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Years ago I worked my 8th grade summer on my paternal uncle’s grain & stock farm in Blaine County, Oklahoma. He and his brother farmed 2 square miles of rich Oklahoma soil. I performed the various farm jobs that summer and, still today, remember it as the best summer of my youth! At a much earlier time, on my mother’s side, my grandfather migrated to Broken Arrow, Oklahoma on the train in 1903 with $3,000 in his pocket. He had already succeeded in two very intense careers: Tombigbee River Logging in Alabama and then went on to Jonesboro; Tennessee to own and operate what they called in those days, late 1800’s, a commissary.
Suffice it to say, Oklahoma has changed dramatically since I was a boy, and I am grateful for my training as a make-believe farmer because it pointed me toward my lifelong interest in commodities and, eventually, catapulted me into the World of Finance as an educator. My passion is helping folks grip an improved Understanding of Financial Markets.
Used to be, brokers charged horrendous fees for managing futures accounts, because viewed from today’s perspective, they were very high. Some funds charged a 5% management fee. That hardly sounds low, does it? But at that point, some funds charged as much as 17% in management fees, in addition to the incentive fees on profits the managers charged. How could they do that and get clients, let alone keep them? How could they hope to generate profits? If memory serves, most didn’t.
For years, after embracing the financial markets, I tirelessly searched for a model which would enable my friends and myself to rely upon to grow a small portion of asset into wealth. At first, all we knew were stocks because that seems to be where most folks got drawn to when considering the markets. Then, finally, I embraced derivatives via the Futures Market... just a few years after the treasurer of The Great County of Orange, was accused of bankrupting the Government by derivative trading.
Managed futures have an unusual feature:
You only need a small portion (say 10%-15%) of your capital directly invested in futures contracts. The rest is held in cash. Back then, interest rates were much higher than today. When the first futures funds were launched, interest rates were 10%, and until the early 1990s were often above 7%. (The chart below is the interest on 3-month treasury bills from the FRED database of the St. Louis branch of the Federal Reserve.) Investors in those days started out with an advantage as a large part of their portfolio (the cash) was already earning positive returns from high interest rates before the futures investing had begun.
Plus, in the early days of futures investing, there were just not that many commodity trading advisors [managed futures investment managers]. The better ones developed some very nice return streams as computers were just being used to offer analysis of trends and those on the "cutting edge" had an advantage. In addition, the costs for developing a public managed futures fund were simply horrendous as compared to today, and of course those costs got passed on to investors in the form of higher fees.
That world has disappeared. Today, there are thousands of traders worldwide competing with each other, many armed with very sophisticated models, specialized trading strategies, high-powered computers and large “brainy” staffs. And Treasury rates, as we all know, are about as low as they can get. Low interest rates, of course, mean very little return on the cash component of portfolios.
About 2005 I began reading
John Mauldin, who with has argued "with the big boys" for years that the cash portion of a managed futures fund should be more actively managed. It just seemed so obvious to me. That is why we want to introduce viewers to the some of John's colleagues, These colleagues have figured out how to put the cash portion of a managed futures fund into the hands of a sophisticated fixed income manager just as John always thought should be done.
But before we get into the fixed income manager, let us tell you why we think we need managed futures component in our portfolio.
When is the last time you paid for something with “‘relative performance?” You can’t. We all pay our bills with cash. That is why John continues to emphasize the importance of absolute returns over the long-term, not relative returns, when it comes to our investments.
Our antenna goes up whenever we hear a money manager boast that he/she outperformed the S&P 500 Index. While it is impressive to beat the S&P 500 when the stock market is up, it is scant consolation to only lose 20% of your money if the S&P 500 is down by 25%. Not losing as much won’t help you buy groceries or pay your mortgage.
One of the potential paths to put absolute returns in your portfolio, in our opinion, is to add a managed futures component. Many academic studies show that managed futures may help increase investor returns because they offer diversification into assets that have a low historical correlation to traditional investments, like stocks and bonds. Of course, there is no guarantee that any investment will generate profits or avoid losses.
In fact, managed futures funds have historically exhibited negative correlation when equity markets trend lower, so an allocation to managed futures can counter, instead of just cushion, the impact of an extended bear market.
Managed futures managers seek to take advantage of price trends. Using sophisticated trading models, they can buy futures positions to catch the trends of a rising market or sell futures positions if markets fall.
For example, during periods of hyperinflation, hard commodities such as gold, silver, oil, grains and livestock tend to do well, as do the major world currencies. During deflationary times, futures provide an opportunity to profit by selling into a declining market with the expectation of buying or closing out a position at a lower price. That is because you get broad diversification and flexibility from the asset classes available in managed futures (commodities, stock index futures, options on futures, interest rates, and currencies -- COSMIC) as well as the ability to profit from upside or downside trends. Keep in mind, past performance is no guarantee of future results and that an allocation to managed futures does not guarantee profits or to protect against losses in a rising or declining market.
According to reliable sources [sources available upon request] managed futures as an asset class have outperformed the S&P 500 TR Index quite handily since July 2000.
