Managed Futures

Understanding how commodities and futures came to play such a major role in our global economy is an essential component of any investor?s education, particularly in light of the impact these assets now exert on stock and currency markets (think of the impact higher or lower oil prices have recently had on the US stock market, for example.) Thanks in part to the Internet and the home computing revolutions, combined with financial innovations by exchanges like the Chicago Board of Trade and the Chicago Mercantile Exchange, smaller investors now enjoy a broad range of investment vehicles designed to give access to these markets. To understand the potential opportunities and risks involved, we present here a brief history of managed futures, exploring along the way some of the potential rewards in a managed approach to commodity and futures investing, and ending with an interview with Frank Pusateri, one of the early pioneers of the industry..

According to author Thomas Northcote, the history of managed commodity trading took its first major step in the late 1930s with the establishment of the Commodity Research Bureau by William Jiler and his brothers. The group produced a widely used charting service for commodity prices employed by advisors and traders. They later produced one of the first computerized trading systems, which they made available for traders, and a computer data bank of commodity prices. The CRB is one of the oldest fundamental newsletters still in existence. In 1949, legendary trader Richard Donchian formed the first commodity fund, Futures, Inc., which traded the markets until 1975. Donchian?s trading concepts inspired a generation of traders, advisors and system developers. In 1957 he introduced a trend following trading system based on moving averages.

In 1952 in a landmark article written for The Journal of Finance, Harry J. Markowitz introduced to the public the ?Markowitz Model? and the beginning of modern portfolio theory, with its principles of diversification. For his analysis, Markowitz eventually shared the Nobel Prize in Economics with William Sharpe and Merton Muller. Later Dr. John Lintner used Markowitz?s concepts to show how including an element of managed commodity investments in a portfolio of stocks and bonds actually increases the risk- adjusted returns, in comparison with a portfolio of stocks and bonds alone, because commodities tend to have a low correlation with these markets.

By the 1960s, volume in futures trading had begun to explode, exceeding 5 million contracts in 1961, and then 10 million in 1966. In 1965, the Dunn and Hargitt Commodity Service Newsletter began publication, and in September, Dunn and Hargitt began trading in the industry?s first managed commodity account.

In the 1970s, Donchian and Markowitz?s ideas had become widespread, as trend-following and diversified commodity funds proliferated, and investor participation increased exponentially. Richard Levin, Malcolm Weiner, Matthew Sterling and Bugs Baer began a joint trading account based on Donchian?s concepts of diversification across commodity markets, trend following, money management and technical analysis. Skyrocketing oil prices and high rates of inflation in the US combined to increase the profits of commodity funds, and the investing public at large began to pay close attention to commodity prices. By most accounts, 1973 was the best year in history for the managed futures industry, and trading volume reached 25 million contracts. The 1970s also saw the rapid development of an array of new futures products, including contracts on interest rates, currencies and heating oil, and the creation of the CFTC by the US Congress to regulate futures trading. By 1978, volume in futures trading exceeded 50 million contracts for the first time, and the big players on Wall Street had begun to take note; in this year Frank Pusateri created the Performance Analysis Department at EF Hutton. In June of 1979, the company Computrac began offering technical analysis software for stocks and commodities, and facilitated an interface between micro-computers and mainframes to access commodity data.

Although much of the 1980s saw the managed futures industry in retreat as inflationary conditions receded and a stock bull market began to form, the rise of the home computer, increasing globalization of markets and the introduction of futures contracts on crude oil all combined to set the stage for the next leg of the managed commodity boom, and by 1984 the industry saw participation reach an estimated $2 billion in managed futures. While 1987 was an unkind year to most stock investors, many managed commodity funds and commodity trading advisors (CTAs) proved their mettle, showing considerable gains even as the US markets plummeted. Lintner?s theory of diversification appeared vindicated for investors who had broadened their stock and bond portfolios to include commodities.

The 1990s saw an acceleration of many of the trends established in the 80s as market globalization continued apace, and the rise of the home computer and the Internet gave smaller investors access to futures and commodities markets. Pension funds and others began to incorporate managed commodities in to their portfolios, and the advent of electronic networks, and the introduction of trading on foreign futures contracts in the US helped to increase liquidity. As the 21st Century begins to unfold with all of its uncertainties, the managed futures industry looks well placed to help investors protect their portfolios from adverse movements in global equity markets, and from geo-political uncertainties such as war or terrorism. To quote Thomas Northcote: ?participation in managed futures can offer profound diversification to even the most conservative investment portfolio. The benefit of this unique diversification can be particularly valuable during times of great economic and political stress and uncertainty.?