Of all the reasons we like managed futures, we probably harp on risk management most frequently. Futures trading comes with significant risk and isn’t for everyone, but exposure to futures markets can be an excellent way to help manage risk in a portfolio. We recently had an opportunity to talk with Elizabeth Flores, the Executive Director of the Asset Managers Group at CME Group, also known as “the world’s leading and most diverse derivatives marketplace.” So, what’s the CME’s perspective on the effects of higher volume and assets shifting into the futures market?

“The substantial influx of assets into the futures markets in recent years and the resulting tremendous increase in open interest has had important implications for CTAs.  It has resulted in increased depth and liquidity in many markets, allowing managers to add previously inaccessible markets to their domain of traded instruments, thereby broadening their opportunity set.  It also augmented the capacity of large diversified trend followers and niche managers alike as liquid products grew even more liquid.     In terms of risk measurement and management, model risk and liquidity risk are entangled. There are no valuation issues with exchange-traded instruments, and model risk is magnified when dealing with illiquid instruments.  In general, the less liquid the instruments traded, the more hidden risk, and the more dangerous model risk becomes. The historic 2008 financial meltdown is a vivid example of this.  The liquidity and transparency of futures greatly facilitates risk management since the notional exposure, margin usage, and prices of the instruments are all known.  A risk manager can therefore easily determine and monitor portfolio risk.”

To us, Flores’ analysis is spot-on. Futures trading isn’t about avoiding risk – it’s about knowing and managing risk, and the liquidity and transparency of the futures market make it an exceptional tool to do so.