Investors generally do an excellent job of looking at their equity allocations at the portfolio level. A single stock that drops 30% in an otherwise steady(ish) overall plan rarely gets much focus. On the other hand, a futures program that dropped 30% would often net a lot of attention. Some of this might be attributable to allocation sizing, but it is often because of a general fear related to futures trading. For the discerning investor, however, the benefits of taking a step back and looking at the big picture can be massive.

The 2022 market is shaping up to be one for the record books, with horrendous volatility, skyrocketing bond prices, and inflation unseen in 40 years. Perhaps not surprisingly to some, trend followers continue to put up their best numbers since 2008. If you were looking to construct a portfolio from scratch, it would be difficult to find a better complement to an equity-heavy portfolio. This strategy type tends to have close to zero or negative correlation to the S&P, goes long and short, provides exposure to a wide swath of markets, including commodities, and historically thrives in down markets. This is logical as trends often persist in times of stress where there is a flight to safety, dropping equity prices, and a rush to treasuries (not this time). So why doesn’t everyone use them? 

My guess is that many investors fear the volatility that is possible with the strategy or simply feel that they do not understand the space. I would argue that the aggressive nature if used properly, can be more beneficial to your portfolio than you may think, and the latter is solved by working with industry professionals like IASG to learn enough to feel comfortable. We even have a section on our website with educational articles to assist in this process. 

Instead of watching an aggressive program by itself, what if investors could view it in the context of their overall portfolio? Much like the stock example, the returns would blend with the overall number, but given the characteristics of futures managers, trend followers, in particular, we get a much different result. In fact, just a small portion of the portfolio allocated to the highest volatility manager can often provide a large impact. 

Mulvaney is perhaps our database’s most aggressive trend manager, with an annualized volatility of almost 34%. Contrast that with Quantica Capital, another trend follower with the same measurement at 10.8%. We get some interesting results if we look at a simple portfolio that adds either of them to an S&P 500-only portfolio. Since 2005, adding just 10% to either futures trader improves the performance of a long-only S&P portfolio in almost every statistical category. This occurs because of their correlation that runs close to zero or slightly negative to the S&P and the characteristic that it often performs its best when the market performs its worst.

Quantica at any percentage helps the overall numbers, but a funny thing happens when you trade that manager more aggressively as well. A $400k investment traded at 4X leverage would require $100k. This would still be 10% of the total in a million-dollar portfolio, but returns, drawdown, and Sharpe all improve dramatically. By changing a more stable program into a “Mulvaney-like” program, we double the returns and cut the max drawdown by over 20%.  

S&P 500MulvaneyQuanticaCARORMAX DDSharpeSt Dev
9010 7.8943.300.5613.59
8020 9.4733.710.6813.21
100  6.1452.560.4115.15
90 106.4447.580.4513.83
80 206.7242.170.5012.61
90 10 at 4x14.0430.290.7718.08

Past performance is not necessarily indicative of future results. The risk of loss in trading commodity futures, options, and foreign exchange (“forex”) is substantial.

Like all portfolio construction, this comes with pros and cons. Improved performance with lower risk is the Nobel prize-winning idea of Modern Portfolio Theory developed by Harry Markowitz. This described that a basket of stocks that act independently of each other is superior to holding individual companies alone. ETFs and mutual funds developed from this idea as most investors now buy large quantities of different corporations in a single purchase rather than single stocks. Unfortunately, this new way of buying increases their correlation to each other, forcing us to look further for this coveted asset mix. Kathryn Kaminski authored a white paper about how this can apply to managed futures, especially as it pertains to “crisis alpha,” which seems timely now. You can read it here: In Search of Crisis Alpha: A Short Guide to Investing in Managed Futures.    

It is not always fun to watch, though, because, despite this movement’s benefits, they can also go down, especially with leverage. Often, they do their best in spurts like now after longer periods of malaise. The good news is that many programs exist on our site with similar characteristics of low correlation to equities with wide diversification. With guidance, the choice between an aggressive manager or not is one that needs to be taken with your own personality and risk tolerance in mind. But opportunities abound if you can step back and view your portfolio as a whole.

Note: While IASG offers separate accounts for many of the programs on our site, we recognize that the initial investment sizes are often disqualifying, particularly for trend managers. We created a broker-dealer to access some of these programs at more realistic levels for accredited investors. We can provide additional details directly for those interested. Please call or email us with questions.    

Photo by Acton Crawford on Unsplash