Capital markets had a challenging year in 2022, facing an inflationary bear market. Traditional investment strategies, such as investing in the NASDAQ and high-yield debt, have generally performed poorly. US Treasuries, which are typically considered a safe haven during stock market volatility, have experienced their worst downturn in over 70 years.
Key Points:
- 2022 was a difficult year for capital markets due to an inflationary bear market.
- Treasuries, traditionally considered a safe haven, have underperformed.
- Managed futures may offer attractive performance and diversification.
- Trend-following is the primary driver of returns for managed futures.
- Managed futures have low correlations with traditional asset classes.
- Managed futures tend to outperform in down markets.
During such times, it is important for portfolio managers and allocators to consider alternative strategies and asset classes that can provide diversification and consistent returns. If Treasuries are no longer effective hedges against risk assets, portfolio construction may require a different approach. Managed futures could potentially be a valuable asset class, especially during periods of high volatility.
The Trend Is Your Friend
John Lintner, one of the creators of the capital asset pricing model (CAPM), wrote about the potential role of managed futures in portfolios of stocks and bonds. According to Lintner, portfolios that include managed futures can offer significant improvements in risk-adjusted returns and have low correlations with traditional assets. This suggests that managed futures could enhance diversification and potentially improve the risk/return profiles of stock and bond portfolios.
The Economic Rationale
The primary driver of returns for managed futures is trend-following or momentum investing. These strategies involve buying assets that have recently risen in price and selling or shorting assets that have recently declined. Managed futures strategies typically focus on liquid futures contracts across various markets, including equity indices, interest rates, commodities, and currencies.
Momentum investing and trend-following have a strong academic foundation and have been shown to explain stock portfolio performance. These strategies can perform well across different market environments and tend to outperform during times of macroeconomic stress.
Set Up and Approach
To evaluate the performance of managed futures strategies, the Barclays BTOP50 Index (BTOP50) can be used as a benchmark. The BTOP50 aims to replicate the overall composition and trading style of the managed futures industry. Analyzing the performance of the BTOP50 over the long term can provide valuable insights into the potential benefits of managed futures.
Stylized Facts
Based on the data, managed futures have, on average, produced positive returns and exhibited lower volatility compared to global stocks. The BTOP50 has also shown unique characteristics in terms of skewness, indicating a positive skewness that is not observed in other asset classes. This suggests that managed futures have the potential to generate positive returns even during times of market volatility.
When Things Get Extreme
Managed futures have an asymmetric return profile. In bull markets, they may not keep pace with equities but can still generate solid returns. However, in bear markets, managed futures tend to outperform stocks and provide positive returns or mitigate downside risk. This makes them particularly valuable during times of market turmoil.
Concluding Remarks
In summary, managed futures have the potential to enhance portfolio diversification and improve risk-adjusted returns. The trend-following strategies employed by managed futures have a long history of positive returns and low correlations with traditional asset classes. During periods of market volatility and economic stress, managed futures have demonstrated their ability to generate positive returns or mitigate downside risk. Therefore, considering managed futures as part of a diversified portfolio may be a prudent decision for investors.
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©Getty Images / maybefalse
This article was originally published on pankajsihag.com.
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