INDEPENDENT RESEARCH ON MANAGED FUTURES'

IMPACT ON SECURITIES PORTFOLIOS

THE LANDMARK LINTNER STUDY:

AN HISTORICAL PERSPECTIVE

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 portfolio 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 a portfolio of stocks alone or from portfolios of stocks and bonds."

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

MANAGED ACCOUNT REPORTS FOLLOW UP ON DR. LINTNER'S STUDY

Managed Account Reports (MAR) is widely recognized by investment professionals as a primary source for Commodity Trading Advisor (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 studies cited were conducted to specifically examine the effect of managed futures in an overall portfolio

MAR STUDY

MAR combined a portfolio of managed futures with (1) a portfolio of stocks; (2) a portfolio of bonds; (3) an efficiently-selected portfolio of stocks and bonds; and (4) an efficiently-selected portfolio of stocks, bonds, and treasury bills. Managed futures investments were tested in two ways, through a) futures trading advisors; 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.)

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 advisors--the MAR Trading Advisor Qualified Universe Index, a dollar-weighted index of trading advisors that MAR tracks currently and has tracked historically. At year-end 1992, 290 trading advisors were in the index. The number of trading advisors in the index fluctuates each month as new trading advisors meet the qualifications for inclusion or as other trading advisors 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 advisors and allocated assets efficiently between them. MAR, however, used a qualified universe of 290 advisors. We believe the latter is more representative of the performance of trading advisors 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 Figure 1, section A, column 3 (see page 10), we find the reward/risk ratio of S&P 500 of 1.00 is greater than the reward/risk ratio of the MAR Trading Advisor Qualified Universe Index of 0.84. However, as column 4 in that table shows, the ratio of the two reward/risk ratios (Sip of 0.84) is greater that the correlation coefficient between the S&P 500 and the MAR Trading Advisor Qualified Universe Index of 0.0087 (Figure 1, section B, column 4), 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.

Figure 1

Returns, Standard Deviations and Correlation Coefficients

Correlation Matrix

Source: MAR

What is the Ideal Mix of Stocks and Managed Futures?

Table A 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 within bold print on table A, page 11); 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 A

MINIMUM VARIANCE FRONTIER FOR S&P 500 INDEX AND

MAR TRADING ADVISOR QUALIFIED UNIVERSE INDEX

Source: MAR

As you can see from the chart above, the ideal mix, in order to potentially get the greatest risk reduction and highest return, is a portfolio consisting of 62% stocks and 38% managed futures. Please note that the ideal mix still carries the risk of loss.

CONCLUSIONS OF MAR STUDY IN OTHER SECURITIES COMBINATIONS WITH MANAGED FUTURES

A. 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.

B. Managed Futures in a Portfolio of Stocks and Bonds

"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."

C. Managed Futures in a Portfolio of Stocks, Bonds, and Treasury Bills

"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.