Alternative Investing
Understanding Managed Futures
November 1, 2010
Topics - Alternative Investing Trend Following Portfolio Construction
Managed futures is an alternative investment that has historically achieved strong performance in both up and down markets, exhibiting low correlation to traditional investments. It was one of the few investing styles that performed well in 2008 as most traditional and alternative investments suffered. As a result, this little understood strategy has attracted much attention.
Hedge funds and commodity trading advisers (CTAs) have pursued managed futures strategies since at least the 1970s, shortly after futures exchanges expanded the set of traded contracts. Still, many investors have shied away from them, perhaps due to a lack of understanding of how and why they work.
The primary driver of most managed futures strategies is trend-following or momentum investing — that is, buying assets that are rising and selling assets that are declining. These strategies are typically applied to liquid exchange-traded futures contracts on various commodities, equity indices, currencies or government bonds.
Trend-following strategies only work if price trends continue more often than not. But why should they? One explanation comes from Daniel Kahneman and Amos Tversky’s Nobel Prize-winning work on behavioral economics in the 1970s and a subsequent large body of research that links behavioral biases to underreaction in market prices.
This paper demonstrates the potential strong performance and diversification benefits of a simple managed futures strategy. The simple portfolio shows explicitly how a managed futures strategy can be implemented in an attempt to demystify the asset class. The hypothetical Simple Managed Futures Strategy has produced strong returns in both bear and bull markets, and has performed consistently across markets.
This document is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein.
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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither AQR nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Diversification does not eliminate the risk of experiencing investment losses.
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