Benefits of Managed Investments

Friday May 18, 2012

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Benefits of Investing in Managed Futures

By their very nature, managed futures provide a diversified investment opportunity. Trading advisors can participate in more than 150 global markets; from grains and gold to currencies and stock indices. Many funds further diversify by using several trading advisors with different trading approaches. In this example, the overall risk is reduced by almost 82 percent from –41.0 percent to –7.5 percent and the return also increases almost 20 percent from +7.4 percent to +8.9 percent. This is mainly due to the lack of correlation and, in some cases, negative correlation between some of the portfolio components in the diversified portfolio. There is even negative correlation between stocks and managed futures as the two markets move independently from each other.

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

Potential to lower overall portfolio risk
Opportunity to enhance overall portfolio returns
Broad diversification opportunities
Opportunity to profit in a variety of economic environments
Limited losses due to a combination of flexibility and discipline

Potential to Lower Overall Portfolio 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. Moreover, managed futures funds generally perform well during adverse economic or market conditions for stocks and bonds, thereby providing excellent downside protection in most portfolios.

One of the tenets of modern portfolio theory, as developed by Nobel prize-winning economist Professor Harry M. Markowitz, is that more efficient investment portfolios can be created by diversifying among asset classes with low to negative correlations. Adding a managed futures fund to a portfolio of traditional stocks and bonds has the potential to reduce risk and improve performance.

Always consider an investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. Performance can vary based on the manager that trades the account. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

Opportunity to Enhance Overall Portfolio Returns

While managed futures can decrease portfolio risk, they can also simultaneously enhance overall portfolio performance. The following chart illustrates that adding managed futures to a traditional portfolio improves overall investment quality while also potentially reducing risk. This has been substantiated by an extensive bank of academic research, beginning with the landmark study by Dr. John Lintner of Harvard University in which he wrote: “… 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.”

1) Managed futures: CASAM CISDM CTA Equal Weighted;
2) Stocks: MSCI World;
3) Bonds: JP Morgan Government Bond Global;
Source: Bloomberg

Including up to 20 percent of total investments in managed futures funds enhances portfolio diversity and therefore promotes greater independence from general market moves.

An investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. Performance can vary based on the manager that trades the account. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

Broad Diversification Opportunities

Managed futures are highly flexible financial instruments traded on many regulated financial and commodity markets around the world. By broadly diversifying across global markets, managed futures can simultaneously profit from price changes in stock, bond, currency and money markets, as well as from diverse commodity markets having virtually no correlation to traditional asset classes.

DIVERSIFICATION OF FUTURES MARKETS

The above list is only a partial list of the futures products currently available around the world. Source: FIA 2007

International futures exchanges are continuing to adapt to growing consumer demand with more and more new futures contracts entering the market. In recent years, futures contracts were issued on ethanol, water and even the weather.

An investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. Performance can vary based on the manager that trades the account. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

EASE OF GLOBAL DIVERSIFICATION
The substantial growth of futures exchanges across the globe afford trading advisers countless opportunities to diversify their portfolios by geographic markets, as well as by product. Trading advisers thus have ample opportunity for profit potential and risk reduction among a broad array of non-correlated markets. Investing in managed futures on a global scale provides protection against geospecific variables such as poor weather or political unrest, which could affect some commodities or financial futures more than others.

Opportunity To Profit in a Variety of Economic Environments

Managed futures trading advisers can generate profit in both increasing or decreasing markets due to the their ability to go long (buy) futures positions in anticipation of rising markets or go short (sell) futures positions in anticipation of falling markets. Moreover, trading advisors are able to go long or short with equal ease. This ability, coupled with their virtual non-correlation with most traditional asset classes, have resulted in managed futures funds performing well relative to traditional asset classes during adverse conditions for stocks and bonds.

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. Conversely, 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 advisers can even use strategies employing options on futures contracts that allow for profit potential in flat or neutral markets.

This ability to accommodate and protect against unpredictable events can be invaluable in today’s volatile global markets.

As the above chart shows, during the stock market crash in 1987, panic hit the stock markets following the largest one-day loss in history. Managed futures reported above 20 percent returns. Similarly after the terrorist attacks of 9/11, the stock market plummeted 16.3 percent. In contrast, managed futures gained 8.3 percent in the same period.

Limited Losses Due to a Combination of Flexibility and discipline

An investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. POTENTIAL TO LIMIT DRAWDOWNS

Drawdowns, or the reduction a fund might experience during a market retrenchment, are an inevitable part of any investment. However, because managed futures trading advisors can go long or short – and typically adhere to strict stop-loss limits – managed futures funds have limited their drawdowns more effectively than many other investments. As the following chart shows, drawdowns for managed futures have been less steep than those for major global equity indices.

Again, an investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. Performance can vary based on the manager that trades the account. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

ABILITY TO RECOVER QUICKLY
Additionally, managed futures generally have shorter recovery times from drawdown periods. This is due in part to the ability to use short trading to take advantage of falling markets, as well as the fact that managed futures often have lower losses to recover. Unable to use short trading to take advantage of falling markets, traditional stock indices may experience extreme drawdowns in bear markets. With reference to the previous chart, the maximum drawdown for stocks was –44.7 percent during the period of 09/2000 through 09/2002. It takes much longer to make up for such large drawdowns. To simply recover, the stock index needed to regain almost 80 percent of its new low level.

Ability to Invest Tax Deferred Funds Through a Self Directed Individual Retirement Account (IRA)

As stated above, futures strategies can offer investors a number of benefits. In addition to being able to invest money from an ordinary account into the futures market, investors can also capitalize on those benefits in a tax-deferred Individual Retirement Account (IRA).

For most investors, IRA investments are generally limited to stocks, bonds and mutual funds because most investors are not aware of the many different kinds of investments which can be made through an IRA. A vast majority of financial institutions which offer IRAs, typically limit investment options to stocks, bonds, and mutual funds.

Contrary to most typical IRAs, there are certain trust custodians who accept futures accounts. Such IRAs are often referred to as “self directed” IRAs. When you roll your assets into a self directed IRA, the assets can continue to grow tax deferred.

Before placing IRA funds into a futures account, funds from an IRA must be invested through a “self directed” IRA because an investor could suffer tax consequences if he transferred money from an IRA directly into a futures account. In order to avoid such tax consequences, the investor can trade futures through a self directed IRA that is held at a trust company. “Self directed” IRAs allow you to invest in managed futures, while still maintaining tax deferred growth because the assets are contained in an IRA.

If you do not already have a self directed IRA that accepts futures trading, you will have to open a self directed IRA through a trust custodian, and then open a futures account under the trust custodian’s name. There are several trust companies or trust custodians that offer self directed IRAs that can utilize the futures and options markets. Your broker, or OEC, if you do not already have a broker, can help you with the process.

Keep in mind, an investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. Performance can vary based on the manager that trades the account. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

Significant Tax Savings

Profits generated from futures transactions are taxed at the rate of 60% long term capital gains and 40% short term capital gains. All short term stock transactions are taxed at the short term capital gains tax rate. In the highest income brackets that would mean a tax saving of 30%.