One of the most important aspects of sound investing, the principle of diversification encourages you to spread your dollars out over a broad range of investments.
The world of investments offers a great deal to choose from besides just stocks and bonds. If you’re really looking to diversify your holdings, managed futures can add a whole new dimension to your portfolio.
They can be very complex and involve a significant amount of risk, and they are not suited to every investor. But if the futures market is something that interests you, it might be helpful to learn a little more about these unique investments.
How they work
To get a better idea of how a managed futures account works, it might be helpful to understand the underlying investments in the account — futures contracts.
These represent a contract to buy or sell a predetermined amount of a specific commodity, a financial instrument or an index at a certain price by a certain date.
The contract can either gain or lose value, depending on the relation of the price of the underlying commodity or index to the price stated on the futures contract.
For purposes of illustration, futures contracts for commodities (such as gold, for example) may be easier to visualize. An investor might enter into an agreement today to buy 100 ounces of gold at $400 an ounce in June of next year. At any time in between, if the actual price of gold rises above $400 an ounce, then the investor can sell their contract and make a profit. Keep in mind that if the price drops below the $400 mark when the contract is up, then the investor will have lost money. Now this is a very simplified explanation of how futures work, but contracts on other things such as currencies, interest rates and financial indices also work in much the same way. The goal is to make a profit by correctly determining the direction the markets will move within a given period of time.
The most common way you can invest in managed futures is through a managed futures fund, which is usually structured as a limited partnership investment.
This type of fund represents a pool of investment dollars gathered from various investors. By pooling your money with others, the cash requirements for each investor in the fund will be much less than if you tried to establish an individual account. Investing this way also helps to limit the amount of risk you are exposed to as an individual. A full-time professional money manager, known as a commodity trading advisor (CTA), makes the investment decisions, constantly reviewing the market for profitable opportunities.
Like most investments, futures entail a certain amount of risk.
There is the possibility of enduring a sizable loss when investing in futures, because actual prices could always fall short of contract prices. But managed futures also offer several benefits that could make them an important part of a well-balanced portfolio.
In addition to professional money management, managed futures offer access to global market opportunities. Keep in mind that global investments involve additional risks, including currency fluctuations, political and social instability, limited public information and possible changes in taxation. But they also afford you another distinct advantage: results from futures investments are completely unrelated to traditional stock investments.
Regardless of whether the stock market is rising, declining, or even trading flat, futures markets could be moving the same or opposite. In fact, statistics show that the returns from investing in futures and those from investing in stocks are very often noncorrelated.
One could be going up while the other is going down, or they might be moving in the same direction, but to varying degrees. This makes managed futures a diversification opportunity that can also provide investors a hedge against movements in their other investments.
Now that you know a little bit more about managed futures, you may want to consider them as a way to add more diversity to your portfolio. While this is just a brief overview of investing in managed futures, a financial consultant can discuss them further and help you decide if they are a good fit for your investment needs.
Kenyon Eastin of Stansbury Park is an Accredited Asset Management Specialist with A.G. Edwards & Sons, Inc. in the Sugarhouse office in Salt Lake City. This article was provided by A.G. Edwards & Sons, Inc., Member SIPC.