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Many investors are looking at managed futures as an attractive complement for their portfolios following the strong performance of these strategies last year. These strategies have characteristics that you want in the alternative bucket of your portfolio - low correlation and positive crisis alpha. The trouble is that the return of managed futures is pretty inconsistent. As a result, many recent buyers of these strategies have been pretty disappointed.
A better approach for an alternatives allocation than a single-strategy investment in managed futures is to pair managed futures with a diversified alpha strategy to create a more consistent return stream. Both strategies are diversifying to each other, leading to a combination of these strategies delivering a more consistent return than either one individually.
The chart below shows the cumulative returns of managed futures, diversified alpha, and a combination of the two. Here we look at the gross reported returns and then add in a 100bps fee, reflecting that there are low-cost clones available to investors of these strategies. It’s clear from the chart that these two approaches are complementary to each other. While there are many considerations to weigh, it looks like a pairing of between 50/50 and 75/25 diversified alpha to managed futures leads to a more consistent return stream.
This approach also considerably reduces the drawdowns that investors in either managed futures or diversified alpha alone would see through time.
There are always a number of considerations to weigh when building a portfolio of assets. For instance, what is most important - Sharpe Ratio, return, drawdowns? All of these attributes are important to consider. Rather than being prescriptive, the table below gives a sense of the portfolio characteristics since January 2002 of different mixes of managed futures and diversified alpha. The highest sharpe ratio is weighted toward diversified alpha and the most limited drawdowns are closer to the 50/50 mix.
For many, building the best alternatives bucket may be a goal in and of itself, and the above gives a good example of how to do that most effectively. Others may be looking to build the best overall portfolio they can. The table below shows the same stats as above, but instead for a portfolio where 50% is allocated to an alternatives portfolio, with the remaining 50% being a traditional 60/40 equities and fixed income portfolio. Such a large allocation to alternatives may not make sense for many investors, but it helps paint the picture of the various trade-offs more clearly.
The table highlights that both diversified alpha and managed futures returns are very advantageous to add to traditional 60/40 investors, considerably improving pretty much all characteristics of their portfolios.
Taken together, it looks pretty clear that most folks considering an allocation to managed futures strategies should also consider adding a share of that allocation to diversified alpha to improve their overall portfolio performance. Across most metrics, a combined portfolio has meaningfully better characteristics than using managed futures alone. And for most investors, adding these pieces creates one of those unique opportunities to improve portfolio consistency while not sacrificing overall return.
