"Diversification Without Risk Management"

On Monday afternoon I sat in on a webinar put on by RCM Alternatives with Jon Robinson from Blueprint Investment Partners and Jerry Parker who is a pioneer in trend following with managed futures. The two partner on the Blueprint Chesapeake Multi-Asset Trend ETF (TFPN). Parker also partners with Cambria on the Cambria Chesapeake Pure Trend ETF (MFUT).

The most interesting part of the webinar came at the end with a couple of comments from Robinson. Blueprint worked with Parker from when Parker ran strategies as a hedge fund and has been a believer in the importance of trend and managed futures for a while. When they talked about portfolio allocations he said they want to have enough in managed futures to have an impact on the portfolio. He pegged that number at 25% or 33% but conceded even 5-10% could help. 

One interesting thing about TFPN is that it has a low correlation to other managed futures funds as well as a low correlation to equities. I asked why that was and they believe it's because of how they size positions and also because they use longer/slower signals than most other managed futures programs. TFPN is only 15 months old, if it turns out to be yet another uncorrelated return stream (uncorrelated to not just equities but also other diversifiers) cool but I don't think 15 months is a enough time to draw a conclusion on that. 

We've done this before, but let's see what 25% to managed futures looks like but instead of picking one fund and dumping 25% in, I will split it up with 5% weightings to five different funds. The differences in things like risk weighting, position sizing, length or combination of signals can cause some fairly big dispersion between funds. As we saw the other day, that dispersion between funds didn't prevent them from collectively going up a lot in 2022. 

Portfolio 1 as follows

Portfolio 2 is 50% VOO and 50% iShares 7-10 Year Treasury ETF (IEF). Over the weekend I stumbled into the S&P Balanced Equity & Bond Index-Moderate which is seems like a useful benchmark for blogging purposes and is 50/50 S&P 500 and 7-10 year treasuries. Portfolio 3 is Vanguard Balanced Index Fund (VBAIX) which of course is a proxy for a 60/40 portfolio.

The correlation between the various managed futures funds is interesting. You wouldn't say they are lowly correlated but the correlations aren't that tight so maybe there is some insulation  against things going wrong versus putting 25% into just one managed futures fund. 

We looked at a similar chart the other day. All five funds really struggled from 2015-2020 but there was variation among the five. This five year run is included in the backtest and obviously they weighed on returns, you can see the lag, but the longer term result was competitive.  

Portfolio 1 lagged in most years but stayed close and then moved ahead when managed futures did well in 2021 and 2022. Staying at least sort of close is important. If you think the long term CAGR is compelling, good but the more interesting thing to me is how much lower the standard deviation is as well as the kurtosis which is captured on the metrics tab of Portfoliovisualizer. Portfolio 1 is 0.06, VOO/IEF is 0.61 and and VBAIX is 0.69. Kurtosis captures susceptibility to adverse outlier events and lower is better with this number. Also the Calmar Ratio is dramatically better, 2.0 versus 0.24 and 0.27 and for this one, higher is better. Calmar captures risk of significant losses. 

The other day when I posted a chart similar to the one above where managed futures went down for five years, I said it was generally doing what it was supposed to, maintaining its negative correlation to equities and I asked "would you want 25% in managed futures" during that period. Maybe, that wouldn't have been so bad. 

The tendency toward negative correlation has certainly held up more often than not in my time with managed futures going back to 2007 when RYMFX first started trading as Rydex Managed Futures. This gets us to the title of the post and Robinson's comments around how much to allocate to managed futures. As you dig in and learn more about the systematic nature of managed futures and the other elements of the strategy, you see how important risk management is to the strategy. Yes but I think in terms of the portfolio, I believe managed futures helps to manage the risk of the portfolio. Robinson made a comment almost in passing about the typical stocks and bonds mix being diversification without risk management. If you are well diversified you always have things going up and things going down. If they all go up together, they can all go down together.

You might agree or disagree with that but his point really resonated. 

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