In a volatile—or sideways—market environment like this one, financial advisors and their clients are always trying to minimize downside risk to portfolios and to provide a more predictable return.

Wealthy investors and institutions have had hedge funds for such purposes, but typically huge minimums, lack of transparency and complex investment strategies make them of little use to the average investor. Now, however, some financial advisors and even some banks are suggesting that clients with more modest assets consider investing in the poor man's hedge: managed futures.

Not exactly a new product, managed futures have been around in one form or another for three decades. But in recent years, this intriguing asset class has been a hot seller. According to BarclayHedge, a total of $238 billion was invested in managed futures globally at the end of the second quarter of 2008, an increase of 6.6% over the prior quarter, and of 28% over a year earlier. Investor interest has grown dramatically in the past 10 years, when managed futures funds boasted only $36 billion in assets under management.

Managed futures funds are invested by money managers called e_SDHpcommodities trading advisors (CTAs), who take both long and short futures positions on such assets as commodities, currencies, equities and bonds. The goal is not to beat the markets, but rather to have a noncorrelating component in a broad investment portfolio. "In my view managed futures are an asset class in themselves," says Bob Franklin, senior vice president and director of alternative investments at Wells Fargo Bank. "Unlike hedge funds, which can show some correlation to markets, they have virtually no correlation to markets."

Up the Down Market

Franklin notes that this year, as the markets have struggled, managed futures have been up 5% to 15%. "Managed futures have their best returns when the markets are down," he says, noting that during 2000 and 2001, when the equities market was down 40%, managed futures were up an average of 20%.

Emphasizing that managed futures are not inversely correlated to the stock market, but are truly not correlated at all, he points out that during the last four years, when markets were rising, managed futures followed the same upward path. Similarly, between 1993 and 2002, while stocks showed an average annual return of 9%, managed futures averaged 7%. "This is exactly what you want from an alternative asset class," argues Franklin. "Not outsized returns, but a way to protect investments."

An investment that goes up when the market goes down and when the market goes up? That might sound too good to be true, and it may be. For one, managed futures are somewhat more volatile than the S&P 500. Franklin says any single managed futures fund could have a standard deviation of returns as high as 18%, and even a fund of funds can be in the 8% to 11% percent range. However, compared with the S&P Index, whose standard deviation of returns has historically been 15%, that's not so bad.

Managed futures funds have lower investment requirements than a typical hedge fund, with minimums ranging from $5,000 to $50,000. That may still be high for some average investors. Since Franklin and other advisors suggest that such funds should ideally be no more than 3% to 5% of a client's portfolio, we're talking about a minimum portfolio of almost $200,000. At Wells Fargo, Franklin says, the typical investor in managed futures would have a portfolio worth at least $1 million.

Another consideration is cost. Managed futures tend to charge fees like hedge funds, averaging 4% to 6%, plus an incentive fee that can be 20% or higher. (With a fund of funds, the embedded fees, because of layering, would make the total fees higher, but there would be no incentive fee.)

Patrick O'Connor, a product manager at Raymond James, says that managed futures are being offered by banks through third-party platforms. "We do provide the product to banks," he says.

The main problem with managed futures, says O'Connor, is that they're not simple investments. "It is a sophisticated product that requires robust due diligence," he says. "It requires a good deal of training before people should be offering it to clients, and it requires a good deal of investor education regarding liquidity issues, fees, taxes and other risks. Investors have to understand it all."

A Long-Term Play

Both Franklin and O'Connor agree that it would be a mistake to view managed futures as a short-term investment vehicle for a low-return environment. "Managed futures are a long-term strategy," says O'Connor. "The right approach is to buy an allocation and then leave it alone. you can check on it, but the investor should not be trading managed futures based on how particular asset classes are doing. That defeats the purpose of the investment strategy."