By DANIEL P. COLLINS
Many family offices and portfolio managers think their holdings are diversified because they follow the classic 60-40 blend of stocks and bonds, with real estate sometimes added to the mix. While that provides greater variety than just a group of stocks from different buckets, it’s not truly diversified because those elements are often tied to the overall performance of the economy.
“They seem to load up on 20 different versions of equity: private equity, value and growth, large cap and small cap,” says Salem Abraham, a commodity trading adviser and president of Texas-based Abraham Trading. “If you told me, ‘Salem, bring a fruit salad over, we are going to do potluck’; and I brought a salad with 20 types of apple in it; you would say: ‘This is an apple salad, not a fruit salad. You ought to try a grape or banana.’”
Michael Dever, CEO of CTA Brandywine Asset Management of Philadelphia and a consultant to family offices, agrees. “There are a lot of [family offices] that still have tens of millions, hundreds of millions of unprotected, naked equity exposure.”
Both advisers recommend a greater allocation to managed futures, an investing strategy that includes a diversified portfolio of futures contracts.
The most prominent is systematic, diversified, long-term strategy trend following — which trades up to six asset classes, including agricultural commodities, livestock, energy, metals, softs, foreign exchange and stock indexes.
Managed futures trade all of these asset classes from either a long or short basis. This is key, because in times of stress, all asset classes can become correlated.
And the strategy does seem to be attracting more interest.
“All we do is managed futures — roughly 60 commodities contracts, and we trade all of them,” says Will Dickson, whose family in Detroit has a long track record in commodities investments. Dickson says he is hearing from more family offices interested in the strategy because of a combination of factors: the volatility in commodities, the geopolitical environment and the sovereign-debt crisis.
“Everything is creating more volatility in the markets, and that’s creating more opportunity for managed futures.”
The key benefit of managed futures is that the approach is not correlated to traditional asset classes. In his book Jackass Investing: Don’t do it, Profit From it, Dever looks beyond how many traditional investors define diversification and instead examines the underlying return drivers of every investment. What he finds is that many traditional and even some alternative strategies are highly correlated to the broad performance of the economy.
“A lot of folks look at their private portfolio as alternative, but the underlying driver of that return is still the same,” says Ryan Hart, chief investment officer for Rhino Alternative Advisors LLC and a longtime managed-futures professional. “It is going to be subject to the same whims of market movement, the macroeconomic factors that plague the traditional liquid markets.”
Far from being a recent investment strategy, managed futures have a track record supported by decades of research. Academics have long known about the value of adding managed futures to a portfolio to reduce risk and enhance risk-adjusted returns.
The managed-futures strategy is not correlated to hedge-fund alternatives or traditional stock and bond investments (see table below), according to a 2018 white paper by Coquest Advisors titled Managed Futures Strategies in a Portfolio.
Institutional investors have often resisted futures strategies, with many portfolio managers instead choosing to diversify with equity-based hedge funds rather than managed futures. That approach proved to be a disaster for investors during the 2008 credit crisis, when managed futures outperformed all traditional asset classes as well as all hedge-fund strategies, with the possible exception of short-sellers.
The paper dug deeper to show how managed futures performed during periods of stress for equities. During the six worst drawdowns for equities between 1980 and 2011, managed futures produced strong results (see blue bar in table below), leading some to believe that managed futures provides “crisis alpha” — referring to opportunities to gain profits by exploiting trends during difficult periods for stocks.
As Dever would put it, the volatility or market dislocations that harmed stocks were a strong return driver for managed futures.
Overall, the key benefit of adding managed futures to a traditional portfolio is the improved risk-adjusted returns, some experts say. The table below shows the impact on various risk metrics when you combine the performance of the Barclay CTA Index (managed futures) with the S&P 500 total-return index.
The paper also said that in addition to diversification and noncorrelation, managed futures provide greater transparency, liquidity and capital efficiencies than most traditional investments.
More recently, Mark Shore, chief research officer at Shore Capital Research LLC, followed up on this research in a paper for the Texas Association of Public Employee Retirement Systems, titled Portfolio Diversification in the COVID-19 Era. Shore points out that in March 2020, the period that saw a sharp decline in equities because of COVID-related closures, managed futures were one of the few investment strategies to earn positive returns (see table below).
Hart points out that managed futures are also not correlated to many more exotic investments—such as private equity, private real estate “[and] all those private investments that a lot of these family offices are invested with.”
While managed futures is an absolute-return strategy, like all other investment strategies, there are better and worse environments for it. What appears to be a relatively poor environment is an extended period of extremely low interest rates. During the zero-interest-rate period after the 2008 credit crisis, managed futures underperformed.
Well after years of false warnings and speculation that the long-term easy-money policy of the Fed would lead to massive inflation, it has finally arrived—and arrived with a vengeance. Subsequently, interest rates are rising.
“That bus is gone,” says Max Eagye, CEO of the research and advisory firm Rhino Alternative Advisors LLC. “There is more volatility in the marketplace and [geopolitical] gyrations with the supply chain as well as inflation,” he says, noting that trend following and strategies such as global macro — based primarily on geopolitical and macroeconomic factors — will do better.
Another important attribute of managed futures is liquidity.
“You want to have capital available to allocate to distressed equity, to distressed credit, distressed real estate — those things occur after something has blown up,” says Hart. “Either you have been sitting on a ton of cash waiting for that to happen, or you need strategies in your portfolio that you can source for that capital.”
The ability to notionally fund managed-futures accounts — that is, invest only a portion of the minimum investment required by a commodity trading adviser — allows investors to gain that diversification without taking capital away from those other opportunities, explains Hart. This is especially valuable now as the broad market is entering a correction.
Investors “will want capital to work with [when] this bottoms out and some sexy real estate or credit deal comes across your desk,” Hart says. “If you are allocated to managed futures, when things turn, you have this source of liquidity.
These days, the only asset class going up is commodities, which you can access through managed futures, Hart says. “Every other long instrument is losing value. If being long commodities make sense now, does it make sense over the long run?
“Trend followers generally do well in periods of rising and elevated volatility, and you have that now. And relative to traditional asset classes, they can still make money from being short equities or short fixed income in these markets. They don’t just have to be long commodities. They can make money from both sides of the markets, and the volatility is attractive to them.”
Daniel P. Collins is a financial media professional with more than 20 years’ experience as a writer and editor. He has expertise covering exchanges, financial markets, regulation and alternative investments. \