Before the advent of managed futures funds in Europe, many European countries—but particularly the UK—suffered the attentions of unscrupulous and largely unregulated futures brokers. These unprofessional operators encouraged retail investors to open their own trading accounts, through which either the vicissitudes of the futures markets or the inflated nature of the brokers’ fees usually managed to ensure that the investors lost most of their money. Many of these unregulated practitioners arrived in Europe from the US, where the strict regulatory regime established by the Securities and Exchange Commission (SEC) or the CFTC had chased them out. The UK and continental Europe also managed to grow a few of their own cowboys.

Gradually, the introduction of a stronger regulatory regime across Europe and the growth of well-regulated managed futures funds — supported by their trade associations—have largely pushed the cowboys out of the forefront of the industry and out of existence, or into less well-regulated centres.

Unfortunately, however, mud sticks, and the futures industry has not managed entirely to recover from such bad press in its infancy. Much of the antipathy towards managed futures in Europe stems from this early history and despite the industry’s best attempts and the wealth of academic evidence that managed futures do have their role to play in modern investment, there remain some in the investment community who will not yet consider derivatives or any type of leverage investment as a viable investment class for institutional money.

THE PRIVATE INVESTOR

Managed futures funds offer the safest mode of entry into the difficult and volatile international futures markets for the private investor. In their book Futures Fund Management, Nicola Meaden and Mark Fox-Andrews, both practitioners in the managed futures industry, state that . . . the chances of an individual investor speculating in the markets independently and making significant money on an ongoing basis are probably less than 25 per cent. Most private traders are going to lose money.

Morton S. Baratz, the founder of Managed Account Reports (Mar) and a major figure in managed futures, agrees:

It is received wisdom in the commodities business that 80-95 per cent of all individuals who manage their own accounts lose money in the markets. Just where that pair of figures comes from, and how accurate either is, is unclear. Each of the three careful inquires we know about puts the figure below 80 per cent. Blair Stewart in 1949, using data covering 1924-32, concluded that about 75 per cent of some 8800 individuals trading for their own accounts were net losers. T. A. Hieronymus, analyzing trading records for 462 individual speculators during 1969, put the fraction of net losers at 65 per cent. And R. J. Teweles and others concluded in 1974 that ‘the average expectation of a trader [of] making profits in any given year will be one in four’.

Morton S. Baratz, The Investor’s Guide to Futures Money Management

Whatever the actual figure is, it is clearly too high for most private investors. The reasons for a high proportion of losses on an individual account are fairly obvious on the surface. For instance, it is likely that the individual speculator will have significantly limited capital, which means that an investment policy cannot be sustained through the inevitable periods of loss.

As small participants in a large market, individual speculators are also unlikely to have easy access to the best of commission deals on their brokerage business, and so will find that they are paying over the odds to participate in the business. They are also unlikely to have a complicated and tested system to apply to the markets and, most importantly, they are not in a position to be able to gather enough information to invest wisely.

Futures markets move violently because of a series of apparently unrelated events: during droughts• the appearance of a rain cloud in Nebraska could send the US grain markets into chaos, or a scandalous story about a country’s premier could have a knock-on effect on that country’s bond markets or equities. Observers of futures in early 1993 would have seen the effect of the substantial flooding in the US’s Mid-West on grain prices, for instance.

The average investor does not have the time or the technology to collect together and distil all the information required to monitor the markets efficiently. In addition, speed of reaction to market news will inevitably be slower.

The Only Advantages for the Private Investor

However, the private investor does have two advantages in trading futures for his own account:

Unlike the professional trader, the private investor does not have to trade if he does not like the look of a market.

The private investor can choose which market he is going to trade in, again unlike a professional trader who probably has a seat on, at most, two exchanges. This limitation is gradually dissolving with the arrival of new technology and 24 hour global trading.

THE INSTITUTIONAL INVESTOR

Institutional investors are increasingly buying specialist expertise rather than developing their own futures investment strategies. In this way they can take advantage of the collective knowledge of the fund manager combined with the selection of a suitable manager and advisers chosen on the basis of past performance, trading history, and so on.

The basic arguments for investing in managed futures are that they provide:

• the opportunity to make money on falling as well as rising markets;
• diversification of a portfolio;
• above-average performance over the longer term;
• negative or low correlation with other asset classes.

There is a wealth of research and theoretical argument on the pros and cons of investing in managed futures. From this, two clear points emerge showing the strengths of managed futures over other asset classes. The first is diversification, the second (which is dealt with later) is performance.

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