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OVERVIEW


The term managed futures represents an industry comprised of professional
money managers known as commodity trading advisors (CTAs) who manage
client assets on a discretionary basis, using global futures and options
markets as an investment medium. However, for managed futures to grow
as an investment alternative, individuals need to increase their knowledge
of and comfort level with the use of managed futures in their investment
portfolios.
Exactly what are the benefits of managed futures as part of an investor’s
overall asset portfolio? Basically, managed futures provide direct exposure
to international financial and non-financial asset sectors while offering

(through their ability to take both long and short investment positions easily)
a means to gain exposure to risk and return patterns not easily accessible
with investments in traditional stock and bond portfolios. Investors must
come to appreciate that the investment benefits in managed futures are wellfounded
in financial theory and empirical evidence. Although it is impossible
to convey all the details of the benefits of managed futures in a short
synopsis, this chapter supports managed futures as a means to


Reduce portfolio volatility risk

Enhance portfolio returns in economic environments in which traditional
stock and bond investment media offer limited opportunities

Participate in a wide variety of new financial products and markets not
available in traditional investment products

GROWTH AND BENEFITS OF MANAGED FUTURES

Futures and options have been used for centuries as both a risk management
tool and a return enhancement vehicle. Yet, managed futures, as an investment
alternative, have been available only since the late 1960s. Today, institutional
investors, such as corporate and public pension funds, endowments
and trusts, and bank trust departments as well as high net-worth individuals,
include managed futures as one segment of a well-diversified portfolio.
As Figure 3.1 illustrates, the dollars under management for CTAs in the
managed futures sector grew from less than $15 billion under management
in 1995 to approximately $30 billion in 2000. Moreover, this number does
not include the billions of dollars under management or in proprietary trading
programs of major financial institutions, which trade similar strategies,
but which do not report to traditional data sources. Assets under management
in publicly traded funds or private pools remained in the range of $8
billion to $10 billion dollars over the period from 1995 to 2000.
This growth in investor demand for managed futures products indicates
investor appreciation of the potential benefits of managed futures—for
example, reduced portfolio risk, potential for enhanced portfolio returns,
ability to profit in different economic environments, and the ease of global
diversification. Futures/options traders receive other special benefits compared
to trading traditional asset classes—for example, lower transaction
costs, lower market impact costs, use of leverage, and trading in liquid markets.
In addition, the market integrity and safety of trading on organized
exchanges for futures/options contracts provide further assurances of transparency
and regulation.

MANAGED FUTURES: RISK AND RETURN
PERFORMANCE

Although funds placed with CTAs have often been regarded as high-risk
investments, over the period from 1990 to 2000, the average annualized standard
deviations of individual CTAs and the average annualized standard
deviations of the 30 individual stocks in the Dow Jones Industrial Average
were similar—that is, approximately 25 percent.1 More important, investment
theory has shown that assets should be compared on the potential
benefit of their improving a portfolio’s Sharpe ratio—such as, (mean return
 risk free return)/standard deviation. Results (see Table 3.1) show that, over
the 11 years from 1990 through 2000, investment in a portfolio of CTAs
(Zurich CTA$ in this study) provides both stand-alone risk and return benefits
generally similar to existing U.S. and world stock and bond investments
as well as increased Sharpe ratios (return-to-risk ratios) when considered as
an addition to widely diversified asset portfolios.2
For stocks, bonds, and CTA$, the individual Sharpe ratios are
Zurich CTA$ (0.60)
S&P 500 Index (0.71)
Lehman Brothers Government/Credit bond index (0.58)
Lehman Brothers World Government bond index (0.30)
MSCI world stock index (0.27)
At the portfolio level, the Sharpe ratio of the portfolios (Portfolio III
of U.S. markets and VI of world markets) that include an investment in


ALTERNATIVE RISK/RETURN OPPORTUNITIES


Table 3.2 for the period 1990—2000 displays the performance of the Zurich
CTA$ and various Zurich CTA strategy-based subsets as well as their correlation
with other CTA-based investment strategies. In general, the correlation
of CTA strategies with other CTA strategies depends on the degree to
which the strategies are based on trend-following or discretionary
approaches. Because most CTAs follow trend-following strategies, the overall
dollar-weighted and equal-weighted indices are also highly correlated with
other CTA strategies dominated by trend-following indices.
Table 3.3 displays the return and risk performance of the Zurich CTA
strategies as well as their correlation with traditional stock and bond indices.
On average, the correlations of the Zurich CTA$ and various Zurich CTA
strategy-based subsets with traditional stock and bond indices are often close
to zero. However, as shown in Table 3.4, CTAs may offer unique risk diversification
benefits, especially in periods in which equity markets perform
poorly. For instance, as Table 3.4 shows for the period from 1990 through
2000, the Zurich CTA$ is negatively correlated (0.30) with the S&P 500
Index when the S&P 500 Index posted its 44 worst months, yet it is positively
correlated (0.17) when the S&P 500 Index reported its best 44
months.
In contrast, as Table 3.4 and Figure 3.3 illustrate, other alternative
investment strategies, such as equity-sensitive hedge funds (event-driven or
global established), often have higher positive correlation with equity markets
when the equity markets are falling than when the equity markets are
rising. Thus, they may not provide the diversification benefits with equities
offered by CTAs.3
The benefits of CTA investment in periods of extreme S&P 500 Index
return movement is further illustrated in Figure 3.4, which indicates that,
when S&P 500 Index returns were ranked from low to high and divided into
four 33-month sub-periods, managed futures offered the opportunity to
obtain positive returns in months in which the S&P 500 Index provided negative
returns as well as in months in which the S&P 500 Index reported positive
returns. In contrast, certain alternative investments, such as equity-based
global established hedge funds, had negative returns in just those months in
which the S&P 500 Index also performed poorly.
46 MANAGED FUTURES
Alternative Risk/Return Opportunities 47
TABLE 3.2 Correlation
Zurich
Zurich Zurich Zurich Zurich Zurich Zurich Trend-
CTA$ CTAEQ Currency Discretionary Diversified Financial Following
Zurich CTA$ 1.00
Zurich CTAEQ 0.94 1.00
Zurich Currency 0.70 0.68 1.00
Zurich Discretionary 0.62 0.52 0.43 1.00
Zurich Diversified 0.93 0.92 0.56 0.58 1.00
Zurich Financial 0.92 0.87 0.63 0.45 0.83 1.00
Zurich Trend-Following 0.96 0.95 0.72 0.50 0.92 0.93 1.00
48 MANAGED FUTURES
TABLE 3.3 Performance: Zurich CTA Universe Strategies and Traditional
Assets (January 1990 to December 2000)
Sharpe Minimum Correlation Correlation
Return Stdev Ratio Monthly S&P 500 Lehman Bond
Zurich CTA$ 11.8% 10.4% 0.60 6.0% 0.06 0.24
Zurich CTAEQ 9.7% 9.8% 0.43 5.4% 0.09 0.20
Zurich Currency 10.8% 13.2% 0.40 8.2% 0.00 0.16
Zurich 12.9% 7.2% 1.01 4.6% 0.05 0.18
Discretionary
Zurich Diversified 10.1% 12.1% 0.37 7.5% 0.09 0.23
Zurich Financial 12.0% 13.6% 0.48 8.6% 0.02 0.32
Zurich Trend- 10.9% 16.5% 0.32 10.4% 0.07 0.24
Following
S&P 500 15.4% 13.9% 0.71 14.5% 1.00 0.37
Leh. Bros. 8.0% 4.2% 0.58 2.5% 0.37 1.00
Gov./Corp
TABLE 3.4 Correlations in Best and Worst 44 S&P 500 Ranked Months
(1990 to 2000)
Worst Best
All S&P S&P 500 S&P 500
Months 44 Months 44 Months
Managed Futures
Zurich CTA$ 0.06 0.30 0.17
Zurich CTAEQ 0.09 0.37 0.22
Zurich Currency 0.00 0.14 0.26
Zurich Discretionary 0.05 0.08 0.03
Zurich Diversified 0.09 0.43 0.16
Zurich Financial 0.02 0.31 0.22
Zurich Trend-Following 0.07 0.35 0.23
Hedge Funds
Zurich Event Driven Universe 0.47 0.64 0.16
Zurich Fund of Funds Universe 0.52 0.61 0.09
Zurich Global Established Universe 0.78 0.71 0.34
Zurich Market Neutral Universe 0.31 0.55 0.15
Traditional Assets
Lehman Gov./Corp. Bond 0.37 0.03 0.03
Alternative Risk/Return Opportunities 49
Correlation in Best Forty-
Four S&P Months
Correlation in Worst
44 S&P Months
-0.40 -0.20 0.00 0.20 0.40 0.60
Event Driven
Fund of Funds
CTA$ Market Neutral
Global
Established
0.80
-0.20
-0.10
0.00
0.10
0.20
0.30
0.40