Introducing Clients to Managed Futures
As market trends shift and economic cycles rotate, so should investors’ portfolios. A statically held allocation of stocks and bonds has proven to provide the returns as well as income needed since the early 1980’s. However, as we head into a period of rising rates for the foreseeable future, bonds appear to lose their strength as a diversified return driver. And as stocks have reintroduced fear to clients through volatility, the second longest bull market in history doesn’t offer much confidence to soon-to-be retirees. Where does this leave investors the opportunity to accumulate wealth and minimize portfolio swings?
The asset class is by no means as simple to explain as stocks (fractional ownership in a revenue generating company) or bonds (contractual obligation to pay interest and principal on borrowed capital). However, an explanation of the asset class can be summarized as investing in:
Multiple asset classes (Equities, Interest Rates, Currencies, & Commodities)
Through futures contracts, a legal agreement to buy or sell a commodity or financial instrument at a predetermined price at a specified time in the future (Investopedia)
Going Long (Expecting the asset to rise in value) or Short (Expecting the asset to decline in value)
This is just a cursory description of what managed futures is, however clients will certainly want to know why it is beneficial to add it to their portfolio.
Since managed futures invests (long and short) in numerous asset classes, and a large set of markets within each asset class, managed futures has the proven ability to produce positive absolute returns independent of market conditions. By being able to capture the returns during an equity bull market, such as 2017, or provide crisis alpha during a bear market, such as 2008, managed futures proves itself as an uncorrelated diversifier.
As Investopedia describes it:
“The potential benefits of managed futures are that the investments may help diversify one's portfolio and, under some conditions, minimize risk. For example, investing in currencies abroad may mitigate domestic risk. Managed futures may also help the individual to profit or minimize risk during periods of slow economic growth.”
If clients love the sound of the strategy, there should be a talk on what to expect when investing in managed futures. Holding this asset class tactically will typically lead to disappointment as the strategy provides returns over the long-term cycle. Implementing the strategy as just a hedge is missing out on much of the alpha provided during prolonged bull markets as well.
To avoid going into academic terminology with clients (we’ll save the kurtosis and skew discussion), it should also be noted that managed futures will provide down days and months more often than up. Said another way, managed futures doesn’t have a great batting average. However, due to the risk management approach often employed in this strategy, the losses should be shallow and expected. When managed futures does catch the profitable trends, they are often large, prolonged, and more than compensating for the previous drawdown. This is another reason the strategy is meant to be held for the long-term.
An introductory discussion with clients as to what managed futures is, and its value on a portfolio could be what helps achieve the retirement goals as market cycles begin rotating.