Managed futures funds offer investors opportunities to generate positive returns even in down markets while also reducing volatility, but advisors say individual investors should be wary of the complex investments.
Unlike regular mutual funds, managed futures funds don't invest directly in stocks or bonds. Instead they buy and sell futures contracts, as well as options, swaps and other derivatives. Futures contracts give the right or obligation to buy or sell a financial instrument such as a stock or bond, a commodity or a currency.
Managed futures funds may take long positions, betting that the underlying asset will increase in value. Or they may take short positions, betting that the asset will decline in value. They may also use leverage, investing with borrowed money. Other mutual funds are generally prohibited from taking short positions, owning derivatives and using leverage.
Managed futures funds are essentially hedge funds that have made some changes to allow them to be sold to retail investors like mutual funds. A decade ago, managed futures funds oversaw $170 billion, according to alternative investment research firm BarclayHedge. The funds grew in popularity after 2008-2009 and in 2016 have almost $334 billion under management.
Advisors say managed futures funds can add diversity to a portfolio, because their returns do not generally track stocks and bonds. This lack of correlation with traditional investments can dampen market swings and is the funds' major attraction.
"We use it in our portfolios for one reason only," says William G. Dorriety, a certified financial planner and president of Optimum Group in Spanish Fort, Ala. "This is strictly an addition to help smooth the volatility."
Dorriety says he generally advises clients to invest no more than 5% in managed futures. High leverage, managers' need to make accurate bets and difficulty in evaluating managers all mandate caution, he says. "It is very sophisticated," he says. "You need to have a wealth of experience or you can lose money fast."
Managed fund managers typically command fees of 2% of assets under management and higher, more than most mutual fund managers. "Certainly the costs are high, which is why the mutual funds companies have started these up," says Rob Brown, chief investment officer of United Capital in Dallas. "They can put a very high expense ratio on them and earn a lot of money."
Brown is not convinced that the sales pitch about diversification and non-correlation to traditional investments holds up. Futures contracts derive their value from stocks and bonds as well as commodities and currencies, he notes. "It isn't as if it is a completely different asset class," he says.
Managed futures funds do not always perform better than or differently from other investments. The Barclay CTA Index of managed futures funds gained 0.95% in the first four months of 2016, almost identical to the unmanaged S&P 500 Index's performance over the same period.
The Securities and Exchange Commission recently proposed tightening restrictions on use of leverage and other risk-related practices of managed futures funds in an effort to protect investors. While generally opposed by the industry, the proposal has been lauded by the Consumer Federation of America.
For most investors, advisors recommend that managed futures funds represent no more than a small portion of a portfolio, if that. Even with the flat returns generated by stock and bond markets since 2014, traditional mutual funds that take long-only positions and don't use derivatives or leverage should represent the core if not the entirety of a portfolio's non-cash portion, they say.
"In managed futures, there's no inherent return," Brown says. "It's a zero-sum game. If you're going to make money, somebody else has to lose it. So you have to be investing in unbelievable skill. You have to invest in somebody who knows what's going to happen before it happens. That's a tough battle."