Managed Futures Research Studies

Independent Research Studies >>> Just the Facts!

At Chart Research we are constantly preaching about the diversification benefits of managed futures account. The independent research presented below will provide a step-by-step overview of two separate studies outlining EXACTLY why managed futures may belong in traditional stock and bond portfolios.

The Landmark Lintner Study:

In 1983, Prof. John K. Lintner of Harvard University presented a landmark paper, "The Potential Role of Managed Commodity-Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds," to the Financial Analysts Federation. The paper stated that "the improvements from holding an efficiently-selected portfolio of managed accounts or funds are so large - and the correlation between returns on the futures portfolios and those on the stock and bond portfolio are so surprisingly low (sometimes even negative) - that the return/risk tradeoffs provided by augmented portfolios . . . clearly dominate the tradeoffs available from portfolio of stocks alone or from portfolios of stocks and bonds.”

Using the composite performance of 15 trading advisers, Lintner showed that the return/risk ratio of a portfolio of trading advisers (or futures funds) is higher than a well-diversified stock/bond portfolio. Furthermore, he found a low correlation between the returns of trading advisers and those of stocks, bonds, or a combined stock/bond portfolio. Lintner examined the period July 1979 through 1982.

While Dr. Lintner’s study is almost 20 years old, research since then has tended to support, rather than contradict, his conclusions.

Managed Account Reports Follow Up on Dr. Linter's Study:

Managed Account Reports (MAR) is widely recognized by investment professionals as a primary source for Commodity Trading Adviser (CTA) performance statistics. Their performance analyses of CTAs and futures funds are often quoted in such financial publications as Barron's, Wall Street Journal, Forbes, Futures Magazine, and other leading financial publications.

The MAR Study

MAR combined a portfolio of managed futures with a:

• portfolio of stocks,
• a portfolio of bonds,
• an efficiently selected portfolio of stocks and bonds, and
• an efficiently selected portfolio of stocks, bonds, and treasury bills.

Managed futures investments were tested in two ways, through a) futures trading advisers and b) futures funds/pools. MAR conducted the analysis for the period January 1980 through December 1992.

First, they evaluated the portfolios to determine if including managed futures increased the risk-adjusted rate of return. Second, they constructed assorted minimum-variance frontiers using combinations of the different asset classes. (A minimum variance frontier is a set of portfolios that provides the lowest standard deviation for a given return of the various combinations.)

The Data

As a proxy for the stock portfolio, they used the nominal returns of the S&P 500 index adjusted for dividends. The S&P 500 index is the dollar-weighted portfolio of 500 large U.S. corporations.

They used the nominal returns on the Lehman Government Bond Index as a proxy for the bond portfolio. This index is a dollar-weighted index of treasury and government-agency bonds with maturities greater than one year.

For managed futures, they first used a portfolio of trading advisers - the MAR Trading Adviser Qualified Universe Index, a dollar-weighted index of trading advisers that MAR tracks currently and has tracked historically. At year-end 1992, 290 trading advisers were in the index. The number of trading advisers in the index fluctuates each month as new trading advisers meet the qualifications for inclusion or as other trading advisers retire.

Another proxy used for managed futures was a portfolio of futures funds/private pools. Here they used the MAR Fund/Pool Qualified Universe Index, a dollar-weighted index of public funds and private pools that MAR currently tracks or has tracked in the past. At year-end 1992, 452 funds/pools were in the index.

For cash, they used the average monthly return on the three-month Treasury Bill.

Differences with The Lintner Study

A key difference between MAR's study and Lintner's is that Lintner selected 15 advisers and allocated assets efficiently between them. MAR, however, used a qualified universe of 290 advisers. We believe the latter is more representative of the performance of trading advisers as a whole and cannot be criticized as having selection bias. Another important difference is that Lintner looked at the enhanced return per unit of risk. In the MAR study, more emphasis was placed on risk-reduction.

Finally, Lintner examined the period July 1979 through December 1982. Mar's analysis covered the period January 1980 to December 1992, a much longer and more recent time period.

The Effect of Including Managed Futures in a Portfolio of Stocks

MAR found that an efficiently allocated portfolio consisting of managed futures and stocks should provide a better reward/risk ratio than stocks alone.

In Table 1, column 4, we find the reward/risk ratio of S&P 500 of 1.00 is greater than the reward/risk ratio of MAR Trading adviser Qualified Universe Index of 0.84. However, as column 5 in that table shows, the ratio of the two reward/risk ratios (Sip of 0.84) is greater than the correlation coefficient between the S&P 500 and the MAR Trading Adviser Qualified Universe Index of 0.0087 (Table 2, column 2), indicating than an efficiently-allocated portfolio consisting of managed futures and stocks should provide a better reward/risk ratio than an investment in stocks alone.

Table 1: Returns, Standard Deviations and Correlation Coefficients

Table 2: Correlation Matrix

Source: MAR
Definitions Standard Deviation: define in economics terms

Return Std Deviation ratio: The return divided by the standard deviation. A high ratio indicates that the investment has a good return for its past variability.

Ratio of MAR Trading Adviser Qualified Universe Index to Ret/Std: compares the return vs variability of the different types of investment with the equivalent ration for that achieved by the CTAs tracked by MAR.

What is the Ideal Mix of Stocks and Managed Futures?

Table 3 shows the specific returns and standard deviations of various combinations of stocks and managed futures along the minimum variance frontier as well as portfolio allocations.

To illustrate the procedure used for each analysis, let's look at the minimum variance portfolio (denoted with bolded print on Table 3). It has a return of 16.5% (column 1) and a standard deviation of 12.7% (column 2). The reward/risk ratio of this portfolio is 1.30 (column 3) which is greater than the 1.00 reward/risk ratio of the S&P 500.

The allocations for the minimum variance portfolio are 61.8% (column 4) in stocks and 38.2% (column 5) in managed futures. For this level of return, the standard deviation decreases from 15.99% to 12.7% (column 2)--a 3.3% reduction in standard deviation. The global minimum variance portfolio has a standard deviation 20.6% lower than a stock portfolio alone. In order to get this reduction in standard deviation, one has to invest about 38% of the assets with managed futures.

Table 3: Minimum Variance Frontier for S&P Index and MAR Trading Advisor Qualifies Universe Index

Source: MAR

As you can see from Table 3 (above), the ideal mix, in order to get the greatest risk reduction and highest return, is a portfolio consisting of 62% stocks and 38% managed futures.

Conclusions of MAR Study in Other Securities Combinations with Managed Futures

A. Managed Futures in a Portfolio of Stocks:

• "An efficiently-allocated portfolio consisting of managed futures and stocks should provide a better reward/risk ratio than an investment in stocks alone." Ideal combination for risk reduction is 62% stocks/38% managed futures.
  

B. Managed Futures in a Portfolio of Government Bonds

• "An efficiently-allocated portfolio consisting of managed futures and bonds should provide a better reward/risk ratio than an investment in bonds alone." Ideal combination for risk reduction is 91% bonds/9% managed futures.
  

• "By allocating about 14% of the assets to managed futures, we get a 14.6% reduction in standard deviation. Further, we see that for all available levels of returns in an efficiently-allocated stock/bond portfolio, the inclusion of managed futures lowers the standard deviation -- offering better return/risk characteristics."

• "An efficient allocation of assets between stocks, bonds, Treasury Bills, and managed futures (7% to managed futures) reduces the risk for a given level of return over an efficiently-allocated portfolio of stocks, bonds, and Treasury Bills.

Summary of MAR Findings

"We concluded that the inclusion of managed futures in a traditional portfolio of stocks, bonds, and Treasury Bills consistently lowered the standard deviation for a given return." A detailed 52-page study on "The Role of Managed Futures in Investment Portfolios" can be purchased for $10 dollars from MAR. They can be reached at 220 Fifth Avenue, New York, NY 10001. Reprinted with permission of Managed Account Reports.

COMMODITY TRADING INVOLVES SUBSTANTIAL RISKS DUE IN PART TO THE HIGHLY SPECULATIVE NATURE OF SUCH TRADING. AS A RESULT, AN INVESTMENT IN A COMMODITY TRADING ACCOUNT IS ONLY SUITABLE FOR YOU IF YOU HAVE ADEQUATE MEANS TO PROVIDE FOR YOUR CURRENT NEEDS AND PERSONAL CONTINGENCIES AND YOU CAN BEAR THE ECONOMIC RISK OF LOSING YOUR ENTIRE INVESTMENT.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.