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Futures: what are they, and why invest?

You may have noticed that part of arty’s portfolios is allocated into one of our own actively managed investment funds, ART 3x. ART stands for Adjusted Risk Technology. This is a systematic investment fund that trades in the futures markets using an algorithmic, trend-following approach. Today we will answer the question: what is a future, and why do we invest in them?

A Future is a contract to enter into a specific transaction in the future. Initially, these were contracts to buy or sell agricultural products, such as grain. Let’s say you are a farmer, and at the beginning of the summer, you decide to sell your future grain to a miller once it’s harvested in the autumn. You agree with the miller to sell a certain amount of grain at a pre-agreed price in October – for example, $ 100 per ton. October comes around, and you sell your grain and get $ 100 per ton. It’s worth noting that in October, the current market price, or spot price, for grain may be only $ 90, in which case you made a good deal, and by fixing your price early, you earned an extra $ 10. However, if the current price is $ 110, you did worse by fixing early and lost out on $ 10. The important thing is that you knew in advance how much money you would receive for your grain, and therefore you could plan your costs and future profits in advance, regardless of the market. This process is called risk hedging.

Over time these forward contracts became standardized; they became transferrable (meaning the contract itself could be bought or sold). They were listed on exchanges where markets for the contracts developed. Eventually, anyone could trade a futures contract for grain without being a farmer or a miller or ever actually owning the physical grain itself.

Side note: many financial players trade in futures markets and ‘forget’ that if you hold the contract all the way to maturity, you actually have to buy and take delivery of the physical commodity. Many financial traders have been surprised to learn that they have bought warehouses full of wheat, corn, potatoes, pork bellies, or even frozen orange juice! 

Futures contracts developed further, from just agricultural commodities to financial instruments such as stocks, bonds and currencies, indices, cryptocurrencies, and even the weather. Exchanges appeared worldwide, allowing local instruments to be bought or sold in advance using futures contracts.

Wherever the exchange or whatever the underlying instrument or commodity is, futures contracts are all alike, and futures prices follow similar patterns. The strategy employed by the ART fund is to recognize and then anticipate these patterns. This is why algorithms and artificial intelligence are suitable for this type of investing. A huge amount of market data must be monitored (more than could be reviewed by any human analyst). Every contract is standardized and traded on an electronic basis platform. arty has to remember to trade out of the contract before it goes into delivery, and we accidentally receive 1 million kgs of unroasted coffee beans!  

One last thing to remember, diversification reduces risk. If you have one instrument that goes down, your portfolio’s entire value goes down with it. If you have two uncorrelated instruments, as one goes down, the other is likely to go up and therefore, your portfolio is protected. ART is uncorrelated with any other instrument in the arty portfolio, which is why we include it to reduce the overall risk. Even within ART itself, we trade many different futures markets, all uncorrelated with each other, to reduce risk and focus on delivering steady, stable returns.

To access a diversified portfolio containing a modern, AI-driven, risk-reducing, actively managed futures fund, click below!

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