With equities, fixed income and other traditional investment solutions showing significant limitations, what other asset class is well positioned to offer true portfolio diversification? Consider Managed futures. For one, many managed futures programs have produced solid returns in the face of declining equity markets. This key characteristic is often referred to as ‘crisis alpha’ and its importance is difficult to overstate: Managed futures performed well during the quarter of Black Monday 1987, the Persian Gulf War of 1990, the Long Term Capital Management episode and Russian Crisis of 1998, the recession of 2000 -2002 following the Tech Bubble, as well as the credit crunch of 2008. During all of these time periods equities suffered and managed futures thrived, offering investors a haven and buffer from declining equity prices.
Investors may believe that hedge funds are most optimally positioned to achieve the important function of portfolio diversification. However, as alluded to above, this is not necessarily the case. Many hedge funds are positively correlated with equity markets. The HFRI Weighted Index shows a strong correlation to the S&P 500 Total Return of 0.74. Also, some hedge funds trade in illiquid markets that lack transparency and readily available mark-to-market pricing. In addition, many hedge funds and private equity funds regularly ‘lock up’ investors for a year or more, rendering the hedge fund investment illiquid.
With the taper under way, and the long-term effects of Fed intervention on the equity and bond markets still largely unknown, it is time for genuine portfolio diversification with the non-correlation benefits of managed futures. Managed futures programs also equip investors with ‘crisis alpha’. And unlike many alternative investments, including hedge funds, it offers more favorable liquidity terms. Futures and options on futures, the underlying markets used by managed futures programs, are exchange-traded and marked to market daily, offering investors and managers both liquidity and a level of transparency.
Diversifying a traditional portfolio with a 10% to 20% allocation to managed futures (see chart below) has the potential to increase overall returns and decrease volatility. Should the current rally in equities extend through the spring, it is set to become the fourth longest rally recorded over the last 113 years. When is a better time to consider the important diversification benefits offered by managed futures?