What Are Managed Futures and How Do They Work?

Managed futures represent a distinct investment approach where professional managers actively trade futures contracts and other derivative instruments across global markets. This strategy aims to generate returns from various market movements. Unlike traditional investments, managed futures focus on opportunities through highly liquid, exchange-traded products, providing exposure to a broad range of asset classes under professional oversight.

Defining Managed Futures

Managed futures involve professionally managed portfolios that primarily trade in financial instruments such as futures contracts, options on futures, and foreign exchange (forex) contracts. The professionals overseeing these portfolios are known as Commodity Trading Advisors (CTAs). A CTA is an individual or firm registered to provide advice and services related to trading these derivative instruments, including managing client funds. CTAs analyze market trends and make trading decisions, aiming to profit from price fluctuations across various global markets.

Futures contracts are standardized legal agreements to buy or sell a specific underlying asset at a predetermined price on a specified future date. These assets can include commodities like oil or agricultural products, financial instruments such as interest rates and stock indices, and foreign currencies. The contracts are traded on regulated exchanges, ensuring standardized terms for quality and quantity. This structure allows participants to either hedge against future price changes or speculate on price movements.

Options on futures work similarly to options on stocks, but their underlying asset is a futures contract. An option on a futures contract grants the holder the right, but not the obligation, to enter into a specific futures contract at a predetermined price on or before a certain date. This provides flexibility in managing exposure to futures markets.

Foreign exchange (forex) contracts are utilized within managed futures, allowing CTAs to take positions on currency price movements. The Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA) regulate CTAs and managed futures accounts. CTAs must register with the NFA and adhere to CFTC regulations.

Operational Strategies

Commodity Trading Advisors (CTAs) employ various strategies to execute their managed futures programs. These approaches fall into two main categories: systematic and discretionary. Systematic strategies are rules-based and rely on computer algorithms to identify trading opportunities and execute trades. These models analyze price trends, volatility, and other market signals. Discretionary strategies, conversely, involve human judgment and analysis by the CTA, often based on fundamental market analysis or macroeconomic themes.

Several common strategy types are utilized. Trend-following is a systematic approach that seeks to identify and capitalize on persistent market trends. CTAs using this strategy take long positions in assets with upward trends and short positions in assets with downward trends. Global macro strategies involve making trading decisions based on broad economic themes, geopolitical events, and fundamental analysis of global markets. These strategies may involve taking positions across different asset classes like currencies, interest rates, and commodities.

Relative value strategies aim to exploit mispricings or inefficiencies between related assets or markets. This could involve taking simultaneous long and short positions in different but related instruments to profit from their convergence to fair value. Managed futures strategies can take both long and short positions across various markets. This means they can potentially profit whether market prices are rising (by going long) or falling (by going short), offering a non-directional approach to market participation.

Accessing Managed Futures

Individuals can gain exposure to managed futures through several avenues. One direct method is to invest with a Commodity Trading Advisor (CTA) through a managed account. In this setup, the CTA manages an individual’s account directly, placing trades on their behalf. This approach provides greater transparency regarding specific holdings and trades.

Another common way to access managed futures is through managed futures mutual funds. These funds pool money from multiple investors to invest in a diversified portfolio of futures contracts managed by a CTA. They offer a more accessible entry point for retail investors compared to direct CTA accounts, which may have higher minimum investment requirements.

Exchange-traded funds (ETFs) that track managed futures indices or invest in managed futures strategies have become popular. Managed futures ETFs package complex futures trading strategies into an easy-to-trade format, offering simplicity, transparency, and liquidity. These ETFs employ systematic, rules-based approaches to trade futures in various asset classes.

Private funds or hedge funds also employ managed futures strategies. These investment vehicles are structured for accredited investors and institutions, offering more complex or specialized strategies. They may utilize a wider range of instruments and employ more sophisticated trading techniques than those found in mutual funds or ETFs.

Key Attributes

Managed futures possess several characteristics that differentiate them within the investment landscape. One notable attribute is the daily liquidity in futures markets. Futures contracts are traded on public exchanges, and their prices are continuously updated, allowing positions to be entered and exited. This high liquidity means that managers can adjust or liquidate positions quickly.

Transparency is another inherent feature, due to the exchange-traded nature of futures. Daily mark-to-market valuations mean that the value of futures contracts is updated at the end of each trading day, providing clear insight into performance and exposure. For investors, the level of transparency can vary depending on the investment structure; managed accounts offer complete transparency, while pooled funds may provide less granular detail. Regulatory bodies like the CFTC and NFA contribute to industry transparency by requiring registration and reporting from CTAs.

Fee structures in managed futures involve two main components: a management fee and an incentive fee. The management fee is an annual charge, a percentage of the assets under management, ranging from 1% to 2% annually. The incentive fee, or performance fee, is a percentage of new profits generated, around 10% to 20%. These fees compensate CTAs for their expertise.

Managed futures exhibit low or non-correlation to traditional asset classes. This means their performance may not move in the same direction as conventional investments, offering diversification benefits within a broader investment portfolio. This characteristic arises from their ability to take both long and short positions across various global markets, independent of overall market direction.

For tax purposes, the gains and losses from regulated futures contracts, including most managed futures, are treated under Section 1256 of the Internal Revenue Code. This means that 60% of any gain or loss is considered long-term capital gain or loss, and 40% is considered short-term capital gain or loss, regardless of the actual holding period. This 60/40 rule can provide a favorable tax treatment for investors compared to typical short-term capital gains, which are taxed at ordinary income rates.