Do you ever feel overwhelmed by the sheer amount of available investment options? You’re not alone — especially when it comes to alternative investments across asset classes, such as managed futures.
Of course, you’ve already heard of stocks and bonds, but you may not know quite as much about managed futures. This alternative investment can help diversify your portfolio, enhance your risk and return profile, and hedge against market volatility.
Read on to learn about two approaches to managed futures: market-neutral and trend-following strategies.
What Are Managed Futures?
Let’s start with the basics: What, exactly, are managed futures? A future is an agreement about buying or selling a commodity or security (i.e., stocks, bonds, or options) at a specific time for a specific price.
Futures — also called futures contracts — allow investors to speculate on the potential direction of a commodity or security. A contract includes an expiration date and locks a set price.
Futures contracts may be used to trade:
- Stock indexes, such as the NASDAQ Composite, S&P 500 and Dow Jones Industrial Average
- Commodities, such as wheat, corn, livestock, oil, coal, gold or copper
- Currency futures, such as the Euro, British pound and Japanese yen
- Precious metal futures, such as gold, silver, platinum and palladium
- U.S. Treasury bonds
Managed futures refer to a portfolio of futures that’s actively managed by a professional broker or adviser. This type of alternative investment provides exposure to more asset classes. Since managed futures aren’t strongly correlated with traditional stocks and bond markets, they’re a great way to diversify your portfolio. This helps protect against market volatility and mitigates risk.
Futures portfolios are managed using a market-neutral or trend-following strategy. Let’s look at each approach.
Market-Neutral Strategy
A market-neutral approach attempts to make a profit from increasing and decreasing prices, all while mitigating risk. This strategy involves taking matching short and long positions in the industry. For instance, you might purchase $5,000 worth of Apple stock, while simultaneously selling $5,000 of Google stock.
In essence, these long and short positions act as hedges to each other, protecting against loss. They work by increasing returns — thanks to spreads creating by mispricing — while reducing the risk that comes from overall market movements.
When utilized properly, the market-neutral approach can allow you to profit from increasing and decreasing stock prices. At the same time, the risk is mitigated, as the focus lies on meeting stock price convergences rather than general market performance. This is because the market-neutral approach isn’t closely correlated with market movements.
There are two kinds of market-neutral approaches:
- Fundamental market-neutral investing: Uses fundamental analysis — or a study of various economic and financial factors that can affect a security’s value — to predict trajectory. Trades are then based on predictions of stock price convergences.
- Statistical market-neutral investing: Applies quantitative methods and algorithms to historical stock performance, with the goal of identifying price discrepancies. Trades are then based on these quantitative past performance indicators.
Trend-Following Strategy
In contrast, the trend-following approach monitors market movements more closely. This type of strategy attempts to profit by going short or long, depending on an analysis of market signals over a certain period.
For instance, if an asset’s price is trending upward, that indicates taking a long position. If the price is on the downswing, taking a short position may be in order.
Sometimes known as momentum investing, it’s based on the idea that market movements aren’t random; instead, rising prices will keep rising while falling prices will keep falling. For futures trading, this means buying contracts when prices are on the rise and selling contracts when prices are lowering.
A trend-following approach attempts to take advantage of the market’s downturns and upswings, using multiple indicators to determine an asset’s direction. Because this strategy is subject to market volatility, trend-following may result in large drawdowns or the percentage of the difference between an investment’s peaks and valleys.
Whether you choose a trend-following or market-neutral approach, investing in managed futures can help balance and diversify your portfolio. This alternative investment offers a way to mitigate risk while hedging against market volatility.
Want to learn more? The accompanying resource further delves into this topic.
Infographic provided by Institutional Advisory Services Group
Author bio: Greg Taunt is Vice President of Institutional Advisory Services Group, a managed futures company. He has more than 10 years of experience in the industry and focuses on maximizing portfolio effectiveness to potentially reduce risk while increasing returns using managed accounts in noncorrelated vehicles.
Sources
https://www.thechartist.com.au/market-neutral-trend-following/
https://www.investopedia.com/terms/m/managed-futures.asp
https://www.investopedia.com/terms/f/futures.asp
