Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
In the ongoing search for more diversification – especially low correlations to stabilize returns in a difficult stock environment – advisors have recently shifted towards alternative investments. From real estate and REITs to gold and other commodities, a recent FPA survey found that 91% of advisors are using some form of alternative investments.
Sadly, though, the focus on finding investments that have a low correlation to equities has grown to such an obsession that we're willing to name anything that has a low correlation as "a new asset class." Indeed, correlation was ranked as the number one criterion for choosing an alternative investment in the FPA’s survey, although that survey did not indicate whether correlation was with respect to equities or other asset classes. While some alternatives truly have their own investment characteristics unique from stocks and bonds, other alternatives – like managed futures – simply represent an active manager buying and selling existing asset classes.
It's about time for us to start distinguishing between a real alternative asset classes (e.g., commodities or real estate) and the value of managed futures.
The inspiration for this article comes from a conversation I had recently with some planners about the use of managed futures in a portfolio as a new "alternative asset class." The planners were considering whether the returns of managed futures had a low enough correlation to be viewed as a different asset class, and they were struggling because some managed futures funds are more correlated to markets than others.
In considering the question, recall what a managed futures fund is in the first place. The managed futures industry consists of commodities trading advisors (CTAs) who invest in futures contracts, generally either using a proprietary trading system/methodology they have developed or simply by investing with discretion. Depending on the manager style and approach, they may go long or short futures contracts, and a manager may use future contracts in any number of market segments, from metals and grains to equity indexes to currencies to bonds.
The prices of futures contracts will fluctuate with the price of the underlying asset (gold, wheat, S&P 500, the Euro, the 10-year Treasury, etc.), although because only a percentage of the futures contract's value is required to trade it, futures trading implicitly involves leverage. Some managed futures funds may try to follow momentum trends; others have more market-neutral strategies.
Nonetheless, price changes for a managed futures fund are a result of price changes in existing asset classes (bonds, equities, commodities, currencies, etc.), which are purchased using a futures contract instead of the underlying investment itself. The overall returns of a managed futures fund are driven by the trading strategies of the fund manager.
