I Ran The Numbers And They Work!

Cliff Asness from AQR wrote a quick post titled Cognitive Dissonance that listed out contradictory ideas that investors have. There were two that I think tie right in to conversations we regularly have here.

Part of his point in these is line item risk, the tendency to be overly focused on the holding that is lagging even if it is "supposed" to lag. A holding that is supposed to lag could be some sort of diversifier that is held for its low to negative correlation to equities. I've frequently said that if gold is your best performing holding, then chances are things in the world aren't going so well. It is similar with managed futures or client/personal holding BTAL. They tend to have a negative correlation to equities. We could say the same thing about merger arbitrage, convertible arbitrage and other absolute return vehicles. A 5% year for absolute return sounds pretty good to me but would be considered only up a little for equities. 

I've told the story about being very early to buy the Standpoint Multiasset Fund (BLNDX) many times. The fund is a combo of equities and managed futures. I had enough previous experience with managed futures to understand the concept would work. Part of how they positioned the concept before the fund launched was a chart similar to this one. 

The 2010's was a rough decade for managed futures in nominal terms. The S&P 500 was up 244% and managed futures went nowhere. Standpoint was empathetic to the emotion of a holding not doing much for an extended period but blending the two, equities and managed futures, together in one strategy delivered a very good result.

You can see that 60/40 equities/managed futures stayed close to 60/40 equities/bonds at a time when managed futures was doing poorly and then pulled ahead in recent years including going up 3.25% in 2022. Looking at AQMIX on your statement kind of going nowhere for 10 years could be difficult but clearly a portfolio with the allocation in Portfolio 3 would have kept up just fine and if they had focused on the bottom line number and not the line items, it would not have been difficult. 

This brings us to a short paper from Man Institute that makes an argument for using leverage to incorporate managed futures kind of along the lines of the ETFs from ReturnStacked. By Man's work, the optimal mix would be 90% in 60/40 and put the remain 10% into managed futures but leverage the 10% 4X so essentially 90% 60/40 and 40% managed futures. We can model this on Portfoliovisualizer. 

The differences aren't that big here though. 90/40 had a higher CAGR than traditional 60/40 but lower than 60% equities/40% managed futures in Portfolio 3. 90/40 had the lowest standard deviation by a decent amount too. The advantage that both managed futures portfolios had over traditional 60/40 is how well they did in 2022. 90/40 was down 1.56% and Portfolio 3 was up 3.25%. Someone retiring on Dec 31, 2021 being all in on traditional 60/40 had a real problem from an adverse sequence of returns. Someone retiring on Dec 31, 2021 with one of the managed futures-heavy portfolios had no such problem. This reiterates a point we've been making for ages, alts currently to a better job than bonds at protecting against equity volatility. 

I said you could model 90/40 in Portfoliovisualizer. With the Wisdomtree US Efficient Core ETF (NTSX) you could actually implement 90/40. As a reminder, a 67% weighting to NTSX equals a 100% weight into VBAIX. To replicate 90% in VBAIX you could allocate 60.3% into NTSX and the remainder into managed futures. It only back tests to 2018 but here's what you get.

The result is similar to the above backtests. The managed futures blend stays reasonably close and then avoid the decline in 2022.

This is all compelling stuff but there is risk to going 40% into any alternative strategy. Managed futures might do what it is "supposed to do" in 59 out of 60 years of your investing lifetime but if the one time it doesn't is a year like 2008 or 2022 and it drops 25%, then you have a big problem. There might never be a consequence for the risk of 40% into one alternative strategy but that doesn't mean you didn't take the risk. 

The real world takeaway for me is to diversify your diversifiers because they can work better than bonds. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.