In a market where stocks and bonds are both trending downward, where can investors look for diversification? Alternatives. Alternatives have traditionally been an asset class reserved for high net worth individuals and those with access to hedge funds and PE funds. The game's changing, and we're in the early innings of alternative investments becoming more accessible to investors. This post focuses on liquid alternative strategies since they're structured in the form of mutual funds or ETFs which don't have lock ups, or restrictions, and can be traded daily.
The most common liquid alternative is managed futures funds. Traditionally only provided by hedge funds, managed futures strategies aim to buy futures contracts to take long and short bets on commodities, currencies, indexes, and bonds (inflation and interest rate bets).
Managed futures strategies diversify portfolios through the use additional asset classes and have 0 to negative correlation to stocks and bonds. The index used to track managed futures performance is the Barclays SG CTA index which takes 30 of the largest futures managers and equally weights them, rebalancing yearly.
Making the diversifier case. Trend following is the managed futures strategy where futures contracts bet based on recent trends that an asset will move up or down in price on a number of assets. This active and tactical approach has fared well against the traditional 60% stock and 40% bond portfolio for a century (see chart below). The other managed futures strategy is called market neutral which takes a 100% long and a 100% short position on assets called a straddle. Finally given their correlation of 0 (uncorrelated) to stock and bond markets they exhibit the higher potential to provide positive returns in any bull or bear market.
The past decade of strong stock performance is still fresh on investors minds. It was marked with low inflation, steady growth, low interest rates, government and central actions helping preventing high volatility, and central banks globally easing monetary policy. These factors blessed stock returns and delivered a lost decade for managed futures.
Flip to the decade before, the Lost Decade, and managed futures outperformed stocks by about 100%. Why was this decade so generous to managed futures? For one, the 2000s presented a lot more volatility than the 2010s. When the underlying of these strategies is active long and short bets on the fluctuation of asset prices volatility helps drive higher returns for the trend followers. Volatility also helps the market neutral style of managed futures investing because its set up as a straddle which allows it to harness the volatility of the asset in a shorter time period increasing the chances to exit both the long and short positions at a net profit.
Where are we today? In a significantly different market environment than the past decade. We have the Fed that's increasing rates to fight higher inflation, swinging commodity prices in the past few months driven by global supply/demand imbalances and war in Europe, a US facing monetary tightening, Europe with an energy crisis, China with a real estate crisis, and emerging markets economies with a variety of agricultural, government, and monetary issues. We haven't seen a perfect global storm in quite some time, and all the volatility that's resulted has helped managed futures while spooking stock investors.
To summarize, managed futures strategies have delivered attractive returns, diversification, and balanced portfolios at the start of the current bear for stocks and bonds beginning in 2022. With high inflation still looming, rates rising, market volatility still present from economic, monetary, and political forces, and a potential recession on the minds of many investors, managed futures strategies have a place in diversified portfolios.
I added the chart below of the S&P 500 Total Return vs the SG CTA since 2000 figuring if you've read till here you may be wondering how they compare against each other in the long run.
Managed Futures Risk Disclaimer: Managed futures employ leverage; they are speculative investments that are subject to a significant amount of market risk, have substantial charges, and are suitable only for the investment of the risk capital portion of an investor’s portfolio. Managed Futures are not appropriate for all investors. Although adding managed futures to a portfolio may provide diversification, managed futures are not a perfect hedging mechanism; there is no guarantee that managed futures will appreciate during periods of inflation or stock and bond market declines. There is no guarantee that managed futures products will outperform any other asset class during any particular time. Diversification does not ensure a profit or protect against a loss. In addition, in periods of extreme economic or geopolitical instability, market and/or regulatory forces may make it difficult to enter or exit positions, which may cause a modification in trading decisions.
Disclaimer: The commentary on this website reflects personal opinions, viewpoints, and analyses of ClearPeak Capital Management LLC employees. Blog posts written by employees should not be regarded as a description of advisory services, solicitation to sell advisory services, or performance returns of ClearPeak Capital Management's clients. Opinions and views depicted in the blog material are subject to change at any time without notice, and are never to be considered investment advice, performance data, or any recommendation that any particular security/portfolio of securities/investment strategy is suitable for any specific person. Indexes are unmanaged, cannot be directly invested in, and all charts were prepared by ClearPeak Capital Management and are for illustrative purposes only. Any mention of a particular security and its related performance data does not constitute a buy or sell recommendation for that security. ClearPeak Capital Management manages its clients' accounts using various investment techniques and strategies which are not discussed in the commentary. Investments in securities involve the risk of loss and past performance is no guarantee of future results.