Here Is the Upside to the Futures Market

With the common belief that futures are highly unpredictable and extremely sensitive to global events — what is their upside and place in an investor's portfolio?

Just as in other forms of investing, the answer may lie in the strategies they allow investors to employ.

"While futures, and in particular commodity futures, can be unpredictable, one significant benefit to a managed futures strategy is the ability to go long or short," said Robert Sinnott, co-portfolio manager of the Natixis ASG Managed Futures Strategy Fund with AlphaSimplex Group. "What this means is that a managed futures strategy has the potential to profit if prices are going up or down. Classic equity holdings generally only profit when equities go up."

Sinnott said a good example of how this ability to go short can be valuable to investors is the price of oil during 2015. If someone was an equity holder in one of the big oil stocks, such as Chevron or Exxon, the fall in oil was bad. However in a managed futures strategy, there is the opportunity to be short oil and therefore profit from its decline. Thus with more opportunities, there is a greater ability to produce returns that act differently than equities and less dependency on just a stock going up to generate returns.

One key to investing in futures, however, is to take a diversified approach, he added.

"We generally have exposure, sometimes long and sometimes short, to over 70 different futures contracts across four different asset classes, stocks, bonds, commodities and currencies," said Sinnott.

"We believe this diversification is very important to help mitigate the unpredictable nature of some futures, and in particular the commodity futures," he said. "Rather than trying to pick one commodity or one asset class, with a broadly diversified Managed Futures strategy, an investor can benefit from the diversification these futures can bring to a portfolio, without taking a concentrated bet on one thing, even if it is shiny and pretty like platinum."

While futures were designed to allow institutions and individuals the ability to hedge natural long and short positions, they also allow individuals the opportunity to speculate on future price movements, said Robert Johnson, president and CEO of The American College of Financial Services.

"Leverage is paramount in the futures market," Johnson said. "When you establish a futures position, you can control a large amount of whatever the futures contract is — wheat, corn, soybeans — with a small investment. But, if the position moves against you, you will receive a margin call causing you to put up more money, or the position will be sold off."

Johnson said individual investors should always remember that leverage is a two-edged sword. If one uses leverage and is right, gains are magnified. But, if one uses futures and is wrong the losses can be magnified.

"Dabbling in the futures market can be hazardous to your wealth," he added.

Frances Hudson, global thematic strategist for Standard Life Investments, adds the markets for futures are often much more liquid and many times the size of those for the underlying securities, which can facilitate larger trades and swifter execution.

She said investors in futures need to get comfortable with new concepts and terminology, the leveraged nature of the investment -- so any potential for substantial gains is balanced by the potential for significant losses -- and trading from one contract to the next as futures contracts are time-limited and liquidity is generally concentrated in the near contracts.

"This brings congestion around the days when contracts roll and generally there are both costs and volatility associated with rolling," she advises.

A last potential benefit to managed futures allocation is something called "crisis alpha," Sinnott added. That is where select managed futures trend-following strategies have not only provided positive returns during some historical crisis periods, but actually seem to provide additional positive return during these periods of crisis in excess of their average return in other market environments.

While even strategies with strongly documented historical crisis alpha may not provide positive returns in every crisis, he notes, over the long term, strategies that exhibit crisis alpha may serve as a good diversifier in a portfolio since they may provide positive returns when other investments are contributing to losses.

"This quality is a differentiating feature for managed futures relative to many other alternative asset classes, some of which have historically shown a consistent positive correlation with equities, although generally with about half the beta exposure," Sinnott adds.

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