The Most Important Blog Post Of The Year?

We spend a lot of time and have a lot of fun here modeling out different types of asset allocation strategies. One of the alternative strategies we talk about often is managed futures. For the purposes of modeling and blogging we use large allocations to the various alts but I try to be very consistent in saying that in real life, I wouldn't put anywhere near 20-25% in any single alternative strategy. We had a small example of why that is important in the equity selloff toward the end of this past week.

The above is all of the single strategy managed futures funds I follow. Like equities, they had a bad day on Friday. They also had a bad day on Thursday, like equities. Managed futures have a pretty reliable negative correlation to equities. Reliable does not mean infallible. The managed futures group was caught wrong footed with bond exposure. Managed futures tracks ten month trends for the most part and so there will be certain market moves that happen faster than a ten month trend following strategy. I use ASFYX for clients (I own some too) because it has a small overlay that uses shorter signals which has helped at times but not this week. 

This next chart compares Vanguard S&P 500 ETF (VOO) with ReturnStacked US Stocks & Managed Futures (RSST) and client/personal holding Standpoint Multi-Asset (BLNDX/REMIX).

It's not easy to read because RSST's volume is spotty and BLNDX only generates one data point per day. Both funds combine equities and managed futures although RSST uses more leverage. 

There is nothing concerning to me about managed futures performance this week. In its renaissance of the last few years there have been plenty of stretches where it is appeared to not do well. I don't use RSST but that it was down so much holders of that one shouldn't be concerned about that drop either. It provides a total of 200% exposure to two different things that were both down on the week. The potential issue would be with sizing the exposure not the performance of the exposure. 

Here is a sampling of alternative funds, other than managed futures, that we talk about regularly on the blog.

Most of them are "working" through this little event but not all of them. This scoreboard of sorts would probably look different for a different type of stock market event. No matter how great anyone might think a strategy is, how great it's diversification benefit might be, nothing can always be best or be infallible. We make that point constantly, there is simply no way to know which ones will work in the next event, even if you think they will all work 90% of the time there will be times that they don't.

We should also point out there is a potential diversification benefit from going narrower than just the S&P 500 for equity exposure. For me, this means sector ETFs, industry/niche ETFs and individual stocks. 

Utilities, staples and REITs had a good week broadly. Bond yields going down should mean those three sectors go up and they did. The reason is that those yieldy sectors look more attractive if bond yields go down. Some of the bigger defense industry stocks did well but the ETF for the group was down slightly. I had a few random names do well despite the broad market decline, that just happens sometimes even if there's no real reason. I threw CBOE Holdings (CBOE) in there, it's a client holding. CBOE has something of a tendency to act as crisis alpha as sort of a derivative of the VIX Index. VIX products trade on the CBOE, volume on VIX products goes up in a decline or is perceived as going up and the common does well.

Obviously most holdings went down for the week, the point is about staying diversified. All of the sectors that did well with rates going down, did poorly as rates went up. I talked yesterday about what might go down if rates go down to 3%, utilities, staples and REITs probably go up if rates drop to 3%. If rates go back to 5% or higher then those sectors will probably go down. This not about trying to predict interest rates, it is about trying to understand the impact on the portfolio from whatever comes next in the yield market. Big difference. 

Repeating from many previous posts, the various diversifiers that are available for investors to use can improve risk adjusted results dramatically but to put in terms that we've been using for the last couple of weeks, make sure you have uncorrelated return streams to build an "ensemble" of diversifiers. As we've looked at, most of the diversifiers are working this time but not all of them. 

I see a lot of what I think is bad advice to put 20% into managed futures. This was the same thought process 18 or 19  years ago when pundits talked about 20% allocations to things like REITs, MLPs and gold. I bagged on that pretty hard on the first iteration of my blog and I am bagging just as hard on that much allocated managed futures now. Managed futures are a magic bullet of diversification, I'm being serious, but not at 20% of a normal portfolio. For investors who even believe in alts, not everyone does by any means, I would think more in terms of 15-25% split among several, uncorrelated diversifiers to safeguard against the instances where individual alts don't work.

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.