3 Reasons to Invest in Managed Futures While Stocks are at All-Time Highs
October 24, 2017
In the US, we’ve been on a strong bull run since March 2009 with few blips along the way. On a global scale, the MSCI All Country World Index (ACWI) is also showing new highs.
However, since Foremost Capital focuses on Managed Futures, this begs a question.
Here are three things to consider when deciding if and how to incorporate Managed Futures into your portfolio in this booming bull market.
Whether caused by business cycles, changes in fiscal or monetary policy, or an unforeseen catalyst, our economy will likely see a recession and a stock market correction in the future. In fact, the burden of proof would be on someone who says we won’t see a significant stock price decline at some point.
Additionally, it is common for stock prices to fall much faster than the rate at which they rise. One way to measure this is comparing the volatility of negative returns to positive returns. Since 1990, the S&P has experienced 214 positive months and 108 negative months. However, the variability of those negative months is greater than the variability of the positive months as measured by standard deviation.
If stock prices fall, it makes sense to diversify a portion of your portfolio away from stock investments to hedge some of that risk.
There are many reasons Managed Futures investments keep a low correlation to stocks. One reason is position flexibility. Commodity Trading Advisors can sell (short) just as easily as they buy (long). Unlike stock trading, there is no borrowing cost for selling short. Another reason is that futures strategies have a wide variety of markets in which they can participate. From agriculture to metals, and credit markets to stock indices (yes stock indices), CTAs literally have the world in front of them. The chart below shows the correlation between three different CTA indices and two stock indices. (Keep in mind, none of these CTA indices are investable.)
This idea has been termed “Crisis Alpha.” While any particular futures investment needs to be evaluated on its own terms, Managed Futures indices have shown more negative correlation to stocks during times of crisis. See chart below from the AIMA. The chart illustrates the rolling 12-month correlation between the SG Trend Index (an index which comprises managed futures trend following strategies) and the returns of global equities (the MSCI World Index) over the past 17 years (2000- 2016). The shaded areas demonstrate times (throughout the 17-year period) where global equity returns over the past 12 months were negative. While there are no guarantees of future performance, that negative correlation is what you want to see from your diversification.
For more info on correlation and how it works, check our blog.
Furthermore, Managed Futures as an asset class have also sometimes shown positive correlations to stocks during periods of stock market strength. This gives further credence to the idea that Managed Futures are flexible enough to generate returns in any kind of economic environment. For this reason, they make strong candidates as alternative investments to help reduce volatility from stock market corrections while keeping the prospect for positive returns during normal market periods. However, past performance is not necessarily indicative of future results. There is no guarantee any particular CTA investment will reduce your portfolio’s risk or perform as expected.
Contrast Managed Futures with simply paying for a put option to protect your stock exposure. Yes, it may be more effective as a direct hedge, but it’s also more likely to lose the premium (negative return) for every time period that stocks don’t fall.
Keep in mind that any specific Managed Futures investment may not behave like its index. For example, CTAs that sell options likely don’t have a correlation history to the S&P like the chart above.
“CTAs are not for everybody. There are always periods of underperformance, but collectively and on average, CTAs offer competitive risk-adjusted and non-correlated returns, and have historically demonstrated their ability to provide downside protection,” -Riding the Wave: AIMA/Societe Generale study on Managed Futures.
“Riding the Wave: AIMA/Societe Generale study on managed futures.” AIMA. Published 9/25/17.
Benson, Robert; Shapiro, Robert; Smith, Dane; Thomas, Ric “A Comparison of Tail Risk Protection Strategies in the U.S. Market” Alternative Investment Analyst Review, Q1 2013.
Kaminski, Kathryn “In Search of Crisis Alpha: A Short Guide to Investing in Managed Futures” August 2016, CME Group.