How Much to Invest in Managed Futures

05/09/2012 7:00 am EST


Fund manager Greg Anderson tells how his fund’s sub-advisors use trend following and forecasting strategies in tandem. He also describes his firm’s method for determining the proper allocation of managed futures within an investor’s overall holdings.

Kate Stalter: Today, I am on the phone with Greg Anderson, Chief Investment Officer at Princeton Fund Advisors.

Greg, I want to start out today by talking about your investment philosophy as it relates to the managed futures fund, and how you balance trend following with some forecasting.

Greg Anderson: Well, Kate, thank you so much. We’re a little bit unique with respect to our fund [Princeton Futures Strategy Fund (PFFAX)] in that we actually have a team, a sub-advisor team, who has been managing a managed futures strategy for over 16 years.

What’s unique in their strategy, and something I really appreciate, is that in addition to what I think is the most prevalent type of managed futures manager—trend followers—we have both fundamental managers who try to predict price movement, and we have managers who go contrarian. So as prices keep moving in a particular direction, their belief is at some point it will revert back to the norm.

And if you look at our portfolio, about half of our portfolio is with trend followers, and then the balance is split between the predictive fundamental managers and those managers that are more contrarian countertrend.

What we’re really trying to do is build a portfolio that works in as many different markets as possible, and really tries to maximize the return for the risk that we take. In other words, can we have the most smooth, controlled type of return stream? We found that that mix works very well for our strategy over time.

Kate Stalter: That leads into how this asset allocation is determined using the sub-advisors. Because there are so many different areas in which one could invest in the futures arena. How do you decide this?

Greg Anderson: You’re right, and there are so many ways to invest, because not only are you looking at the types of managers in terms of how they operate their systems, but also the markets they trade in. So one of the things where we’re a little different is: We have a focus where we have about half of our portfolio, on average, targeted to be in commodity futures and half to be in financial futures.

One of the things that we look at: How do the individual managers allocate their trading to the different markets? Then within the balance of how much in trend following versus how much in predictive fundamental managers versus contrarian.

Again, what we’re really trying to do is build a portfolio where we capture the majority of the returns in a very good trending market, but we’re willing to leave a little bit of the up off, so that we can kind of control the tops and bottoms as markets keep going up, or keep going down.

When it does reverse, we’ve got managers that can help smooth that volatility, the contrarian countertrends. And then also, the predictive managers, oftentimes they may be first to a market.

They’re very different than a trend follower, because a trend follower is looking for price pattern, either up or down. They’re agnostic to which way, but…they never get in at the bottom. They have to see the price move in that direction. And they never get out at the top. They have to see the price change before they’ll get out.

The fundamental manager oftentimes is predicting, so he may move into a market that the trend followers could be the opposite way, because he believes something has changed. At the same time, he may set profit targets and say, “When it reaches this level, I am going to exit, even though the price continues to go up and the trend followers are still in it. It’s now hit my profit target and I’ve moved out.”

We think that level of diversity is very unique. We like how it kind of controls both the return and the risk profile.

Kate Stalter: I want to talk a little bit about the use of managed futures for individual investors. As you’re well aware, when most people think about the markets, they think about equity markets or perhaps the fixed-income market. I know you have some ideas on how managed futures should fit in to a retail investor’s portfolio. Tell us about those.

Greg Anderson: Again, managed futures is very unique, because it’s one of the only asset classes that has very low correlation to almost every other type of investment. So if you look at how managed futures correlates to equity markets, basically the term would be, it really has no correlation.

And what that means is: That it doesn’t really move in any predictive pattern to how equity markets move. It means if equity markets go up, managed futures could move up with it. If markets go down, they can move down with it, or they could be the opposite, where if the markets are moving down, managed futures is up.



It’s that lack of correlation that makes it such a great tool to bring into anyone’s investment portfolio from a diversification standpoint.

If you look at years like 2000, 2001, 2002, and 2008, which were very challenging years for equities markets, managed futures tended to perform very well in those markets. And the fact is that they can be both long or short with equal ease, so they don’t really care which direction. They just need the markets to move in a direction.

It means that in a negative market environment, they can go short the market. They can be short against stock indices. So I think that unique diversification means it really fits in almost any portfolio.

The question that I then get asked so much is: “Well, how much is the right amount,” in terms of what can get allocated into a portfolio. And typically the range that we see advisors and clients use ranges somewhere between 5% and 20% of their portfolio. I think 20% gets to be a little bit higher for most people’s level of comfort, so the normal range I see is more in the 5% to 10%, 5% to 12.5% range of a portfolio.

We do it a little differently. We actually look at an investor’s portfolio. We look at how much is really kind of fixed income for liquidity needs, and we pull that out and then we say, what’s left? This, to us, is the risk capital.

We tend to allocate about 10% of the risk capital to managed futures. If it’s too little of an allocation, it really doesn’t have an impact on helping to diversify the portfolio, so we think it’s a great blend from that standpoint.

Kate Stalter: And would this change according to a person’s age, risk tolerance, that sort of thing?

Greg Anderson: Well, if you follow the method that we utilize—and again, everybody has a different method—where we say the fixed-income portion, we kind of count as really liquidity, safety of capital, those types of things—it’s cash flow needs.

So typically as you see an investor get older, in time you often see their portfolio become more oriented to fixed income. In that case, the allocation is dropping a little bit, simply because the amount that they allocate to risk is coming down, and more is moving to fixed income. So you see the weighting dropping in that scenario.

When investors may be younger, they may be more oriented to more risk-oriented investments. When I say risk, I mean non-fixed income, not investment-grade fixed income, so it could be equities. It could be high-yield fixed income. It could be emerging-market debt. All of those different things.

So I think from our perspective, age kind of changes that weighting between the equities—the risk—and the fixed income, and so you’d see someone younger with maybe a little bit more risk-oriented portfolio. They would probably have a greater piece of managed futures in the portfolio from that standpoint, but we think it fits in every portfolio because of that lack of correlation.

In fact, if you look at managed futures to fixed income, it still has a very low correlation to fixed income, maybe 0.2% to 0.3%. Even to other alternative investments it has very low correlation, so it’s so unique in terms of how it fits a portfolio. I think it belongs in every portfolio; it’s just what level.

Kate Stalter: And it sounds like you’re describing what might be a core holding versus something that could be tactical and you trade it in and out.

Greg Anderson: Correct. And the reason why we look at it as a core holding: One, the characteristics that make it, in terms of its lack of correlation, its return history and those types of things. We think it fits from all those standpoints.

Then when you look at how broad the universe is for managed futures…in other words, we trade in both domestic and global markets. We trade in currencies, interest rates, stock indices, but we trade in commodities. So we trade probably well over 100 to 150 different markets, and we can go long or short equally.

So when you look at it, we are as diverse as any investment that I am aware of in terms of the different markets that can be traded. And the fact that you can go either long or short means if you have a period like an inflationary period, managed futures could perform very well in that inflationary market, as prices move up because you’ve got an upward trend in prices.

If you have a downward or deflationary environment and prices are moving down, since managed futures can be equally at ease with short positions, it can do very well as prices decline. So it really fits, I think, as truly a strategic allocation and portfolio that should belong at all times, because the diversity allows it to be traded in all different types of markets and investment periods.

Also watch: Managed Futures Demystified

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