If you want to spread risk and balance your returns over time, then it makes sense to invest in a variety of asset classes. You can allocate a certain percentage of your investment portfolio to equities, bonds, currencies, derivatives, private markets, collectibles, and alternative (or non-traditional) investments.
As far as alternative investments go, managed futures add stability to your portfolio. Allocating assets to managed futures helps to balance your portfolio as the drawdown (potential short-term losses) has been shown to be around 5%, which is much lower than other investment types.
From year to year, the typical drawdown of equities and bonds is between 10 and 20%. However, during financial crises, the drawdown can be much higher. For example, the S&P 500 saw 57% drawdown in 2008 and the NASDAQ saw a 78% drawdown between 2000 and 2002.
In this article, we’re going to explore what asset allocation means, how it protects you from losses, and how much you should allocate to managed futures.
What Is Asset Allocation?
Asset allocation refers to building a portfolio that has a good mix of investments, including the following.
Stocks (Equities): Ownership in companies, including publicly traded equities (liquid, easy to buy and sell) and private market equities (not liquid, often requiring long-term commitments), offering growth potential with varying levels of risk, including large-cap, mid-cap, small-cap, international, and emerging market stocks.
Bonds (Fixed Income): Loans to governments, corporations, or municipalities, providing steady income with lower risk compared to stocks.
Real Estate: Physical properties or real estate investment trusts (REITs), offering income through rent, property appreciation, or dividends.
Commodities: Tangible assets like gold, oil, and agricultural products, acting as a hedge against inflation and market volatility.
Alternative Investments: Non-traditional assets like managed futures, private equity, hedge funds, and venture capital. They are used to diversify portfolios, provide balanced returns, and offer more liquidity.
Cash and Cash Equivalents: Highly liquid and low-risk options. These include savings accounts and money market funds.
Derivatives: Financial contracts like futures and options that allow investors to hedge risks or speculate on price movements of underlying assets.
Cryptocurrencies: Digital assets such as Bitcoin or Ethereum, offering high return potential but extreme volatility.
Infrastructure and Private Credit: Investments in large-scale infrastructure projects (roads, energy) or private loans to businesses, providing stable, long-term returns.
Sustainable/ESG Investments: Investments focused on companies that meet Environmental, Social, and Governance (ESG) criteria, aligning returns with values.
The aim of asset allocation is to spread out your investments so that no single market event can throw your entire portfolio off balance. You’re essentially creating a safety net. If one investment type takes a hit, another helps cushion the blow.
Managed futures play an important role in this mix. Unlike traditional investments, managed futures are uncorrelated. This means they aren’t tied to the same market trends and when stocks are falling or bonds are under-performing, managed futures often generate gains.
The managed futures investment manager uses advanced software and algorithms to predict future movements. They use data analysis, along with their own experience, to decide whether to take a long or short position on different assets. This means managed futures often perform well in bull, bear, or even sideways markets.
How Much Should You Allocate To Managed Futures?
The sweet spot for most investors is between 5% and 10%. It strikes the right balance between meaningful benefits when managed futures perform well, while still allowing for bigger gains from other investments over time.
The main benefit is that managed futures shield you from market volatility. For example, even a small 5% allocation could have reduced losses significantly during major crises like the Global Financial Crisis or the recent inflation-driven bear market.
Having said that, the right percentage depends on personal circumstances and appetite for risk. Investing is as much about behavior as it is about numbers.
However, managed futures have shown the potential to outperform most asset classes (except for crypto, which comes with the downside of being highly volatile). Some managed futures strategies achieve over 20% returns annually, after costs.
Making your managed futures allocation around the 10% mark is a practical choice for balancing risk and reward, as well as improving overall performance.
What Happens When You Add Managed Futures?
When you blend managed futures into a typical 60/40 portfolio (60% stocks, 40% bonds), the results are often impressive.
Each small increase in the managed futures allocation, let’s say 5%, reduces the overall risk (standard deviation) and improves risk-adjusted returns. This is measured using tools like the Sharpe Ratio and Sortino Ratio, which balance return against the level of risk you take.
The impact of managed futures on portfolio risk can be seen in reduced standard deviation, as shown in studies such as SG CTA results. SG CTA stands for Société Générale CTA, which is a systematic managed futures strategy.
In simpler terms, adding managed futures doesn’t just add potential returns – it smooths out the ups and downs. The drawdowns in tough years are smaller, meaning you lose less during bad markets.
2008 Global Financial Crisis: Managed futures reduced losses while stocks plummeted.
2022 Inflation-Driven Bear Market: A 5% allocation cut losses by over 2%, and a 10% allocation reduced drawdowns by close to a quarter.
How to Fund Your Managed Futures Allocation
The next question is – where do you pull funds from to put into managed futures?
A common approach is to take it pro-rata from your existing stocks and bonds. This ensures the core balance of your portfolio stays intact while adding the diversification benefits of managed futures.
For investors with a slightly higher risk tolerance, you could fund it more heavily from bonds. This makes sense because stocks tend to outperform bonds over the long term. Managed futures also tend to do even better during stock market downturns, so they can help balance things out when bonds don’t offer as much protection.
But don’t overdo it. Large allocations that deviate too much from the traditional portfolio mix can become “bets” that might not work out as planned. A balanced, gradual approach works best.
Key Takeaway
Adding managed futures is all about balance.
Allocating 5% to 10% improves your portfolio’s risk-return profile without overwhelming it. It also increases the overall performance of your investments with annual returns as high as 20%.
Managed futures act as a stabilizer, especially during turbulent markets, offering a hedge when stocks and bonds struggle.
As is the case with any investment strategy, consistency leads to success. Set a sensible asset allocation strategy and stick with it through the ups and downs, and you’re more likely to see long-term benefits.