Saturday, November 14, 2015

Risk premium investing and managed futures

One of the key developments in portfolio management has been the growing focus on risk premium investing. Whether called risk premiums, exotic beta, or some other name,  more investors want to divide up their risks through the major market factors and not just focus on market cap weighted indices.  There is still ambiguity on what are the risk premiums that should be the focus of investor attention but there is general agreement that we can classify them into a set of categories:

  • Valuation
  • Carry 
  • Size 
  • Credit 
  • Momentum
Managed futures has traditionally provided access to the momentum or trend form of these risk premiums in dynamic fashion through trading both long and short through the major futures market. Carry across currencies also can be accessed through futures albeit the set of currencies will not include emerging markets. Size effects cannot be employed except through a few stock indices. Valuation, except through relative global comparisons, is also hard to access through futures markets. There are also some risk premiums that cannot be accessed through futures such as credit.

Hence, there is a reason to mix managed futures with some swap or cash strategies or structures. For example, there is no direct way managed futures can get exposure to a credit  risk premium, so mixing managed futures which focuses on momentum with credit exposure through collateral usage allows for a combination of risk premiums.

A full complement of risk premiums can be accessed for full global macro investing through the more innovative use of collateral. Since most managed futures only use about 20 percent or less of cash for margin, the excess cash not used for margin can be employed in other strategies to access alternative risk premiums.

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