge selling point when building a portfolio or model. Adding in a dash of futures can be a great choice to deliver on a variety of long-term goals and can potentially replace bonds as a source of stability.
The best part is that getting access to managed futures has never been easier. As we said in the opening, the asset class was once reserved for larger and institutional investors. Qualified investors would have to use a CTA or be a client at an investment bank to add exposure. Not so today. Thanks to the ETF boom, there are now numerous managed futures ETFs on the market.
With these funds, investors can have access to both index or active management within the sector. The key with selecting managed futures funds is to open the hood and understand what you are buying. Taxes can vary, with some funds being structured as partnerships providing a K-1 statement at tax time. Moreover, investors need to know what the fund owns and what areas it focuses on.
Active Large-Cap Growth ETFs
These ETFs were selected on their ability to tap into the managed futures strategy. They have AUM between $142M and $1.02B and expenses between 0.65% and 1.01%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| DBMF | iMGP DBi Managed Futures Strategy ETF | $767M | 14.3% | 3.5% | 0.85% | ETF | Yes |
| CTA | Simplify Managed Futures Strategy ETF | $159M | 12.4% | 6.9% | 0.78% | ETF | Yes |
| FMF | First Trust Managed Futures Strategy Fund | $141M | 6.6% | 3.2% | 1.01% | ETF | Yes |
| KMLM | KFA Mount Lucas Managed Futures Index Strategy ETF | $253M | 3.1% | 0% | 0.90% | ETF | No |
| WTMF | WisdomTree Managed Futures Strategy Fund | $197M | 2.9% | 0% | 0.65% | ETF | Yes |
Overall, managed futures represent a unique asset class for portfolio construction. They can provide steady absolute returns while providing low correlation to standard and even other alternative asset classes. This makes them a top choice for investors looking to build a portfolio or add them to a model for diversification benefits.
Bottom Line
Diversification and steady returns await those investors in managed futures. The asset class — once reserved for institutional and qualified investors — can now be tapped by regular Joes and their advisors with ETFs. That’s great news, as everyone can now benefit from their non-correlated nature and absolute returns.
1 Morgan Stanley (May 2024). Managed Futures as a Potential Solution to Market Volatility
2 AQR (December 2010). Understanding Managed Futures