In 2015, markets experienced much uncertainty and change. An increase in volatility as measured by the CBOE Volatility Index (VIX), interest rates that were pushed higher by the Federal Reserve after a long anticipatory period, and a number of geopolitical and macroeconomic factors weighed heavily on markets. Investors have yet to see any relief in 2016, as markets continue to be roiled by volatility.
In times such as these, investors should consider anchoring portfolios with investments that serve as true diversifiers, such as managed futures. Such strategies seek to dampen overall portfolio risk, and generate positive returns regardless of market direction. Here are three reasons why Managed Futures makes sense today.
Managed futures funds have proven to be uncorrelated to stocks and bonds, as well as other alternative asset classes, over time, thus offering true diversification to a portfolio. In fact, of all the alternative mutual fund categories, the managed futures category has provided the greatest correlation benefit over the last five years (a period chosen to correspond with the growth in alternative mutual funds). Low correlations with other assets means that when included in a diversified portfolio, managed futures funds should reduce overall volatility. Reducing volatility is important because of its positive effect on compounding and the fact that investors are more likely to stay the course when they don’t have to suffer large swings in performance.
Rolling 1-Year Correlations with Credit Suisse Managed Futures Index
Due to the ability of trend following managed futures strategies to short asset classes experiencing downward trends, and the ability of counter trend strategies to generate positive returns regardless of market direction, managed futures strategies have the potential to protect capital during volatile or downward-trending markets.
In fact, data shows that during five of the most painful market routs—the 1998 Russian debt crisis, the 2000 technology bubble, the terrorist attacks of September 11, 2001, the financial crisis of 2007-2008 and Brexit of June 2016—managed futures strategies not only provided downside risk management, but generated meaningfully positive returns.
As alluded to previously, many managed futures funds follow market trends. That means that managers purchase assets that are trending higher while shorting securities that are trending lower.
In our case, we purposefully and tactically buck market trends by utilizing a proprietary model that is distinctly counter-trend. We see opportunities when noise, fear and greed are present in the market and seek to profit from these emotions by capturing the appropriate inflection points.
If you already understand the benefits of allocating portfolio assets to a traditional managed futures strategy that moves in tandem with market trends, then you’ll grasp the benefits of a counter-trend managed futures strategy. Counter-trend seeks to sell short-term over-bought levels while concurrently buying short-term over-sold levels. This allows counter-trend strategies to thrive amid volatile markets regardless of their direction and react quickly to market inflection points. Importantly, counter-trend strategies are not the opposite of trend following. Rather, they are indifferent to longer term trends. While there is no one fixed recipe for allocating to managed futures strategies, using both trend following and counter trend as a pairing strategy has been additive to portfolio performance historically.