I have had many conversations with investment professionals regarding asset allocation. During those chats, I usually refer to managed futures investing as participation in a distinct asset class. Occasionally, I have been corrected with the comment that “Managed futures is an investment strategy; not an asset class.”
Why is this distinction even important? Well, an asset class obviously belongs in an asset allocation model whereas an investment strategy may not.
So where do these labels come from? According to the CFA textbook, (Investment Analysis and Portfolio Management, Reilly and Brown, [7th Edition, 2003]), an asset class comprises a group of securities that have similar characteristics, attributes, and risk/return relationships. Traditionally, the three primary asset classes have been stocks, bonds, and cash equivalents. In recent years, commodities and real estate have been increasingly regarded as standalone asset classes. How, then, to think about alternative investments such as hedge funds and, more specifically, managed futures?
The term “investment strategy” is used very broadly. Most often, it describes a methodology for selecting investments, usually according to a certain set of criteria. An investment strategy can be very specific and pertain to a particular opportunity or security. Buying a security based on a matrix of valuation factors combined with market volume indicators is an example of a strategy. It could describe an overall approach to investing. For example, many investment advisors attempt to deploy an investment strategy focused on diversification when allocating client portfolios.
Is there a correct answer and does it even matter? As alternative investments go mainstream, I believe it’s time to acknowledge that the broad universe of alternatives is another asset class, alongside stocks, bonds, cash, real estate and commodities. Within each of those asset classes, there are a myriad of asset class categories and this is precisely where managed futures fits. Once you have decided to add the alternatives class to your asset allocation model, you will likely want to categorize alternatives across the various underlying disciplines such as long/short, market neutral, event-driven, macro, and managed futures. You are already doing this for your stock portfolios as you consider large or small caps, value or growth, developed or emerging, and so on. Therefore, I believe the correct answer to the starting question is actually: “Neither; managed futures is an asset class category”.
Does it matter? I believe it does, but only if the terminology challenge has somehow resulted in managed futures being left out of your asset allocation models!
The empirical evidence in circulation about the potential benefits of allocating to Managed futures when constructing a well-diversified portfolio is overwhelming.
"The combined portfolios of stocks (or stocks and bonds) after including judicious investments in leveraged Managed futures accounts show substantially less risk at every possible level of expected return than portfolios of stock (or stocks and bonds) alone." -Dr. John Lintner, The Potential Role of Managed futures Accounts in Portfolios of Stocks and Bonds (1983)
“We found that allocating to Managed futures allows investors to achieve a very substantial degree of overall risk reduction at limited costs.”—Journal Of Investment Management, Vol.2, No. 1 (2004): “Managed futures and Hedge Funds: A Match Made in Heaven."
“For appropriately constructed portfolios, Managed futures are shown to offer unique downside risk control along with the simultaneous potential for upside returns.” (Ibbotson Associates, 2005): “Managed futures and Asset Allocation”