How to invest in trend following strategies using ETFs

Whether you're trading trend following strategies in your day trading or you’re simply looking at fresh ways to diversify your investment portfolio, managed futures ETFs are worth exploring.

What is trend following?

Trend following or trend trading is a very appealing concept because of its simplicity. You buy an asset when its price is rising and sell an asset short when its price is falling. The idea is that that momentum will carry the price further in the same direction.

Trend following is an active investment style that involves going both long and short in financial markets. While stock markets have shown to go up over time, justifying the traditional buy-and-hold strategy, there are also a lot of uptrends and downtrends in the meantime that provide investing opportunties to trend followers.

 

trend following advantage

Source: The HedgeFundJournal

 

With trend trading there are a lot of false starts but if you can get in early to one or two big trends and ride them, that's what can make the strategy profitable.

BUT… implementing this trading strategy is easier said than done. Beginner forex traders understand the steep learning curve involved!

It’s because there are many ways to identify a trend. Trends can be identified using different measures of price calculation, volatility and/or technical indicators like moving averages. In fact, depending on the timeframes involved, there is often disagreement about whether the price trend is up, down or sideways!

Investing with money managers

It’s for this reason that investors turn to trend following experts for guidance on how to trade the trend.

Professionals who manage portfolios using a trend following strategy for a pool of investors are known as Commodity Trading Advisors (CTAs) and the funds they manage are known as Managed Futures.

The trouble is that access to these types of risky alternative investments, which are in effect hedge funds is heavily gated. Oftentimes there are minimum investments in the hundreds of thousands of dollars. It’s understandable on the part of the fund manager because they want to attract only ‘sophisticated investors’ who understand the risks. However, the net effect is that smart retail traders and investors get left out. That’s where ETFs come in.

What are Managed Futures?

Let’s explore how these managed futures funds do their trend following strategy. The portfolios normally consist of exchange-traded futures contracts. Futures are contracts where a buyer is obligated to buy or a seller is obligated to sell an asset at a predetermined price.

Managed futures are deliberately as diversified as possible to include almost every asset class. Usually the largest component of the funds is either long or short forex (foreign currencies), fixed income (bonds) and commodities.

These funds invest into all these different asset classes to be exposed to as many potential price trends as possible. The huge advantage to investors is that the returns in these funds are typically non-correlated with the stock market. So therefore investors use them to hedge their portfolios and add another layer of diversification.

 

trend following exampleSource: Pimco

 

The funds use a pre-defined set of mathematical rules and formulas to determine when to buy and when to sell their investments. These rules have been devised by backtesting past price action and measures of volatility.

The fund managers won’t ever give away proprietary information on how their strategies work but they are not so-called ‘black-boxes’. All trend following CTAs use the same premise of trading momentum with diversifcation and strong risk management. Common techniques include buying at multi-day highs or selling at multi-day lows and closing the position when realised volatility rises beyond a certain measure.

How to play it: ETFs

Managed Futures ETFs are a way to passively invest using exchange traded funds into a managed futures fund or index.

The following tables shows 3 of the largest managed futures ETFs by assets under management (AUM).

 

managed futures ETFsSource: ETFSdb.com

 

The search box in the instruments panel of the FlowBank trading platform makes it very easy to find ‘managed futures’.

 

managed futures flowbankSource: FlowBank Pro trading platform

Best Managed Futures ETFs

Buying managed futures EFTs is an easy way to gain exposure to trend-following and the world of managed futures. Like all ETFs, the instruments can be bought and sold during regular trading hours just like ordinary stock. Here are 3 well-known managed futures ETFs available through FlowBank:

WisdomTree Managed Futures ETF (WTMF)

The fund normally invests at least 80% of its net assets in "managed futures". It is actively managed and seeks to achieve positive total returns in rising or falling markets that are not directly correlated to broad market equity or fixed income returns. The fund is managed using a quantitative, rules-based strategy designed to provide returns that correspond to the performance of the WisdomTree Managed Futures Index. It is non-diversified.

First Trust Managed Futures Strategy ETF (FMF)

The fund is actively managed and seeks to achieve positive returns that are uncorrelated to broad market equity or fixed income returns. Under normal market conditions, the fund and a wholly-owned subsidiary of the fund organized under the laws of the Cayman Islands, invest significantly in a portfolio of exchange-listed futures.

iM DBi Managed Futures Strategy ETF (DBMF)

The fund seeks to achieve its objective by: (i) investing its assets in managed futures strategy; (ii) allocating up to 20% of its total assets in its wholly-owned subsidiary, which is organized under the laws of the Cayman Islands, is advised by the Sub-Adviser, and will comply with the fund's investment objective and investment policies; and (iii) investing directly in debt instruments for cash management and other purposes. It is non-diversified.

Pros and Cons of Managed Futures

 

Pros

Cons

Low correlation with equities makes them good for diversifcation

Often lower or negative returns when stock market is rising

Useful for hedging

Higher volatility of profits / losses

Access to a professional hedge fund type investing strategy

Potentially higher fees to pay for the active management

 

LiveWire

1 hour ago

5G will be MUCH faster than 4G

1 hour ago

Emerson and PureCycle sign a digital tech deal

2 hours ago

Nasdaq gaining back its strength relative to the S&P 500

bg_nwsletter